The Hidden Adjustment: Re-examining the Capital-Labor-Mix in the Harrod-neutral Growth Model

Marcel R. de la Fonteijne

MPRA Paper from University Library of Munich, Germany

Abstract: For several decades, it has been acknowledged that the conventional implementation of capital- and labor-augmenting technical progress within CES production functions gives rise to a fundamental paradox: either the production function must be Cobb-Douglas, or technical progress must be labor-augmenting only. Despite this inconsistency—commonly referred to as the “Cobb-Douglas or labor-augmenting-only paradox”—the approach remains widely used in modern growth models. In this paper, we revisit this theoretical issue through the lens of the Modern Universal Growth Theory (MUGT). MUGT rejects all existing formulations of neutral and non-neutral technical progress and offers a revised implementation that resolves the paradox. Within this framework, economic growth is represented as partially exogenous, through technical change, and partially endogenous, through capital accumulation. We derive explicit expressions to translate total factor productivity (TFP) into measurable output growth, establishing a coherent link between productivity dynamics and long-run economic performance. The central conclusion of MUGT is that no production function can yield a Balanced Growth Path (BGP) unless the capital-labor mix is explicitly adjusted over time. In this sense, MUGT exposes a structural limitation of all traditional growth models and provides a general framework to overcome it. A key contribution of this paper is the analysis of so-called Harrod-neutral (labor-augmenting) technical progress. We demonstrate that, despite its apparent simplicity, this approach implicitly requires a continuous adjustment of the capital-labor mix—a hidden mechanism that has remained largely unexamined. By revealing this adjustment, we not only explain the inner workings of Harrod's model, but also show that the same hidden mechanism exists across all combinations of capital- and labor-augmenting progress. This insight strengthens the case for adopting the MUGT as a consistent and transparent foundation for growth theory, in which each growth parameter has a clear, consistent, and economically meaningful interpretation.

Keywords: Capital and Labor Augmented Technical Progress; Growth Model; Maximum Profit Condition; Production Functions; General Technical Progress; Capital-Labor-mix; Elasticity of Substitution; DSGE; Total Factor Productivity; Solow model; Hicks; Harrod; Modern Universal Growth Theory; MUGT (search for similar items in EconPapers)
JEL-codes: E00 E20 E23 E24 (search for similar items in EconPapers)
Date: 2025-07-05
New Economics Papers: this item is included in nep-gro
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