427

Eastern Economic J ournal, Vol . 31, No. 3, Summer 2005

J esus Felipe: Asi an Devel opment Bank, P. O. Box 789, 0980 Mani l a, Phi l i ppi nes. E-mai l : jfel i pe@adb.org.
A THEORY OF PRODUCTION
1
THE ESTIMATION OF THE COBB-DOUGLAS
FUNCTION: A RETROSPECTIVE VIEW
J esus Felipe
Asian Development Bank
and
F. Gerard Adams
Northeastern University
As Solow once remarked to me, we would not now be concerned with
the question [the existence of the aggregate production function] had
Paul Douglas found labors share of American output to be twenty-five
per cent and capitals share seventy-five instead of the other way around
[Fi sher, 1969, 572].
I hope that someone skilled in econometrics and labor will audit and
evaluate my critical findings [Samuel son, 1979, 934].
INTRODUCTION
Despi te honori ng Dougl ass i mportant contri buti ons to economi cs, to the poi nt of
argui ng that I f Nobel Pri zes had been awarded i n economi cs [], Paul H. Dougl as
woul d probabl y have recei ved one before Worl d War I I for hi s pi oneeri ng econometri c
attempts to measure margi nal producti vi ti es and quanti fy the demands for factor i nputs
[Samuel son, 1979, 923], Samuel son [1979] offered a grave assessment of the empi ri cal
si gni fi cance of the Cobb-Dougl as producti on functi on and the associ ated margi nal
producti vi ti es. The argument that Samuel son sketched i s that the parameters of what
i s bel i eved to be an aggregate producti on functi on may be no more than the outcome
of an i ncome di stri buti on i denti ty. I t i s i roni c that thi s same argument had been put
forward very cl earl y by other schol ars wel l before Samuel son. The professi on, how-
ever, i gnored i t. The argument had appeared i n Phel ps Brown [1957], Si mon and
Levy [1963] and Shai kh [1974]. Moreover, Si mon [1979] thought that the argument
was so i mportant that he di scussed i t i n hi s Nobel Lecture. Shaikh [1980] provides one
of the most comprehensive treatments of the earl y di scussi ons of the argument. More
recent di scussi ons and extensi ons are provi ded by Fel i pe and McCombi e. See refer-
ences.
Marlia Fitriana
1211011091
428
EASTERN ECONOMI C JOURNAL
The Cobb-Dougl as producti on functi on i s sti l l today the most ubi qui tous form i n
theoreti cal and empi ri cal anal yses of growth and producti vi ty. The esti mati on of the
parameters of aggregate producti on functi ons i s central to much of todays work on
growth, technol ogi cal change, producti vi ty, and l abor. Empi ri cal esti mates of aggre-
gate producti on functi ons are a tool of anal ysi s essenti al i n macroeconomi cs, and
i mportant theoreti cal constructs, such as potenti al output, techni cal change, or the
demand for l abor, are based on them.
This paper takes up Paul Samuelsons invitation (quoted above) to evaluate empirically
his arguments; and it does so by using the original data set of Cobb and Douglas [1928].
The ori gi ns of the Cobb-Dougl as form date back to the semi nal work of Cobb and
Douglas [1928], who used data for the U.S. manufacturing sector for 1899-1922 (although,
as Brown [1966, 31], Sandel i n [1976], and Samuel son [1979] i ndi cate, Wi cksel l shoul d
have taken the credi t for i ts di scovery, for he had been worki ng wi th thi s form i n the
19th century).
At the ti me, Dougl as was studyi ng the el asti ci ti es of suppl y of l abor and capi tal ,
and how thei r vari ati ons affected the di stri buti on of i ncome [Dougl as, 1934]. To make
sense of and i nterpret the numbers obtai ned, Dougl as needed a theory of producti on.
He began by pl otti ng the seri es of output (Day i ndex of physi cal producti on), l abor
(workers empl oyed), and fi xed capi tal on a l og scal e. He noted that the output curve
l ay between the two curves for the factors, and tended to be approxi matel y one quar-
ter of the di stance between the curves of the two factors (Fi gure 1).
FIGURE 1
Cobb-Douglas [1928] Data Set (Logarithmic Scale)
6.2122
5.6278
Log (K)
Log (Y)
Log (L) 5.0435
4.4591
1899 1905 1911 1917 1922
Wi th the hel p of Cobb, Dougl as esti mated econometri cal l y what i s known today as
the Cobb-Dougl as producti on functi on. Thi s semi nal paper pl ays a paramount rol e i n
the hi story of economi cs, si nce i t was the fi rst ti me that an aggregate producti on
functi on was esti mated econometri cal l y and the resul ts presented to the economi cs
professi on, al though as Levi nsohn and Petri n [2000] note, economi sts had been rel at-
429
THE ESTI MATI ON OF THE COBB-DOUGLAS FUNCTI ON
i ng output to i nputs si nce the earl y 1800s. The esti mated OLS regressi on Q
t
= B(L
t
)

