Elasticity of substitution and growth: normalized CES in the Diamond model

Summary.

It is often asserted that the more substitutable capital and labor are in the aggregate production the more rapidly an economy grows. Recently this has been formally confirmed within the Solow model by Klump and de La Grandville (2000). This paper demonstrates that there exists no such monotonic relationship between factor substitutability and growth in the Diamond overlapping-generations model. In particular, we prove that, if capital and labor are relatively substitutable, a country with a greater elasticity of substitution exhibits lower per capita output growth in transit and in steady state.