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FACTOR SUBSTITUTION AND ECONOMIC GROWTH: A UNIFIED APPROACH

Published online by Cambridge University Press:  09 January 2012

Jianpo Xue  and
Chong K. Yip
Jianpo Xue
Affiliation:
Renmin University of China
Chong K. Yip*
Affiliation:
The Chinese University of Hong Kong
*
Address correspondence to: Chong K. Yip, Department of Economics, The Chinese University of Hong Kong, Shatin, Hong Kong; e-mail: chongkeeyip@cuhk.edu.hk.
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Abstract

This paper provides a unified approach to characterizing the relation between factor substitution and economic growth in different one-sector growth models (namely, the Solow, Ramsey, and Diamond models). Our main finding is that if better factor substitution raises savings in the steady state, then a higher per capita income results. There are two channels by which factor substitution affects savings: the positive efficiency effect via income and the ambiguous distribution effect via factor income shares. If the efficiency effect dominates, then a higher elasticity of substitution leads to a higher level of per capita steady-state income. In transition, factor substitution affects the rate of convergence both directly and through the equilibrium profit share. The former arises from diminishing marginal productivity of capital whereas the latter reflects its relative scarcity. Depending on the interaction of these effects, the net outcomes are characterized.

Keywords

Elasticity of SubstitutionNormalized CES Production FunctionRate of Convergence
Type
Articles
Information
Macroeconomic Dynamics , Volume 16 , Issue 4 , September 2012 , pp. 625 - 656
Copyright
Copyright © Cambridge University Press 2012

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