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A production function estimator with proxy variables and firm fixed effects

Author

Listed:
  • Andrey Stoyanov

    (York University, Department of Economics, Faculty of Liberal Arts and Professional Studies)

  • Nikolay Zubanov

    (Goethe University Frankfurt, Faculty of Economics and Business Administration, Grueneburgplatz 1, 60323 Frankfurt am Main, Germany)

  • Yoonseok Lee

    (Syracuse University, Department of Economics and Center for Policy Research, 426 Eggers Hall, Syracuse, NY 13244, USA)

Abstract

We show, in a very plausible theoretical setting, that control function estimators (CFEs) of firm production function, such as Olley-Pakes, may be biased. The bias will occur, in particular, when investments respond differently to short- and long-lasting changes in productivity. We modify the original CFE approach to allow for this differential response by introducing firm fixed effects to the control function. Applying our modified CFE to the data, we find that it does better than the existing CFEs in terms of controlling for persistent unobserved heterogeneity in productivity. Our findings imply that allowing firm fixed effects in the control function enhances its ability to capture firm productivity, and hence improves statistical quality of productivity estimates.

Suggested Citation

  • Andrey Stoyanov & Nikolay Zubanov & Yoonseok Lee, 2015. "A production function estimator with proxy variables and firm fixed effects," Working Papers 2015_2, York University, Department of Economics.
    • Handle: RePEc:yca:wpaper:2015_2
    as

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    References listed on IDEAS

    as
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    Keywords

    production function; control function estimator; panel data;
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