Bayesian MC

2
estimation
R. Gonzales
MAMS
Project and
capital-labor
substitution
elasticity
Frequentist
approach
Bayesian
approach
Conclusion
Bayesian MC
2
estimation of the capital-labor
substitution elasticity in developing countries
Rolando Gonzales Martnez
4th regional meeting economic analysis of public policies with computable
general equilibrium models - ESPAE, Guayaquil
April, 2012
Bayesian MC
2
estimation
R. Gonzales
MAMS
Project and
capital-labor
substitution
elasticity
Frequentist
approach
Bayesian
approach
Conclusion
Motivation: MAMS Project
Part of the project Strengthening Macroeconomic and
Social Policy Coherence through Integrated Macro-Micro
Modelling
1
involved the estimation of the capital-labor
substitution elasticity for the computable general
equilibrium model MAMS (Maquette for Millennium
Development Goals Simulation, see Logfren and
Daz-Bonilla, 2010)
1
Organized by the United Nations Development Program (UNDP), the
United Nations Department of Economic and Social Aairs (UNDESA),
and Unidad de Anlisis de Polticas Sociales y Econmicas de Bolivia
(UDAPE).
Bayesian MC
2
estimation
R. Gonzales
MAMS
Project and
capital-labor
substitution
elasticity
Frequentist
approach
Bayesian
approach
Conclusion
Capital-labor substitution elasticity
CES production function (Arrow et al., 1961):
q = A
_
`
1

+ (1 )k
1

_
1
, (1)
q is real output, A is factor productivity,
2 [0, 1] is a distribution parameter
2 [0, ) is the elasticity of substitution between capital and
labor. The rst order condition of the restricted optimization
problem of the rms is,
pA

1
_
`
1

+ (1 ) k
1
1
_

= w,
then,
` =
_
_
_
pA
_
`
1

+ (1 ) k
1
1
_ 1
1

w
_
_
_

,
Bayesian MC
2
estimation
R. Gonzales
MAMS
Project and
capital-labor
substitution
elasticity
Frequentist
approach
Bayesian
approach
Conclusion
Estimable equation
` =
_
p
w
_

_
`
1

+ (1 ) k
1
1
_
1
, (2)
Replacing (1) in (2), the labor demand equals,
` =
_
p
w
_

A
1
q,
then,
q
`
=
_
w
p
_

()

A
1
.
This equation can be log-linearized,
y =
0
+
1
x, (3)
for y = ln(q/`), x = ln(w/p), w/p real wages and

0
= ln + (1 )lnA,
1
:= . See Cicowiez (2011).
Bayesian MC
2
estimation
R. Gonzales
MAMS
Project and
capital-labor
substitution
elasticity
Frequentist
approach
Bayesian
approach
Conclusion
A frequentist approach to estimate (3)
Plug up an (additive) error term
i .i .d
N
_
0,
2

_
in (3) to
become it an empirical model:
y =
0
+
1
x + (4)
Use any available information to "measure" y = ln(q/l )
and x = ln(w/p)
2
Estimate (4) with a canned software, as e.g. Eviews or
Stata.
2
For the Bolivian case, yearly data of ouput and output deator from
national accounts was used to measure q and p, respectively; l and w were
employed population and earnings from the household survey, respectively.
Since the cut year of the MAMS model is 2006, the total available sample
has 10 observations.
Bayesian MC
2
estimation
R. Gonzales
MAMS
Project and
capital-labor
substitution
elasticity
Frequentist
approach
Bayesian
approach
Conclusion
Some problems of the frequentist approach
1
Some developing countries have only a short sample
of inaccurate data to estimate (4)
3
.
2
The usual estimation problems of endogeneity, omitted
variable bias, nonstationarity, serial correlation cannot be
easily corrected with a small sample size.
3
If the estimated value of
1
is not the expected, it is a
usual frequentist practice to perform an informal "search"
process across dierent local-DGPs (most of the time
without the correction to the Type I error) until the model
"matches" the theory, the estimations in similar countries,
or the subjective perception of the modeler/client.
3
But frequentist techniques only make sense in large samples.
Furthermore, an error in x leads to a downward biased estimation of , in a
magnitude toward zero. See Hausman (2001) for details.
Bayesian MC
2
estimation
R. Gonzales
MAMS
Project and
capital-labor
substitution
elasticity
Frequentist
approach
Bayesian
approach
Conclusion
Frequentist results
M
1
is equation (4), M
2
as in Jabbar (2002), M
3
as in Tipper
(2011). The frequentist results are not Hendry-congruent
4
.
4
See Hendry, David F (1997). On congruent econometric relations: A
comment. Carnegie-Rochester Conference Series on Public Policy. Number
47, 1, 163-190
Bayesian MC
2
estimation
R. Gonzales
MAMS
Project and
capital-labor
substitution
elasticity
Frequentist
approach
Bayesian
approach
Conclusion
Bayesian approach
With Bayesian methods, it is possible to incorporate previous
empirical work and economic theory in (3), together with the
expert criteria of professionals in the eld
5
.
Let X = [1
n
(x
1
, ..., x
t
)
0
], = [
0

1
], y = (y
1
, ..., y
t
)
0
,
y N(X, s
2
I
n
),
then,
N(
0
, B
0
), s
2
IG(
0
/2,
0
/2).

js
2
, y N(, B
1
),
B
1
= [s
2
X
0
X +B
1
0
]
1
,
= B
1
[s
2
X
0
y +B
1
0

0
].
5
In developing countries the knowledge and the experience of experts in
the eld is a valuable source of information that can be exploited to
improve the estimation of elasticities
Bayesian MC
2
estimation
R. Gonzales
MAMS
Project and
capital-labor
substitution
elasticity
Frequentist
approach
Bayesian
approach
Conclusion
Markov Chain Monte Carlo (MC
2
) sampler
(a) Let s
2(0)
be a starting value of s
2
.
(b) At the g-th iteration,

