Piketty's Elasticity of Substitution: A Critique

This article examines Thomas Piketty’s explanation of a falling wage share. Piketty explains rising income inequality between labor and capital as a result of one parameter of a production function: an elasticity of substitution, σ, between labor and capital greater than one. This article reviews Piketty’s elasticity argument, which relies on a non-standard definition of capital. In light of the theory of land rent, it discusses why the non-standard capital definition is a measure of wealth, not capital and is problematic for estimating elasticities. It then presents simple long-run estimates of σ in constant elasticity of substitution functions for Piketty’s data as well as for a subset of his capital measure that comes closer to the standard definition of productive capital. The estimation results cast doubt on Piketty’s hypothesis that σ is greater than one