Working Paper: CEPR ID: DP15687
Authors: Sebastian Gechert; Tomas Havranek; Zuzana Irsova; Dominika Kolcunova
Abstract: We show that the large elasticity of substitution between capital and labor estimated in the literature on average, 0.9, can be explained by three issues: publication bias, use of cross-country variation, and omission of the first-order condition for capital. The mean elasticity conditional on the absence of these issues is 0.3. To obtain this result, we collect 3,186 estimates of the elasticity reported in 121 studies, codify 71 variables that reflect the context in which researchers produce their estimates, and address model uncertainty by Bayesian and frequentist model averaging. We employ nonlinear techniques to correct for publication bias, which is responsible for at least half of the overall reduction in the mean elasticity from 0.9 to 0.3. Our findings also suggest that a failure to normalize the production function leads to a substantial upward bias in the estimated elasticity. The weight of evidence accumulated in the empirical literature emphatically rejects the Cobb-Douglas specification.
Keywords: Elasticity of Substitution; Capital; Labor; Publication Bias; Model Uncertainty
JEL Codes: D24; E23; O14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Publication bias (C46) | Average elasticity of substitution (C51) |
| Omission of first-order condition for capital (D24) | Average elasticity of substitution (C51) |
| Publication bias (C46) | Mean elasticity (D12) |
| Mean elasticity (D12) | Inflation of elasticity estimates (E31) |
| Failure to normalize production function (D24) | Upward bias in elasticity estimates (C51) |
| Model specification and data quality (C51) | Elasticity of substitution (D11) |
| Cobb-Douglas specification (C51) | Elasticity of substitution (D11) |