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, wher e 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 cros s equation restrictions implied by theory. By estimating the unrestricted p roduction set for a sufficiently general production structure we are able t o consider the appropriate cross-equation restrictions to ensure that equil ibrium unemployment is independent of the capital stock and technological p rogress in the long run. We argue that there is little empirical support fo r 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 s hares. An increase in the cost of capital for example will, therefore, incr ease equilibrium unemployment. In so far as such an increase cannot be perm anent, its effects are shown to be highly persistent in the presence of rea l inertia. (C) 2000 Elsevier Science B.V. All rights reserved.