High Elasticity Of Substitution Research Articles

Does Marginal Employment Substitute Regular Employment? - A Heterogeneous Dynamic Labor Demand Approach for Germany

In Germany we observe a decline in regular employment and an increase in atypical forms of employment. Especially marginal part-time employment which is characterized by lower tax rates and lower social security contributions increased substantially after a reform in 2003 made this type of employment even more attractive to employers. In our paper we estimate the substitutability of regular employment by marginal part-time employment using data on the industry level before and after the reform.We detect high substitution elasticities with respect to three skill categories of regular employment in both time periods. The substitutability of unskilled full-time workers increased significantly after the reform.

Distorted Gravity: The Intensive and Extensive Margins of International Trade

By considering a model with identical firms, Krugman (1980) predicts that a higher elasticity of substitution between goods magnifies the impact of trade barriers on trade flows. In this paper, I introduce firm heterogeneity in a simple model of international trade. I prove that the extensive margin and the intensive margin are affected by the elasticity of substitution in exact opposite directions. When the distribution of productivity across firms is Pareto, the predictions of the Krugman model with representative firms are overturned: the impact of trade barriers on trade flows is dampened by the elasticity of substitution, and not magnified. (JEL F12, F13)

Factor Substitution, Average Firm Size and Economic Growth

This paper extends the Lucas (1978, The Bell Journal of Economics 9(2), 508–523) analysis of firm size by taking into account a normalised aggregate CES production function. In a general equilibrium framework it is proved that there is an inverse relation between the elasticity of substitution and average firm size. If interpreted together with the fact that richer countries are characterised by a higher elasticity of substitution, this result can explain why the recent literature finds a positive association between the importance of SMEs in an economy and its stage of development, but seems to fail in finding causality between the two. Both have a common origin: a high value of the elasticity of substitution. This paper also provides a first empirical test of the theory proposed using cross-country data from both developed and developing countries.

Substitution Between Money and Near-Monies in Switzerland

This paper investigates the substitutability between money and near-money assets during the period 1976 to 1996 in Switzerland. Financial developments have made a variety of instruments available to store wealth and conduct economic transactions. These developments have generated a “near money” component in households’ and businesses’ portfolio balances. It is important to evaluate the effect of “near-money” on money demand and the effectiveness of monetary policy. Towards this goal, five monetary assets: currency and demand deposits at commercial banks, demand deposits with the postal system, deposits on transaction accounts with banks, savings deposits and time deposits are considered. We evaluate the degree of substitutability among these assets using the Morishima elasticity. Results show that various monetary assets substitute for one another. Consistent with a high degree of diversification, the Morishima elasticity is significantly larger when adjustment takes place in the price of a relatively broader monetary asset as compared with a narrower one. Targeting a broad monetary aggregate captures a variety of assets that contribute to liquidity and aggregate demand, enhancing the effectiveness of monetary policy. Nonetheless, high elasticity of substitution between monetary assets has made it increasingly difficult to target money demand via changes in the interest rate. As a result, in 1999 the Swiss National Bank abandoned monetary targeting in favor of an expected inflation target.

Vertical Specialization and the Border Effect Puzzle

A large body of empirical research finds that a pair of regions within a country tends to trade 10 to 20 times as much as an otherwise identical pair of regions across countries. In the context of the standard trade models, the large is problematic, because it is consistent only with high elasticities of substitution between goods and/or high unobserved national border barriers. The author proposes a resolution to this puzzle based on vertical specialization, which occurs when regions or countries specialize only in particular stages of a good's production sequence. The author develops a Ricardian model of intra-national and international trade, and shows how endogenous vertical specialization magnifies the effects of border barriers such as tariffs. He calibrates the model to match relative wages, trade shares, and vertical specialization for the U.S. and Canada. The model implies a much smaller border barrier and border effect than previous estimates.

