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Unformatted text preview: ISSN 0111-1760 How Sound are the Foundations of the Aggregate Production Function? J Felipe & JSL McCombie No. 0116 Jesus Felipe is at the Georgia Institute of Technology and JSL McCombie is Fellow and Director of Studies of Economics, Downing College, Cambridge. We are grateful, as usual, for the comments and encouragement of Geoff Harcourt. We are also grateful for the comments received at seminars given at the University of Otago and the Victoria University of Wellington, New Zealand. Email: firstname.lastname@example.org and email@example.com September 2001 Department of Economics School of Business University of Otago PO Box 56 Dunedin NEW ZEALAND Ph: 00 64 3 479 8725 Fax: 00 64 3 479 8174 Email: firstname.lastname@example.org 1 How Sound are the Foundations of the Aggregate Production Function? J Felipe 1 & JSL McCombie Abstract: The aggregate production function has been subject to a number of criticisms ever since its first empirical estimation by Cobb and Douglas in the 1920s, notably the problems raised by aggregation and the Cambridge Capital Theory Controversies. There is a further criticism due initially to Phelps Brown (and elaborated, in particular, by Simon and Shaikh) which is not so widely known. This critique is that because at the aggregate level only value data can be used to estimate production function, this means that the estimated parameters of the production function are merely capturing an underlying accounting identity. Hence, no reliance can be placed on estimates of, for example, the elasticity of substitution as reflecting technological parameters. The argument also explains why good statistical fits of the aggregate production functions are obtained, notwithstanding the difficulties posed by the aggregation problem and the Cambridge Capital Controversies noted above. This paper outlines and assesses the Phelps Brown critique and its extensions. In particular, it considers some possible objections to his argument and demonstrates that they are not significant. It is concluded that the theoretical basis of the aggregate production function is problematic. JEL Classification : O3 O4 Keywords : Cobb-Douglas, production function, income identity Introduction It is somewhat paradoxical that one of the concepts most widely used in macroeconomics, namely the aggregate production function, is the one whose theoretical rationale is perhaps most suspect. The serious problems raised by the Cambridge Capital Theory Controversies dominated high theory in the late 1960s and early 1970s, and eventually led to an agreement that reswitching and capital reversing were theoretically possible (Harcourt, 1972). This posed serious problems for the justification of the use of the neoclassical one-sector aggregate production function as a parable. The revival of interest in growth theory with the development of endogenous growth theory is still squarely in the tradition of the neoclassical 1 Jesus Felipe is at the Georgia Institute of Technology and JSL McCombie is Fellow and Director of...
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