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Cambridge Journal of Economics Advance Access published online on December 13, 2007
Cambridge Journal of Economics, doi:10.1093/cje/bem043
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© The Author 2007. Published by Oxford University Press on behalf of the Cambridge Political Economy Society. All rights reserved.

Correcting for biases when estimating production functions: an illusion of the laws of algebra?

Jesus Felipe, Rana Hasan and J. S. L. McCombie*

* Jesus Felipe: Asian Development Bank, Manila, Philippines, Cambridge Centre for Economic and Public Policy, University of Cambridge, UK, Centre for Applied Macroeconomic Analysis, College of Business and Economics, Australian National University Australia; Rana Hasan: Asian Development Bank (Manila, Philippines); and J. S. L. McCombie: Cambridge Centre for Economic and Public Policy, University of Cambridge, University of Cambridge and Downing College, Cambridge, UK. The authors are grateful to Steven Durlauf and to two anonymous referees for their comments and suggestions. Any remaining errors are solely the authors'. This paper represents the views of the authors and does not represent those of the Asian Development Bank, its Executive Directors or the countries that they represent

Address for correspondence: Jesus Felipe, Asian Developement Bank, Manila, Philippines, Email: Jfelipe{at}adb.org

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.

Key Words: Accounting identity • Endogeneity • Omitted-variable bias • Production function

JEL classifications: C13, D24, O47

Manuscript received May 21, 2007; final version received September 5, 2007.


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