Elasticity of substitution between public and private capital: Evidence from manufacturing firms in Europe

Abstract

Most macroeconomic models either assume that public and private capital are perfectly substitutable in the production process or they are combined under a Cobb–Douglas type production function. Using post-crisis data from European manufacturing firms, this letter finds the elasticity of substitution between public and private capital to be 3.45, suggesting these widely used assumptions are invalid. Besides, firms with higher dependence on external financing tend to have a higher elasticity of substitution.