(K
t
)

,
where Q
t
, L
t
, and K
t
represent (aggregate) output, l abor, and capi tal , respecti vel y, and
B i s a constant, showed that the el asti ci ti es came remarkabl y cl ose to the observed
factor shares i n the Ameri can economy, that i s, = 0.75 for l abor and = 0.25 for
capi tal (Cobb and Dougl as esti mated the regressi on i mposi ng constant returns to scal e
i n per capi ta terms. Standard errors and R were not reported). These results were
taken, implicitly, as empirical support for the existence of the aggregate production func-
tion, as well as for the validity of the marginal productivity theory of distribution.
Dougl as [1967] documents that the Cobb-Dougl as producti on functi on was recei ved
wi th great hosti l i ty. The attacks were from both the conceptual and econometri c poi nts
of vi ew. At the ti me, many economi sts cri ti ci zed any stati sti cal work as futi l e (i t was
argued that the neocl assi cal theory was not quanti fi abl e). Others l aunched an econo-
metri c cri ti que agai nst thi s work, noti ci ng probl ems of mul ti col l i neari ty, the presence
of outl i ers, the absence of techni cal progress, and the aggregati on of physi cal capi tal .
These i ssues were rai sed and di scussed by Samuel son [1979].
I n thi s paper we ful l y devel op the argument that al l the esti mati on of the Cobb-
Dougl as functi on does i s to reproduce the i ncome accounti ng i denti ty that di stri butes
val ue added between wages and profi ts. I f thi s i s the case, one must seri ousl y questi on
not onl y Cobb and Dougl as ori gi nal resul ts, but the pl ethora of esti mati ons carri ed
out duri ng the l ast seven decades.
To begi n, one must remember that two strands of the l i terature questi oned l ong
ago the noti on of an aggregate producti on functi on from a theoreti cal poi nt of vi ew.
These are summari zed and di scussed by Fel i pe and Fi sher [2003]. One strand i s the
so-cal l ed Cambri dge (UK) Cambri dge (USA) capi tal debates. I n a semi nal paper,
Joan Robi nson [1953-54] asked the questi on that tri ggered such debate: I n what uni t
i s capi tal to be measured? Robi nson was referri ng to the use of capi tal as a factor of
producti on i n aggregate producti on functi ons. Because capi tal goods are a seri es of
heterogeneous commodi ti es (i nvestment goods), each havi ng speci fi c techni cal char-
acteri sti cs, i t i s impossible to express the stock of capi tal goods as a homogeneous
physi cal enti ty. Robi nson cl ai med that onl y thei r val ues can be aggregated. Therefore,
i t i s i mpossi bl e to get any noti on of capi tal as a measurabl e quanti ty i ndependent of
di stri buti on and pri ces.
2
The second strand of the l i terature that questi ons the noti on of aggregate produc-
ti on functi on i s known as the aggregati on l i terature. Thi s one studi es the condi ti ons
under whi ch neocl assi cal mi cro producti on functi ons can be aggregated i nto a neocl as-
si cal aggregate producti on functi on. The best exponent of thi s work i s Frankl i n Fi sher,
whose extensi ve work began i n the mi d 1960s and was compi l ed i n Fi sher [1993].
Fi sher concl uded that the condi ti ons for successful aggregati on of mi cro producti on
functi ons i nto an aggregate producti on functi on wi th neocl assi cal properti es are so
stri ngent that one shoul d not expect any real economy to sati sfy them. The concl u-
si ons of the Cambri dge debates and the aggregati on l i terature are so damagi ng for the
