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Our colleagues published in Review of Economic Dynamics

02/06/2021

The article "Measuring capital-labor substitution: The importance of method choices and publication biasby Tomáš Havránek, Zuzana Havránková and Dominika Ehrenbergerová from IES and Sebastian Gechert from IMK Düsseldorf was published in the May issue of the prestigious journal Review of Economic Dynamics

The elasticity of substitution between capital and labor is a key parameter that reflects the extent to which one factor of production can be substituted for the other. Its empirical estimates vary considerably in the existing literature, with the average of all estimates being 0.9, which is assumed by the so-called Cobb-Douglas production function often used in macroeconomic models.
In their research paper, our colleagues use meta-analysis to show that the large elasticity of substitution between capital and labour to date can be explained by publication bias, but also by the choice of data and methods used in the estimations. Without these biases the mean elasticity  falls to 0.3, showing that the commonly used version of the Cobb-Douglas production function is not a correct representation of economic relations.  

The paper has been mentioned on Twitter by e.g. Vitor Constâncio (former Vice President of the ECB), Pol Antras (Professor of Economics at Harvard), and shared by Olivier Blanchard (MIT), Per Krusell (IIES) , Gianluce Violante (Princeton), Cristiano Cantore (Bank of England) among others.     

The main points of the research are also summarised in the official abstract below:

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.

Congratulations on the successful research and publication!

Autor - Barbora Holková

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