Elasticity in CES Production Functions: New Estimates for Europe and Different Nesting Structures

This study addresses the scarcity of empirical estimates on the elasticity of production factor substitutions, a crucial parameter in general equilibrium models for policy analysis. Employing the non-linear least squares estimation method, we determine the elasticity of substitution between capital, labor, energy, and materials in the Constant Elasticity of Substitution model across Europe at both aggregate and sectoral levels. Through rigorous analysis, we identify the optimal nesting structure of the production function for our data, rejecting widely used CES functional forms such as Cobb-Douglas and Leontief. Our findings reveal changes in elasticity of substitution over time, with Eastern Europe exhibiting greater ease of substitution compared to Western Europe, particularly between capital and labor. While elasticities in tertiary sectors diverge over time, those in energy-intensive sectors converge, though they remain statistically different, underscoring the necessity of region-specific elasticity sets in CGE models. JEL Classification: C51, Model Construction and Estimation; D24, Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity