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A Problem with Some Estimations and Interpretations of the Mark-up in Manufacturing Industry

  • Jesus Felipe
  • J. S. L. McCombie

This paper evaluates the methodological foundations of some recent attempts to estimate econometrically the degree of market power and the degree of returns to scale in manufacturing. The method discussed is based on estimating the aggregate production function in growth rate form. It is argued, following an argument made in another context by Phelps Brown, Shaikh & Simon, that as the data used in empirical analyses are in value terms (i.e. monetary values at constant prices), the parameter derived as a mark-up can be reinterpreted simply as a coefficient from the income accounting identity, which takes a value of unity subject to omitted variable bias. Thus, it cannot be unambiguously interpreted as a mark-up. It is also shown that the large estimates of the degree of increasing returns to scale are similarly flawed. The argument also has implications for understanding cyclical fluctuations of the Solow residual, which turns out to be largely the result of the procyclical fluctuations of the profit rate.We conclude by questioning whether the aggregate production function can ever be statistically tested or, in other words, whether it is capable of being refuted, as opposed to its parameters being merely estimated.

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Article provided by Taylor & Francis Journals in its journal International Review of Applied Economics.

Volume (Year): 16 (2002)
Issue (Month): 2 ()
Pages: 187-215

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Handle: RePEc:taf:irapec:v:16:y:2002:i:2:p:187-215
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  1. Ian Domowitz & R. Glenn Hubbard & Bruce C. Petersen, 1986. "Market Structure and Cyclical Fluctuations in U.S. Manufacturing," NBER Working Papers 2115, National Bureau of Economic Research, Inc.
  2. Tatom, John A, 1980. "The "Problem" of Procyclical Real Wages and Productivity," Journal of Political Economy, University of Chicago Press, vol. 88(2), pages 385-94, April.
  3. Robert E. Hall, 1986. "Market Structure and Macroeconomic Fluctuations," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 17(2), pages 285-338.
  4. Jesus Felipe & J. S. L. McCombie, 2003. "Some methodological problems with the neoclassical analysis of the East Asian miracle," Cambridge Journal of Economics, Oxford University Press, vol. 27(5), pages 695-721, September.
  5. Solow, Robert M, 1974. "Law of Production and Laws of Algebra: The Humbug Production Function: A Comment," The Review of Economics and Statistics, MIT Press, vol. 56(1), pages 121, February.
  6. Benjamin Eden & Zvi Griliches, 1991. "Productivity, Market Power and Capacity Utilization When Spot Markets are Complete," NBER Working Papers 3697, National Bureau of Economic Research, Inc.
  7. Robert Barsky & Mark Bergen & Shantanu Dutta & Daniel Levy, 2002. "What Can the Price Gap between Branded and Private Label Products Tell Us about Markups?," Working Papers 2002-02, Bar-Ilan University, Department of Economics.
  8. Susanto Basu & John G. Fernald, 1996. "Returns to scale in U.S. production: estimates and implications," International Finance Discussion Papers 546, Board of Governors of the Federal Reserve System (U.S.).
  9. 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.
  10. Norrbin, Stefan C, 1993. "The Relation between Price and Marginal Cost in U.S. Industry: A Contradiction," Journal of Political Economy, University of Chicago Press, vol. 101(6), pages 1149-64, December.
  11. Jesus Felipe & Carsten Holz, 2001. "Why do Aggregate Production Functions Work? Fisher's simulations, Shaikh's identity and some new results," International Review of Applied Economics, Taylor & Francis Journals, vol. 15(3), pages 261-285.
  12. Basu, S. & Fernald, J.G., 1993. "Are Apparent Productive Spillovers a Figment of Specification Error," Papers 93-22, Michigan - Center for Research on Economic & Social Theory.
  13. Hall, Robert E., 1987. "Productivity and the business cycle," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 27(1), pages 421-444, January.
  14. Waldmann, Robert J, 1991. "Implausible Results or Implausible Data? Anomalies in the Construction of Value-Added Data and Implications for Estimates of Price-Cost Markups," Journal of Political Economy, University of Chicago Press, vol. 99(6), pages 1315-28, December.
  15. Bresnahan, Timothy F., 1989. "Empirical studies of industries with market power," Handbook of Industrial Organization, in: R. Schmalensee & R. Willig (ed.), Handbook of Industrial Organization, edition 1, volume 2, chapter 17, pages 1011-1057 Elsevier.
  16. Harcourt,G. C., 1972. "Some Cambridge Controversies in the Theory of Capital," Cambridge Books, Cambridge University Press, number 9780521096720.
  17. Lucas, Robert E, Jr, 1970. "Capacity, Overtime, and Empirical Production Functions," American Economic Review, American Economic Association, vol. 60(2), pages 23-27, May.
  18. Robert E. Hall, 1986. "The Relation Between Price and Marginal Cost in U.S. Industry," NBER Working Papers 1785, National Bureau of Economic Research, Inc.
  19. Jesus Felipe & J. S. L. McCombie, 2005. "How Sound are the Foundations of the Aggregate Production Function?," Eastern Economic Journal, Eastern Economic Association, vol. 31(3), pages 467-488, Summer.
  20. 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.
  21. Simon, Herbert A, 1979. " On Parsimonious Explanations of Production Relations," Scandinavian Journal of Economics, Wiley Blackwell, vol. 81(4), pages 459-74.
  22. J. S. L. McCombie, 2001. "What Does the Aggregate Production Function Show? Further Thoughts on Solow's "Second Thoughts on Growth Theory"," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 23(4), pages 589-615, July.
  23. 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.
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