A New Approach to Estimating Production Function Parameters: The Elusive Capital-Labor Substitution Elasticity

Parameters of taste and technology are central to a wide variety of economic models and issues. This article proposes a simple method for estimating production function parameters from panel data, with a particular focus on the elasticity of substitution between capital and labor. Elasticity estimat...

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Bibliographic Details
Published in:Journal of business & economic statistics 2011-10, Vol.29 (4), p.587-594
Main Authors: Chirinko, Robert S., Fazzari, Steven M., Meyer, Andrew P.
Format: Article
Language:English
Subjects:
Capital formation
Capital investments
Capital stocks
Cost estimates
Datasets
Economic models
Elasticity
Estimating techniques
Estimation bias
Estimation methods
Financial investments
Mathematical independent variables
Musical intervals
Panel data
Parameter estimation
Production function parameters
Production functions
Studies
User costs
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Summary:Parameters of taste and technology are central to a wide variety of economic models and issues. This article proposes a simple method for estimating production function parameters from panel data, with a particular focus on the elasticity of substitution between capital and labor. Elasticity estimates have varied widely, and a consensus estimate remains elusive. Our estimation strategy exploits long-run variation and thus avoids several pitfalls, including difficult-to-specify dynamics, transitory time-series variation, and positively sloped supply schedules, that can bias the estimated elasticity. Our results are based on an extensive panel comprising 1860 firms. Our approach generates a precisely estimated elasticity of 0.40. Although existing estimates range widely, we document a remarkable convergence of results from two related approaches applied to a common dataset. The method developed here may prove useful in estimating other structural parameters from panel datasets.
ISSN:0735-0015
1537-2707
DOI:10.1198/jbes.2011.08119