Sectoral elasticity of substitution and returns to scale in South Africa

Abstract

Elasticity of substitution and returns to scale are estimated on sectoral basis for South Africa using panel-based generalized least square. Apart from sectoral differences in terms of elasticity of substitution, the study found that elasticity of substitution is below unity in all the sectors. Most of the sectors studied are found to have increasing returns to scale in production. The study further explores the implications of elasticity of factor substitution and returns to scale on growth and employment creation. The amount of jobs that can be created from growth of the sectors with constant or decreasing returns to scale can be argued to be greater than jobs from the same level of output growth generated from sectors with increasing returns to scale. The above is the case comparing the employment creating potential of the same amount of additional output in all the sectors being compared. By virtue of scale economies, a sector like finance, insurance, real estate and business services generates more output with less proportional increase in inputs. This means growth in this sector may not have the desired impact on jobs creation. However, a glance at the share of the sector in the country's total output and employment may spare one from making the kind of conclusion given above. This sector may generate more jobs because of being a sector making up about 20% of the country's total value added and employment; even if sectors like utilities and construction experience the same level of output growth. Given its importance for growth and employment, the study also recommends for further investigation into the reasons why elasticity of substitution is lower in sectors like utilities, mining and trade, catering and accommodation service.