On the Terms of Trade and Sectoral Reallocations

A commonly held view is that a small open economy adjusts to a negative external shock by switching both expenditure and resources toward the domestic traded goods sector. We show that, when both labor and imported inputs are used as factors of production, the average labor intensity in the nontraded sector may increase substantially with a decline in the terms of trade. This can lead to an internal transfer of labor into the nontraded sector, and an improvement in the trade balance even with a decline in traded sector output. This result depends on a combination of a high elasticity of substitution across nontraded varieties and large differences in labor intensities in the production of nontraded varieties. Our analysis suggests that intersectoral labor flows are not necessarily a good measure of an economy's flexibility, and that intersectoral resource reallocation and expenditure-switching can move in opposite directions.

Market linkages with fragmented production

I use a Ricardian model to analyze the transmission of technology shocks between countries when production processes are fragmented. The analysis emphasizes the role of three factors in determining how the gains from technical progress are shared between the innovating country and the rest of the world: the elasticity of substitution in consumption of final goods, the elasticity of substitution between intermediate and final production stages, and the pattern of production. In contrast to models with trade in final goods only, a high elasticity of substitution in consumption may be associated with losses for the innovating country when there is complete vertical specialization in production. I also examine the transmission of shocks in a three-country world where two countries are linked in a vertical production relationship.

Sustainability and Substitution of Exhaustible Natural Resources: How Resource Prices Affect Long-term R&D Investments

Traditional resource economics has been criticised for assuming too high elasticities of substitution, not observing material balance principles and relying too much on planner solutions to obtain long-term growth. By analysing a multi-sector R&D-based endogenous growth model with exhaustible natural resources, labour, knowledge, and physical capital as inputs, the present paper addresses this critique. We study transitional dynamics and the long-term growth path and identify conditions under which firms keep spending on research and development. We demonstrate that long-run growth can be sustained under free market conditions even when elasticities of substitution between capital and resources are low and the supply of physical capital is limited, which seems to be crucial for today's sustainability debate.

Pension Wealth and Household Saving: Evidence from Pension Reforms in the United Kingdom

Using three major U.K. pension reforms as natural experiments we investigate the relationship between pension saving and discretionary private savings. Unlike most differences-in-differences approaches which rely on average differences between control and treatment group, we use economic theory to model the response of each individual household. The empirical analysis, based on the Family Expenditure Survey, uses both time-series and cross-sectional variation to identify the behavioral response. The earnings-related tier of the pension scheme is found to have a negative impact on private savings with relatively high substitution elasticities; the impact of the flat-rate tier is not significantly different from zero.

On the Link between Dollarisation and Inflation: Evidence from Turkey

This paper investigates the role of dollarisation in the dynamics of inflation in Turkey. Descriptive analysis suggests that, in addition to high inflation and economic instability, institutional factors also played an important role in the evolution of dollarisation in Turkey. The empirical findings corroborate the importance of dollarisation in the dynamics of inflation. The results suggest that shocks to dollarisation initially lead to a decline in the monetary base as the public switches from domestic to foreign money holdings. However, the monetary base increases later on to generate the required inflation tax for a given budget deficit. The findings also indicate that the fiscal authority tries to compensate part of the decline in inflation tax through raising administered prices. As expected, the exchange rate responds positively to shocks to dollarisation owing to the high elasticity of substitution between domestic and foreign currency.

Productivity Dynamics with Technology Choice: An Application to Automobile Assembly