noti on of an aggregate producti on functi on that one wonders why i t conti nues bei ng
used. The answer of the defenders of the use of aggregate producti on functi ons, as
Cohen and Harcourt [2003, 209] note, i s that these l owbrow model s remai n heuri s-
ti cal l y i mportant for the i ntui ti on they provi de, as wel l as the basi s for empi ri cal work,
430
EASTERN ECONOMI C JOURNAL
that can be tractabl e, frui tful and pol i cy-rel evant. I f Samuel son [1979] was correct,
however, thi s i nstrumental i st posi ti on i s probl emati c and i ndefensi bl e.
The rest of the paper i s structured as fol l ows. I n the next secti on we re-esti mate
the Cobb-Dougl as functi on wi th the ori gi nal Cobb-Dougl as [1928] data set, taken from
Pesaran and Pesaran [1997, data fi l e CD.FI T] and reproduced i n Tabl e 1.
TABLE 1
Output, Labor, and Capital
Year Output Labor Capi tal
1899 100 100 100
1900 101 105 107
1901 112 110 114
1902 122 118 122
1903 124 123 131
1904 122 116 138
1905 143 125 149
1906 152 133 163
1907 151 138 176
1908 126 121 185
1909 155 140 198
1910 159 144 208
1911 153 145 216
1912 177 152 226
1913 184 154 236
1914 169 149 244
1915 189 154 266
1916 225 182 298
1917 227 196 335
1918 223 200 366
1919 218 193 387
1920 231 193 407
1921 179 147 417
1922 240 161 431
Source: Pesaran and Pesaran [1997; data fi l e CD.FI T].
We poi nt out a seri es of probl ems, i n parti cul ar the poor resul ts obtai ned once an
exponenti al ti me trend i s i ntroduced i n the regressi on i n order to capture the evol u-
ti on of techni cal progress. Most l i kel y, i f Cobb and Dougl as had i ntroduced the trend
i n thei r functi on, thei r resul ts woul d not have been publ i shed, and, as Sol ow poi nted
out, we woul d not now be di scussi ng aggregate producti on functi ons. We then provi de
a si mpl e i nterpretati on of what the esti mated parameters of the aggregate Cobb-Dougl as
producti on functi on are. As Samuel son [1979] conjectured, thi s expl anati on i s that al l
the aggregate Cobb-Dougl as functi on regressi on captures i s the path of the val ue
added accounti ng i denti ty accordi ng to whi ch val ue added equal s the sum of the wage
bi l l pl us total profi ts. I n thi s secti on, the Cobb-Dougl as form i s si mpl y deri ved as an
al gebrai c transformati on of the i denti ty. Thi s transformati on embodi es the resul t that
the esti mated parameters must be the factor shares. Then we take a second l ook at
the Cobb-Dougl as [1928] data set i n l i ght of the di scussi on i n the previ ous secti on and
sol ve the conundrum regardi ng the ti me trend. We conti nue by aski ng whether the
aggregate producti on functi on provi des an adequate framework to test for constant
returns to scal e and competi ti ve markets through the margi nal producti vi ti es. Thi s i s
431
THE ESTI MATI ON OF THE COBB-DOUGLAS FUNCTI ON
an i mportant questi on because Dougl as was convi nced that the coi nci dence of the
esti mated coeffi ci ents wi th the actual factor shares recei ved by l abor and capi tal cor-
roborated the neocl assi cal theory of i ncome di stri buti on. Thi s i ssue i s rel evant for
todays work.
A FIRST LOOK AT THE EMPIRICAL EVIDENCE
Tabl e 2 reports several regressi ons and resul ts very si mi l ar to those obtai ned by
Cobb and Dougl as. These resul ts wi l l hel p us hi ghl i ght some of the i ni ti al cri ti ci sms
thei r work faced. The fi rst regressi on reports unrestri cted esti mates of the regressi on
Q
t
= B(L
t
)

