Declining labour share : Evidence of a change in the underlying production technology

Abstract

The study demonstrates that the decline in the labour share in Finland can not be explained by the Cobb-Douglas production function.Instead, we propose an approach based on the constant-elasticity-of-substitution (CES) production function with labour- and capital-augmenting technical progress.The model is augmented by imperfect competition in the output market.According to the empirical results based on estimation of the first-order-conditions, the technical elasticity of substitution is significantly less than unity (0.6) and hence the Cobb-Douglas production function is rejected.The growth rate of the estimated labour-augmenting technical progress has decreased in recent years, which is not consistent with the 'new-economy' hypothesis. Capital-augmenting technical trend has exploded during the same period, which provides a possible explanation for the rapid growth of the Solow residual.The main contributing factor behind the declining labour share is, however, the increasing mark-up. Keywords: production function, elasticity of technical substitution, input-augmenting technical progress, new economy