Long-run relationships between labor and capital: Indirect evidence on the elasticity of substitution

This paper proposes an indirect method for making empirical inference on the elasticity of substitution between capital and labor. The idea is that estimates of the elasticity may be retrievable from theory derived behavioral equations, by conducting comparative statics with respect to this parameter. This approach is readily applicable to more realistic models than those which are commonly used to derive estimates of the substitution elasticity. It is demonstrated that the conventional approach does not yield sensible estimates on quarterly Finnish manufacturing data. By applying the indirect method, a long-run empirical relationship is found that is consistent with an elasticity of substitution below one. (C) 2007 Elsevier Inc. All rights reserved.