(K
t
)

i n l ogari thms. The resul ts i ndi cate that the constant returns to scal e
restri cti on i s not rejected by the data. These resul ts are suffi ci entl y good to val i date
Cobb and Dougl ass poi nt. I n parti cul ar, the two el asti ci ti es are rel ati vel y cl ose to the
observed factor shares i n output, and thus add up to one, i ndi cati ng constant returns
to scal e (chi -square test). The second regressi on shows the esti mates of the regressi on
i n per capi ta terms and i mposi ng the constant returns to scal e restri cti on, as Cobb and
Dougl as esti mated i t i ni ti al l y. The i mpl i ci t el asti ci ty of l abor i s 0.751 wi th a t-val ue of
16.15.
TABLE 2
Cobb-Douglas Regression, I
(1899-1922 unless otherwise indicated; OLS estimates)
1. l nQ
t
= c + l nL
t
+ l nK
t
Constant
0.18 0.807 0.233
(0.41) (5.56) (3.67)
R
2
= 0.975; D.W. = 1.52;
1
2
= 0.19
2. I N PER CAPI TA TERMS:
l n(Q
t
/L
t
) = ( + 1)l nL
t
+ l n(K
t
/L
t
) Constant 1
0.18 0.04 0.233
(0.41) (0.44) (3.67)
R
2
= 0.636; D.W. = 1.52
3. l nQ
t
= c + T + l nL
t
+ l nK
t
Constant
2.81 0.0468 0.906 0.526
(2.03) (2.26) (4.48) (1.54)
R
2
= 0.966; D.W. = 1.63
4. q
t
= + ,
t
+ k
t

0.10 1.39 1.51
(2.77) (8.53) (2.53)
R
2
= 0.80; D.W. = 1.67;
1
2
= 4.59
5. ESTI MATI ON PERI OD:
1899-1920: l nQ
t
= c + l nL
t
+ l nK
t
Constant
0.79 1.09 0.08
(1.42) (4.88) (0.73)
R
2
= 0.972; D.W. = 1.21;
1
2
= 2.13
Chi -square test (
1
2
): H
0
: + = 1 (cri ti cal val ue 5 percent si gni fi cance l evel : 3.84). t-stati sti cs i n parentheses.
432
EASTERN ECONOMI C JOURNAL
These esti mates, however, soon ran i nto the cri ti ci sm that Cobb and Dougl as had
not i ncl uded a measure of techni cal progress i n thei r equati on. Samuel son [1979, 924]
cl ai ms that Schumpeter was shocked that the Cobb-Dougl as formul a di d not al l ow for
techni cal progress.
3
The sol uti on proposed was to add an exponenti al ti me trend to the
regressi on. We therefore re-esti mated i t, i ncl udi ng an exponenti al ti me trend (T),
that i s, Q
t
= Be
T
(L
t
)

(K
t
)

