Estimating the elasticity of substitution between capital and labour

Harrasova, Julija (2020) Estimating the elasticity of substitution between capital and labour. Fraser of Allander Economic Commentary, 44 (4). ISSN 2046-5378

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Abstract

This study estimates the elasticity of substitution between capital and labour as well as rates of factor-augmenting technical progress across both the aggregate economy and individual industries in the UK and Scotland. Both single equation and system estimation frameworks are used and the finding is that elasticity estimates are highly sensitive to the choice of method. Using system estimation techniques previously not applied to the UK, the finding is that aggregate elasticity is 0.94, which is significantly higher than previous results for the UK. Also, sectoral elasticities are characterised by high variability. Technological progress is also found to be overall net labour-augmenting which supports the neoclassical steady-state growth theorem. With augmentation directed at labour, and under complementarity between factors of production, the conclusion is that technical change is capital-biased, which is consistent with the declining labour share of income observed in UK data. Aggregate elasticity in Scotland is 1.3, however, this result should be interpreted with caution as it suffers from small sample bias and may reflect poorer quality of data.

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