Estimating Production Functions with Fixed Effects

I propose an estimation procedure that can accommodate fixed effects in the widely used proxy variable approach to estimating production functions. The proposed procedure allows unobserved productivity to have a permanent component in addition to a (nonlinear) Markov shock. In contrast to dynamic panel methods, the procedure does not rely on differencing out the fixed effect and thus is not limited to within-firm variation for identification. Finally, implementation is straightforward since it only entails adding a two stage least squares step using internal instruments