July 2017

IZA DP No. 10898: The Effects of Globalization and Technology on the Elasticity of Substitution

published in: Review of World Economics, 2018, 154 (3), 617-647

The elasticity of substitution between capital and labor (?) is usually considered a "deep parameter". This paper shows, in contrast, that ? is affected by both globalization and technology, and that different intensities in these drivers have different consequences for the OECD and the non-OECD economies. In the OECD, we find that the elasticity of substitution between capital and labor is below unity; that it increases along with the degree of globalization; but it decreases with the level of technology. Although results for the non-OECD area are more heterogeneous, we find that technology enhances the substitutability between capital and labor. We also find evidence of a non-significant impact of the capital-output ratio on the labor share irrespective of the degree of globalization (which would be consistent with an average aggregate Cobb-Douglas technology). Given the relevance of ? for economic growth and the functional distribution of income, the intertwined linkage among globalization, technology and the elasticity of substitution should be taken into account in any policy makers' objective function.