Capital–labor substitution and long-run growth in a model with physical and human capital

• We examine the link between factor substitution and endogenous growth.
• Previous work relied on one-sector models with exogenous long-run growth.
• We use a one-sector endogenous growth model with physical and human capital.
• The long-run growth rate is increasing in the elasticity of substitution.

Most of the literature analyzing the growth-substitutability nexus considers models in which long-run growth is exogenous. We study this link in an endogenous growth model with physical and human capital. We show that for two economies differing uniquely in factor substitutability, the one with the higher elasticity of substitution will have higher long-run growth. This is due to the efficiency effect of a higher factor substitution. Furthermore, if the initial ratio of physical to human capital is below (above) its steady-state value, the economy with the higher elasticity of substitution will have a higher (lower) steady-state physical capital income share.