The capital-labor substitution elasticity and technical biases in production are critical parameters. The received wisdom claims their joint identification is infeasible. We challenge that interpretation. Putting the new approach of “normalized” production functions at the heart of a Monte Carlo analysis we identify the conditions under which identification is feasible and robust. The key result is that jointly modeling the production function and first-order conditions is superior to single-equation approaches especially when merged with “normalization.” Our results will have fundamental implications for production-function estimation under non-neutral technical change, for understanding the empirical relevance of normalization and variability underlying past empirical studies. (JEL E22, O33, O41)

We exploit a provision in Spanish labor laws whereby employment protection is more stringent for firms with 50+ employees. Firm-level evidence suggests that during the credit crunch of 2008-09, healthy firms with less than 50 employees borrowing from troubled banks grew faster in sectors where production factors were sufficiently substitutable. This effect is made possible by firms’ substituting labor for capital when the rental cost of capital increases. Our analysis sheds new light on the importance of labor regulation and the technological substitutability of the factors of production in enabling firms to adjust to financial shocks.

Using a normalized CES function with factor-augmenting technical progress, we estimate a supply-side system of the U.S. economy from 1953 to 1998. Avoiding potential estimation biases that may have occurred in earlier studies and putting a high emphasis on data consistency, we obtain robust results not only for the aggregate elasticity of substitution but also for the parameters of labor and capital augmenting technical change. We find that the elasticity of substitution is significantly below unity and that technical progress shows an asymmetrical pattern where the growth of labor-augmenting technical progress is exponential, while that of capital is hyperbolic or logarithmic.