Declining labour share – Evidence of a change in underlying production technology?

The study demonstrates that the decline in the labour share in Finland can not be explained by the Cobb-Douglas production function. Instead, we propose an approach based on the constant-elasticity-of-substitution (CES) production function with labour- and capital-augmenting technical progress. The model is augmented by imperfect competition in the output market. According to the empirical results based on estimation of the first-order-conditions, the technical elasticity of substitution is significantly less than unity (0.6) and hence the Cobb-Douglas production function is rejected. The growth rate of the estimated labour-augmenting technical progress has decreased in recent years, which is not consistent with the ‘new-economy’ hypothesis. Capital-augmenting technical trend has exploded during the same period, which provides a possible explanation for the rapid growth of the Solow residual. The main contributing factor behind the declining labour share is, however, the increasing mark-up.

Introduction: According to the so called Kaldor facts, a set of empirical regularities — stylized facts—seem to characterize observed growth processes in several countries despite considerable cross country heterogeneity (Kongsamut, Rebelo and Xie 2000): Per capita output grows at a rate that is roughly constant
The capital-output ratio is roughly constant
The real rate of return to capital is roughly constant
The shares of labour and capital in national income are roughly constant
These stylized facts suggest that several aggregate “great ratios” evolve smoothly over time and appear to provide a set of assumptions that can be exploited when constructing models of economic growth. In fact, as Kongsamut et al. (2000) argue,
they have had an enormous impact on the construction of growth models. Also, since the Cobb-Douglas functional form for the production function is so widely used in the literature, many economists have come to believe that capital accumula- tion, technical progress and labour force expansion have no lasting effect on unem-ployment (Rowthorn 1999b).

Author: Antti Ripatti, Jouko Vilmunen

Source: Research Discussion Papers, Bank of Finland

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