Correcting for Biases When Estimating Production Functions: An Illusion of the Laws of Algebra?

Abstract

This paper shows that the endogeneity bias that allegedly appears when estimating production functions using value data, and which the literature has tried to deal with since the 1940s, is simply the result of omitted-variable bias due to a poor approximation to an accounting identity. This problem has no econometric solution. As a result, recent attempts to solve the problem by developing new estimators are questioned. The only possible way to estimate the technological parameters of the production function is to use physical quantities.

Keywords: Accounting identity, Endogeneity, Omitted-variable bias, Production function

JEL Classification: C13, D24, O47