Capital-Labor Substitution and Saving Rate Dynanics

Résumé

We characterize the dynamics of saving rate in the standard exogenous growth model with aggregate CES production function. A hump-shaped saving rate may arise along the transitional dynamics if capital and labor complements one another. In this case, the marginal productivity of capital, which determines the substitution effect of capital accumulation, decreases faster than the average productivity, which determines the income effect. By calibrating the model, we obtain a very good fit between our simulations and data concerning the saving rate. However, we also show that some crucial features of the model are empirically implausible. In particular, the data do not corroborate the decreasing path of capital income share exhibited by the model in replicating the hump-shaped saving rate. The paper finally shows that this empirical shortcoming can be overcome by considering a technology that exhibits endogenous, non-linear elasticity of substitution between capital and labor.