The Normalized CES Production Function: Theory and Empirics

52 Pages Posted: 22 Feb 2011

See all articles by Rainer Klump

Rainer Klump

University of Frankfurt - Economics and Business Administration Area

Peter McAdam

European Central Bank (ECB)

Alpo Willman

University of Kent - Canterbury Campus

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Date Written: February 14, 2011

Abstract

The elasticity of substitution between capital and labor and, in turn, the direction of technical change are critical parameters in many fields of economics. Until recently, though, the application of production functions with non-unitary substitution elasticities (i.e., non Cobb Douglas) was hampered by empirical and theoretical uncertainties. As has recently been revealed, “normalization” of production functions and production-technology systems holds out the promise of resolving many of those uncertainties. We survey and critically assess the intrinsic links between production (as conceptualized in a macroeconomic production function), factor substitution (as made most explicit in Constant Elasticity of Substitution functions) and normalization (defined by the fixing of baseline values for relevant variables). First, we recall how the normalized CES function came into existence and what normalization implies for its formal properties. Then we deal with the key role of normalization in recent advances in the theory of business cycles and of economic growth. Next, we discuss the benefits normalization brings for empirical estimation and empirical growth research. Finally, we identify promising areas of future research on normalization and factor substitution.

Keywords: Normalization, Constant Elasticity of Substitution Production Function, Factor-Augmenting Technical Change, Growth Theory, Identification, Estimation

JEL Classification: C22, E23, E25, 030, 051

Suggested Citation

Klump, Rainer and McAdam, Peter and Willman, Alpo, The Normalized CES Production Function: Theory and Empirics (February 14, 2011). ECB Working Paper No. 1294, Available at SSRN: https://ssrn.com/abstract=1761410

Rainer Klump (Contact Author)

University of Frankfurt - Economics and Business Administration Area ( email )

Schumannstrasse 60
D-60325 Frankfurt am Main
Germany
+49 69 798-22288 (Phone)
+49 69 798-28121 (Fax)

Peter McAdam

European Central Bank (ECB) ( email )

Kaiserstrasse 29
Eurotower
D-60311 Frankfurt am Main
Germany
0049 69 13440 (Phone)
0044 69 1344 6000 (Fax)

Alpo Willman

University of Kent - Canterbury Campus ( email )

Finland

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