Unemployment and the capital stock: a dynamic structural model of the UK supply side

This paper estimates a consistent supply side model of the UK economy, where the production structure is modelled using a dynamic flexible functional form. We derive consistent factor demands, output price and wage equations and estimate them on aggregate data, testing, then imposing all of the cross equation restrictions implied by theory. By estimating the unrestricted production set for a sufficiently general production structure we are able to consider the appropriate cross-equation restrictions to ensure that equilibrium unemployment is independent of the capital stock and technological progress in the long run. We argue that there is little empirical support for the restrictions with respect to the level of the capital stock, and show that in general the natural rate of unemployment is a function of factor shares. An increase in the cost of capital for example will, therefore, increase equilibrium unemployment. In so far as such an increase cannot be permanent, its effects are shown to be highly persistent in the presence of real inertia. (C) 2000 Elsevier Science B.V. All rights reserved.