Income and factor substitution: an investigation on the Solow growth model under the constant elasticity of substitution

Journal of Economic Studies. 2022. Vol. 49. No. 3. P. 397–421.

Alatas S.

The purpose of this study is to examine whether the elasticity of substitution (ES) varies between developed and developing countries. The author derives the growth regressions from the Solow model under the constant elasticity of substitution production function by using the first-order Taylor series expansion and estimate them for each country group classified based on time-varying behavior of income per worker using the data-driven algorithm. The ES is not unitary and varies among country groups. Developed countries generally have a higher ES than developing countries. For the first time, the author uses the first-order Taylor series expansion to linearize the steady-state value of income per worker, as the author considers this approach to be relatively more straight-forward and tractable. Furthermore, the author estimates the equations using both cross-section and panel data techniques and employs the data-driven algorithm proposed by Phillips and Sul (2007) to classify countries.

Keywords: economic growth, elasticity of substitution, Constant Elasticity of Substitution, Solow growth model, Cobb-Douglass