Capital-labor substitutability in Malaysian manufacturing: alternative estimates and policy implications

Maisom Abdullah

ISU General Staff Papers from Iowa State University, Department of Economics

Abstract: The question of appropriate factor proportions and concern for the low absorption of labor in LDC manufacturing have made these issues important areas for research and policy in the developing countries. This is especially so in Malaysia since unemployment increased from a rate of 3 percent in 1970 to 8.7 percent in 1987, despite large investments within this period;In this study, econometric analysis of capital-labor substitutability is conducted for the Malaysian manufacturing sector for the period 1963-1984. Estimates of the elasticity of substitution are computed using the Constant Elasticity of Substitution (CES) production function approach, the translog cost approach and the CES-translog cost approach. Comparisons of alternative estimates of the elasticity of substitution between capital and labor are also made;The statistical analysis shows that most of the Malaysian industries at the 5-digit industrial classification level exhibit relatively low elasticities of substitution between capital and labor. This provides a clearer understanding of the relatively low labor absorption in the Malaysian manufacturing sector. Other factors which may be responsible for the choice of inappropriate factor proportions including biases in government policy as well as private decisions by firms are also discussed.

Date: 1989-01-01
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