During the 1980’s, all Japanese automobile producers opened assembly plants in North America. Industry analysts and previous research claim that these transplants are more productive than incumbent plants and that they produce with a substantially different production process. I compare the production processes by estimating a model that allows for heterogeneity in technology and productivity, both of which are intrinsically unobservable. The model is estimated on a panel of assembly plants, controlling for capacity utilization and price effects. The results indicate that the more recent technology uses capital more intensively and it has a higher elasticity of substitution between labour and capital. Hicks-neutral productivity growth is estimated to be lower, while capital-biased (labour-saving) productivity growth is higher for the new technology. Using the estimation results, I decompose industry-wide productivity growth and find plant-level changes in lean plants to be the most important contributor. Plant-level productivity growth is further decomposed to reveal the importance of capital-biased productivity growth, increases in the capital‐labour ratio, and returns to scale. Measuring technological change, which is defined as the shift of a production function over time, becomes harder if plants can choose which production technology to adopt. In the automobile assembly industry there is evidence that plants choose to operate with mass or lean technology. I estimate technical change for the industry using a rich plant-level data set for the U.S. Firms choose which technology to employ, but their choice is not observable to me. The shape of both technologies and the rate and factor-bias of their shift over time is estimated jointly with the technology decision. I use the model to decompose aggregate productivity growth and find that firm-level change in lean production plants is the most important contributor to aggregate productivity growth for the industry, but it only appears after controlling for the technology choice. In contrast with previous results in the literature, relocation of resources between plants is only the second most important effect. Labour productivity growth at lean plants is driven by increased capital use and capital-biased technical change. In mass production plants, on the other hand, almost all labour productivity advance is the result of Hicks-neutral technological growth. Traditional productivity measures suggest that the automobile industry enjoyed a considerable productivity improvement since the 1980’s, the period when the first Japanese producers entered the industry in the U.S. The number of vehicles produced per worker, an often quoted statistic, is on average higher in Japanese transplants than in plants owned by American producers. Researchers have concluded that entry of more productive plants caused industrywide productivity to increase. Compositional changes at the intensive margin—relocation of shares between active plants—and the extensive margin—plant turnover—are thought to be the principal sources of aggregate productivity change. 167

Foreign Direct Investment and Enterprise Restructuring in Central Europe

Foreign direct investment is at the forefront of economic policy decisions in Central Europe, as it is expected to accelerate enterprise restructuring and aid in the successful transition to a market economy. This paper contains a panel data study of the effects of FDI in 11 different manufacturing sectors within three Central European economies: Hungary, Poland and the Czech Republic. We find evidence that FDI has increased labour productivity levels in most manufacturing sectors. We are able to differentiate between sectors with a high elasticity of substitution between labour and capital and those that are inelastic. We have also presented evidence to support the theory that the impact on labour productivity is predominantly due to the intangible assets introduced by foreign firms, rather than simply the fixed capital investment associated with FDI.

Economic Growth, Technical Change Biases, and the Elasticity of Substitution: A Test of the De La Grandville Hypothesis

A recent development in microeconomic theory suggests that the size of the elasticity of substitution between factors is relevant to economic growth. This study undertakes an empirical investigation of this proposition, comparing two economies--the United States and South Korea. The authors' test results support the de la Grandville hypothesis that the elasticity of substitution is a potent explanatory variable of economic growth. This inquiry also provides a clue to the puzzle that the U.S. elasticity of substitution between labor and capital is well below unity whereas that of South Korea is close to unity; nonetheless, the U.S. Factor shares have tended to remain fairly stable whereas the distributive shares of South Korea seem to have changed in favor of capital. Their findings indicate that a high elasticity of substitution is a bad signal for the distribution of income under the paradigm of modern technology. Copyright 1991 by MIT Press.

THE POVERTY TRAP AND THE LAFFER CURVE—WHAT CAN THE GHS TELL US? *

Budget constraints are drawn up for annual hours and net pay, typically composed of two linear segments: 'benefit-constrained', where extra work forfeits benefit and 'normal', where extra work is subject to the standard marginal tax rate. There are additional linear segments for those on upper tax rates. By ordering males according to the ratio of their maximum net earning power to that when totally unemployed, we establish the appropriate cut-off point for the poverty trap and upper rate segments, from which we estimate labor supply responses to slope and intercept variables. The results suggest high substitution elasticities for those who experienced unemployment during the previous year and those on higher incomes; for average employed men the elasticity was quite l.

CES Production Functions in Manufacturing and Problems of Industrialization in LDCs: Evidence from Korea

Information about the elasticity of substitution between capital and labor is very important in LDCs for several reasons. First, development policies in many LDCs pursue both rapid industrialization and widespread distribution of its benefits by expanding industrial employment opportunities. If the elasticity of substitution is high, it is relatively easy to expand employment opportunities without sacrificing output growth by manipulating relative factor prices properly (or, for that matter, by reducing the wage-rental ratio since the factor intensities of output depend on relative factor prices). Second, high elasticity of substitution makes possible a flexible response to external changes. For example, a factor price change in the international market (i.e., an oil price shock) can be partially absorbed by adopting laborintensive production processes.' In this article, I am going to discuss CES production functions for two-digit industries in Korea. One of my main purposes in this article is to show empirically that the elasticities of substitution are not zero in almost all of Korea's industries regardless of the firm's size.2 Furthermore, I shall show that production functions differ across different size groups of business firms in a given industry. Since it is widely acknowledged that wage-rental ratios in small and medium firms are lower than in large firms,3 nonzero elasticities of substitution between labor and capital in small-medium firms will have an important policy implication. That is, by encouraging the activities of smalland medium-sized firms one can expand employment opportunities in the manufacturing sector and enhance the efficiency of the economy by adjusting the industrial structure to be consistent with domestic factor endowments. It is conceivable that the direct importation of production technologies

Energy Substitution in U. S. Manufacturing: A Regional Approach

One response of economists to energy-market developments of the 1970s was to launch a series of studies in which the objective was to estimate energy substitution parameters characterizing important sectors of the U.S. economy. Relatively high substitution elasticities between energy and other inputs would permit firms to mitigate the effects of energy price increases by shifting to less energy-intensive factor proportions. The seminal work in this effort was carried out by Berndt and Wood [5], Griffin and Gregory [14], Pindyck [28], Halvorsen [16], and Fuss [12].'The research was substantially abetted by developments in production theory, where the work of McFadden [23], Diewert [8], and Christensen, Jorgenson and Lau [6] yielded new and flexible production and cost function forms. Empirical work on energy substitution has continued.2 For the most part the data analyzed have been highly aggregative, applying to, say, total U.S. manufacturing, or perhaps to the various two-digit sectors comprising that total. To date little effort has been given to investigating energy-substitution relationships at the regional level in the U.S. This is unfortunate since we know that the U.S. economy is actually composed of regions which are differently endowed with resources, have developed at different rates, and are comprised of different sectoral mixes. The distinct possibility exists that regions differ in terms of the way in which energy inputs relate to other inputs in production. Furthermore, even though the energy crisis may seem to be a national phenomenon, national policy responses are worked out within a context of shifting and colliding regional conflicts, stemming in large part from real or imagined perceptions of how energy market developments impact different regions. It would seem especially important, therefore, to identify

Inter-Fuel Substitution Possibilities: A Translog Application to Intercountry Data

One of the pressing issues in current energy policy debates in both the U. S. and other consuming countries is the feasibility of substantially reducing the use of crude oil. In some energy consuming sectors suchl as transportation, the shortrun mechanism to reduce consumption is through lower utilization of energyconsuming equipment while in the long-run, the equipment can be redesigned to achieve greater fuel efficiencies. In electricity generation and heatilng uses the primary mechanism to reduce consumption is inter-fuel substitution rather than capital/energy substitution. This paper is concernied with estimating the interfuel substitution relationships between fossil fuels (coal, gas, and residual fuel oil) in the generation of electricity. It is important to consider fossil fuel substitution possibilities in electricity generation both because considerable technical flexibility exists2 and because electric utilities are large consumers of fossil fuels. For example, electric utilities consumed 25% of primary energy inputs in the U. S. in 1970. Although not as high as the U. S., the other developed countries exhibit a similar pattern. In the 20 0. E. C. D. coun-tries, electric utilities consumed 50% of the coal, 17% of the gas, and 11% of petroleum products.3 High substitution elasticities among fuels in electricity generation indirectly increase subsequenit substitution of electricity for petroleum as a fuel source in residential, commercial, and industrial sectors. Thus the nature and extent of inter-fuel substitution possibilities in electricity generation are fundamental to the question of reducing dependency on crude oil. There have been several econometric studies of inter-fuel substitution in electricity generation using a variety of estimation procedures and samples. MacAvoy [15] used cross sectional data for U. S. power regions to examine substitution between nuclear fuel and fossil fuel. Griffin [10] estimated dynamic price and cross price elasticities among fuels utilizing annual time series data. More recently, Joskow and Mishkin [13] used individual plant data to analyze fuel choice in a logit model framework. But probably the approach capturing the most attention is the application of

