Capital-labor substitution impact in the business performance of the firms in the European Union

The recent improvements in new technology and the increase of capital investments have brought new attention to the extent that labour can be substituted by capital in firms in the European Union. As the substitution of labour by capital is increased, the interest of this paper is to observe the impact of the capital-labour substitution on the business performance of the firms in the European Union from 1990 until 2018. By using an unbalanced panel data of 18988 observations, this paper takes into account random effect regression model, country fixed effect regression model, year fixed effect regression model and industry fixed effect regression model. It yields into the conclusion that capital-labour substitution has a negative significant effect on the return on assets of the firms in the European Union from 1990 until 2018. However the substitution between labour and capital has the least negative significant effect in the Manufacturing Industry. The main limitations of this paper are the low number of data for some of the countries in the European Union and the endogeneity of the data. However, his paper adds value to the current literature by bringing an insight to the optimal investment strategy that should be implemented by the firms in the European Union in the new century.