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On the Rental Price of Capital and the Profit Rate: The Perils and Pitfalls of Total Factor Productivity Growth

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Author Info
Jesus Felipe
J. S. L. Mccombie

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Abstract

This paper considers the implications of the conceptual difference between the rental price of capital, embedded in the neoclassical cost identity (output equals the cost of labor plus the cost of capital), which is used in growth accounting studies; and the accounting profit rate, which can be derived from the National Income and Product Accounts (NIPA). The neoclassical identity is a 'virtual' identity in that it depends on a series of assumptions (constant returns to scale and perfectly competitive factor markets). The income side of the NIPA also provides an accounting identity for output as the sum of the wage bill plus the gross operating surplus. This identity, however, is a 'real' one, in the sense that it does not depend on any assumption and thus it always holds. It is shown that because the neoclassical cost identity and the income accounting identity according to the NIPA may be expressed as formally equivalent expressions, estimations of aggregate production functions and growth accounting studies are tautologies. Likewise, the test of the hypothesis of competitive markets using Hall's (1988) framework gives rise to a null hypothesis that cannot be rejected statistically. Finally, it is argued that the NIPA identity does hold in constant prices, pace Denison (1972a, 1972b).

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Article provided by Taylor and Francis Journals in its journal Review of Political Economy.

Volume (Year): 19 (2007)
Issue (Month): 3 ()
Pages: 317-345
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Handle: RePEc:taf:revpoe:v:19:y:2007:i:3:p:317-345

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  1. Fisher, Franklin M, 1971. "Aggregate Production Functions and the Explanation of Wages: A Simulation Experiment," The Review of Economics and Statistics, MIT Press, vol. 53(4), pages 305-25, November. [Downloadable!] (restricted)
  2. Samuelson, Paul A, 1979. "Paul Douglas's Measurement of Production Functions and Marginal Productivities," Journal of Political Economy, University of Chicago Press, vol. 87(5), pages 923-39, October. [Downloadable!] (restricted)
  3. John Fernald & Brent Neiman, 2003. "Measuring productivity growth in Asia: do market imperfections matter?," Working Paper Series WP-03-15, Federal Reserve Bank of Chicago. [Downloadable!]
  4. Jesus Felipe & J. S. L. McCombie, 2004. "To measure or not to measure TFP growth? A reply to Mahadevan," Oxford Development Studies, Taylor and Francis Journals, vol. 32(2), pages 321-327. [Downloadable!] (restricted)
  5. Felipe, Jesus & McCombie, J. S. L., 1999. "Wan's "New Approach" to Technical Change: A Comment," Journal of Comparative Economics, Elsevier, vol. 27(2), pages 355-363, June. [Downloadable!] (restricted)
  6. Prescott, Edward C, 1998. "Needed: A Theory of Total Factor Productivity," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(3), pages 525-51, August.
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  7. Chang-Tai Hsieh, 1999. "Productivity Growth and Factor Prices in East Asia," American Economic Review, American Economic Association, vol. 89(2), pages 133-138, May. [Downloadable!] (restricted)
  8. McCombie, J S L, 1987. "Does the Aggregate Production Function Imply Anything about the Laws of Production? A Note," Applied Economics, Taylor and Francis Journals, vol. 19(8), pages 1121-36, August.
  9. Jesus Felipe & F. Gerard Adams, 2005. ""A Theory of Production" The Estimation of the Cobb-Douglas Function: A Retrospective View," Eastern Economic Journal, Eastern Economic Association, vol. 31(3), pages 427-445, Summer. [Downloadable!]
  10. Jesus Felipe, Carsten A. Holz, 2001. "Why do Aggregate Production Functions Work? Fisher’s simulations, Shaikh’s identity and some new results," International Review of Applied Economics, Taylor and Francis Journals, vol. 15(3), pages 261-285, July. [Downloadable!] (restricted)
  11. Shapiro, Matthew D, 1987. "Are Cyclical Fluctuations in Productivity Due More to Supply Shocks or Demand Shocks?," American Economic Review, American Economic Association, vol. 77(2), pages 118-24, May. [Downloadable!] (restricted)
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  12. Simon, Herbert A, 1979. "Rational Decision Making in Business Organizations," American Economic Review, American Economic Association, vol. 69(4), pages 493-513, September. [Downloadable!] (restricted)
  13. McCombie, John S L & Dixon, R, 1991. "Estimating Technical Change in Aggregate Production Functions: A Critique," International Review of Applied Economics, Taylor and Francis Journals, vol. 5(1), pages 24-46, January.
  14. Kim Jong-Il & Lau Lawrence J., 1994. "The Sources of Economic Growth of the East Asian Newly Industrialized Countries," Journal of the Japanese and International Economies, Elsevier, vol. 8(3), pages 235-271, September. [Downloadable!] (restricted)
  15. Edward F. Denison, 1961. "Measurement of Labor Input: Some Questions of Definition and the Adequacy of Data," NBER Chapters, in: Output, Input, and Productivity Measurement, pages 347-386 National Bureau of Economic Research, Inc. [Downloadable!]
  16. Robert E. Hall, 1988. "The Relation Between Price and Marginal Cost in U.S. Industry," NBER Working Papers 1785, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  17. Shaikh, Anwar, 1974. "Laws of Production and Laws of Algebra: The Humbug Production Function," The Review of Economics and Statistics, MIT Press, vol. 56(1), pages 115-20, February. [Downloadable!] (restricted)
  18. Ronald M. Albers, 2002. "New technologies and productivity growth in the Euro area," Working Paper Series 122, European Central Bank. [Downloadable!]
  19. Hall, Robert E, 1988. "The Relation between Price and Marginal Cost in U.S. Industry," Journal of Political Economy, University of Chicago Press, vol. 96(5), pages 921-47, October. [Downloadable!] (restricted)
  20. Nelson, Richard R, 1981. "Research on Productivity Growth and Productivity Differences: Dead Ends and New Departures," Journal of Economic Literature, American Economic Association, vol. 19(3), pages 1029-64, September. [Downloadable!] (restricted)
  21. Fisher, Franklin M & McGowan, John J, 1983. "On the Misuse of Accounting Rates of Return to Infer Monopoly Profits," American Economic Review, American Economic Association, vol. 73(1), pages 82-97, March.
  22. Barro, Robert J, 1999. " Notes on Growth Accounting," Journal of Economic Growth, Springer, vol. 4(2), pages 119-37, June. [Downloadable!] (restricted)
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  23. Labini, Paolo Sylos, 1995. "Why the interpretation of the Cobb-Douglas production function must be radically changed," Structural Change and Economic Dynamics, Elsevier, vol. 6(4), pages 485-504, December. [Downloadable!] (restricted)
  24. Nadiri, M Ishaq, 1970. "Some Approaches to the Theory and Measurement of Total Factor Productivity: A Survey," Journal of Economic Literature, American Economic Association, vol. 8(4), pages 1137-77, December. [Downloadable!] (restricted)
  25. Jesus Felipe & Franklin M. Fisher, 2003. "Aggregation in Production Functions: What Applied Economists should Know," Metroeconomica, Blackwell Publishing, vol. 54(2-3), pages 208-262, 05. [Downloadable!] (restricted)
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