The employment effects of wage changes in poor countries

It is commonly argued that a rise in ‘modern1 sector wage rates in poor countries will reduce employment as a result of factor substitution. However, it is shown that this need not apply, even assuming the existence of high elasticities of substitution, if there are segregated labour markets, as is common in poor countries. When all labour markets are considered, a rise in ‘modern’ sector wage rates may increase total employment opportunities through the shift in demand towards the more labour intensive low‐wage sector. The effects of a rise in ‘modern’ sector wage rates must, therefore, be analysed in terms of its effect on the distribution of employment opportunities and income throughout the whole economy and not just in one sector.

LABOUR ABSORPTION WITH IMPORT-SUBSTITUTING INDUSTRIALIZATION: AN EXAMINATION OF ELASTICITIES OF SUBSTITUTION IN THE BRAZILIAN MANUFACTURING SECTOR

In the less developed countries employment generation has emerged as a major problem. Those countries characterized by import substituting industrialization have been especially unable to expand employment opportunities, and their industrialization has been capital intensive in nature. Two different explanations for the failure of import substituting industrialization to absorb labor have been put forth. One school of thought Stresses the structural characteristics of industrialization, while an alternative explanation focuses on distortions in the factor markets. Much of this controversy implicitly revolves around the magnitude of the elasticities of Substitution — the "structural critic" school maintaining very Iow, or zero, elasticities of Substitution and the "market critic" school implying relatively high elasticities of Substitution. The CES production function is fitted to a regional cross-section of twenty-two Brazilian industries. The OLS estimates, made from 1960 industrial census data, show elasticities of Substitution ranging from .44 to 2.67 with over 50 percent of those estimated falling between .8 and 1.1. For the total manufacturing sector the elasticity of Substitution (estimated across states) was 1.0. The relatively high estimated elasticities of Substitution provide Support for the "market critic" school. Using the production function estimates to generate factor demand functions, the importance of factor market distortions is indicated. Distortions in the Brazilian labor market are quantified and, assuming their removal, a Iower bound estimate of the resulting employment generation is made, amounting to an increase of 11.4 percent in total manufacturing employment. Because of data limitations and the difficulties in quantification, no similar estimates were made regarding the capital market distortions.

An Empirical Investigation of the Heckscher-Ohlin Theory: A Comment

Constant-elasticity-of-substitution (CES) production functions are often assumed to be an adequate tool when investigating international trade. Earlier in this journal Michael Hoddl reported an empirical investigation of the Heckscher-Ohlin theory, with the conclusion that his results strongly suggested the importance of factor-intensity reversals over the range of relative factor prices spanned by the countries considered. Hodd calculated the capital-labour ratios (CIL ratios) for goods produced in Great Britain (UK) and exported to the United States (US), and the CIL ratios for goods produced in the US and exported to the UK. He further investigated the CGIL ratios for exported goods when also produced in the other country. With these data it can be shown readily that Hodd's results cannot be interpreted in the way he has done. This implies, in considering the two-country case of the UK and the US, that the CES production functions cannot be applied as a tool in the explanation of factor intensities in international trade. The reason for assuming CES production functions is to rescue the suspect premise of internationally identical production functions for the same products. Consider two countries I and II, the factors L and C, and two goods X and Y. It is assumed that there are CES production functions (internationally identical for the same goods), with the production function of Xhaving a higher elasticity of substitution than that of Y. This means that the isoquants of X are opened to a wider degree than those of Y. (See Figure 1.) Further, it is assumed that country I is rich in capital relative to country II. To apply CES production functions it must be assumed that one country has a factor endowment which leads to a CIL ratio higher than tan Ca;2 and conversely for the other country. When factor endowments are such that both countries have CIL ratios either higher or lower than tan a, the conclusions of the HeckscherOhlin theory follow.3 But then there would be no reason for assuming cEs production functions.