Assessing the effects of measurement errors on the estimation of the production function

This article explores the reasons why GMM estimators of production function parametersare generally found to produce unsatisfactory results. I attribute this finding to the inaccurateconstruction of the variables used in production function analysis. In particular, I suggest that theproblem lies in the use of common price deflators as well as in a capital variable that does notreflect the true flow of capital services because of short-run equilibrium effects. I show that thepractice of using industry-wide deflators leads to lower scale estimates, mainly due to a relevantdownward bias in the labour coefficient. At the same time, it introduces a large upward bias inestimating the elasticity of output with respect to technological innovation. Moreover, asignificant improvement in the estimates of capital coefficients is obtained if the information onthe degree of capacity utilization is adequately exploited