(g )
N(

(g )
, B
(g )
1
),
s
2(g )
IG(
1
/2,
(g )
1
/2),
where,
B
(g )
1
= [s
2(g 1)
X
0
X +B
1
0
]
1
,

(g )
= B
(g )
1
[s
2(g 1)
X
0
y +B
1
0

0
],

(g )
1
=
0
+ (y X
(g )
)
0(g )
).
with a repetition of the Gibbs sampling (b) until g = B +G it
is possible to estimate with (assuming quadratic loss),
min

E[L(

, )] = min

_
_

_
2
(jy)d.
Bayesian MC
2
estimation
R. Gonzales
MAMS
Project and
capital-labor
substitution
elasticity
Frequentist
approach
Bayesian
approach
Conclusion
Prior elicitation
From equation 3 it is clear that the prior for
0
would be,

0
=
1
ln + (1
1
)lnA. (5)
The components of the prior variance-covariance matrix B
0
,
B
0
=
_
Var (
0
) Cov(
0
,
1
)
Cov(
0
,
1
) Var (
1
)
_
,
can be elicitated given the fact that,
Var (
0
) : = Var (
1
ln + (1
1
)lnA)
= [(ln)
2
+ (lnA)
2
+ 2ln( +A)]Var (
1
) (6)
and,
Cov(
0
,
1
) = E(
0

1
) E(
0
)E(
1
)
Thus,
0
,
1
and B
0
can be fully elicitated assigning values to
the hyperparametes A and , without a previous frequentist
estimation
Bayesian MC
2
estimation
R. Gonzales
MAMS
Project and
capital-labor
substitution
elasticity
Frequentist
approach
Bayesian
approach
Conclusion
Prior elicitation for the Bolivian case
Bayesian MC
2
estimation
R. Gonzales
MAMS
Project and
capital-labor
substitution
elasticity
Frequentist
approach
Bayesian
approach
Conclusion
Bayesian results
Bayesian MC
2
estimation
R. Gonzales
MAMS
Project and
capital-labor
substitution
elasticity
Frequentist
approach
Bayesian
approach
Conclusion
Conclusion
The estimation of in developed countries is close to one
or even larger than one
The estimated value of in the study is congruent with
the empirical fact that in developing countries the
estimation of tends to be lower
The Bayesian approach seems an interesting alternative for
the estimation of the capital-labor substitution elasticity in
developing countries, as with this technique it is possible
to compensate data limitations with a rigorous
inclusion of the experience of professionals in the eld,
theoretical concepts or previous empirical work,
through prior elicitation.
The combination of the prior criteria with data evidence
produces an estimator (a Bayesian estimator) that
exploits both sources of information
Bayesian MC
2
estimation
R. Gonzales
MAMS
Project and
capital-labor
substitution
elasticity
Frequentist
approach
Bayesian
approach
Conclusion
References
* Arrow, K.J. ,H.B.Chenery, B.S.Minhas, R.M. Solow (1961). Capital-Labor Substitution and Economic
Eciency. The Review of Economics and Statistics, 43, 3, pp.225-250
* Cicowiez, Martn (2011). Un Modelo de Equilibrio General Computado para la Evaluacin de Polticas
Econmicas en Argentina: Construccin y Aplicaciones. Tesis de Doctorado. Universidad Nacional de La
Plata. Captulo 4.
* Hausman, Jerry (2001). Mismeasured Variables in Econometric Analysis :Problems from the Right and
Problems from the Left. The Journal of Economic Perspectives, Vol.15, No.4 (Autumn,2001), pp.57-67.
* Hendry, David F. (1997). On congruent econometric relations: A comment. Carnegie-Rochester
Conference Series on Public Policy, 47(1), 163-190.
* Jabbar Saed, Afaf Abdul (2002). Technological Progress and Capital-Labour Substitution in the Jordanian
Industry: 1985-1997.Journal of Economic and Administrative Sciences, Vol.18, No.2.
* Lofgren, Hans, Carolina Diaz-Bonilla (2010). MAMS: An Economy Wide Model for Analysis of MDG
Country Strategies: Technical Documentation. The World Bank (mimeo).
* Tipper, Adam (2011). One For All? The Capital-Labour Substitution Elasticity In New Zealand.Paper
prepared for the 52nd New Zealand Association of Economists conference, Wellington, NewZealand.
Bayesian MC
2
estimation
R. Gonzales
MAMS
Project and
capital-labor
substitution
elasticity
Frequentist
approach
Bayesian
approach
Conclusion
10 iterations, no burn-in,
0
= 1 10
2
,
0
= 1 10
3
Bayesian MC
2
estimation
R. Gonzales
MAMS
Project and
capital-labor
substitution
elasticity
Frequentist
approach
Bayesian
approach
Conclusion
100 iterations, no burn-in,
0
= 1 10
2
,
0
= 1 10
3
Bayesian MC
2
estimation
R. Gonzales
MAMS
Project and
capital-labor
substitution
elasticity
Frequentist
approach
Bayesian
approach
Conclusion
1100 iterations, no burn-in,
0
= 1 10
2
,
0
= 1 10
3
Bayesian MC
2
estimation
R. Gonzales
MAMS
Project and
capital-labor
substitution
elasticity
Frequentist
approach
Bayesian
approach
Conclusion
1100 iterations, no burn-in,
0
=
0
= 1 10
4
Bayesian MC
2
estimation
R. Gonzales
MAMS
Project and
capital-labor
substitution
elasticity
Frequentist
approach
Bayesian
approach
Conclusion
1100 iterations, no burn-in,
0
=
0
= 1 10
4