, i n l ogari thms and unrestri cted. The resul ts, shown i n the
thi rd regressi on of Tabl e 2, are somewhat surpri si ng i n that now the coeffi ci ent of the
i ndex of capi tal i s negati ve and i nsi gni fi cant. Neverthel ess, despi te these resul ts, the
regressi on di spl ays a fi t of 0.966. The negati ve si gn of the capi tal coeffi ci ent remai ns
i n the fourth regressi on, when the equati on i s esti mated i n growth rates (and worse,
the coeffi ci ent now i s stati sti cal l y si gni fi cant). Al though the fi t i s l ower, i t i s sti l l a not
negl i gi bl e 0.80. Fi nal l y, to test for stabi l i ty, the fi fth regressi on was esti mated for
1899-1920. One mi ght argue that the years 1921-22 coul d be taken to be outl i ers si nce
output dropped by al most a quarter and then recovered. Al though the resul ts are very
poor (see el asti ci ti es), the fi t conti nues to be very hi gh. And the recursi ve and rol l i ng
esti mati ons of thi s regressi on (not shown but avai l abl e upon request) prove i ts fragi l -
i ty. Onl y the regressi on wi th the compl ete peri od yi el ds sensi bl e resul ts. We thus
concl ude that i f computer technol ogy had al l owed Cobb and Dougl as to perform the
anal ysi s carri ed out here, thei r resul ts woul d have been di smi ssed.
We must note that the resul t of a negati ve capi tal coeffi ci ent i s not news to those
who have esti mated Cobb-Dougl as producti on functi ons. I n fact, i t i s a standard fi nd-
i ng [Lucas, 1970; Romer, 1987; Kl ette and Gri l i ches, 1996; Gri l i ches and Mai resse,
1998]. How can these resul ts be i nterpreted i f one i nsi sts that a producti on functi on
has been esti mated? Why does the regressi on work better wi thout a ti me trend, whi ch
proxi es the evol uti on of technical progress? Do we have to open the econometri cs and
data-mi ni ng tool ki ts and torture the data unti l more acceptabl e resul ts appear (for
exampl e, endogenei ty of the regressors, uni t roots and possi bl e coi ntegrati on i ssues,
l ack of adjustment of the stock of capi tal for uti l i zati on capaci ty)? Or, do we need to
devel op a new growth model to justi fy a negati ve (or zero) el asti ci ty for capi tal ? We
bel i eve a more parsi moni ous expl anati on can be provi ded.
THE INCOME ACCOUNTING IDENTITY AND THE AGGREGATE
PRODUCTION FUNCTION
As i ndi cated i n the I ntroducti on, the argument of thi s paper i s that al l esti mati ons
of aggregate producti on functi ons do i s to reproduce the di stri buti on i ncome account-
i ng i denti ty. I n thi s secti on we devel op the argument. To begi n, l et us wri te the i n-
come accounti ng i denti ty for real val ue added (Q), that i s, the di fference between
gross output and i ntermedi ate materi al s, at ti me t, whi ch equal s the sum of the total
wage bi l l (W) pl us total profi ts () [Samuel son, 1979]. Thi s i s:
(1) Q
t
= W
t
+
t
= w
t
L
t
+ r
t
K
t
,
where w i s the average real wage rate, L i s total empl oyment, r i s the observed real
profi t rate (not the rental pri ce of capi tal ), and K i s the stock of capi tal . Thi s expres-
si on i s si mpl y an accounti ng i denti ty that expresses how val ue added i s di vi ded between
wages and total profi ts (the l atter i ncl udes both pure profi ts and the i mputed cost of
433
THE ESTI MATI ON OF THE COBB-DOUGLAS FUNCTI ON
capi tal ), and does not requi re any assumpti on (for exampl e, economi c profi ts are zero,
constant returns). I n the words of Samuel son: No one can stop us from l abel i ng thi s
l ast vector [resi dual l y computed profi t returns to property or to the nonl abor factor]
as (RC
j
), as J.B. Cl arks model woul d permi teven though we have no warrant for
bel i evi ng that noncompeti ti ve i ndustri es have a common profi t rate R and use l eets
capi tal (C
j
) i n proporti on to the (P
j
q
j
W
j
L
j
) el ements! [Samuel son, 1979, 932].
To conti nue wi th the argument, total l y di fferenti ate the i denti ty Equati on (1) wi th
respect to ti me and express i t i n growth rates. Thi s yi el ds:
(2) q a w a r a a k a a k
t t t t t t t t t t t t t t
= + + + = + + ( ) ( ) ( ) 1 1 1 ,
where l owercase l etters denote the growth rates of the correspondi ng vari abl es (and
wi th ^ for the wage and profi t rates),
t t t t
w r
t
= + ( ) a a

1 , a
t
= (w
t
L
t
)/Q
t
i s the l abor
share, and 1 a
t
= (r
t
K
t
)/Q
t
i s the capi tal share.
Now suppose that i n thi s economy the factor shares are constant (that i s, a
t
= a),
and that the wage and profi t rates grow at constant exponenti al rates, that i s, w e
t
wt
=
( )

and r e
t
rt
=
( )

, where t denotes ti me, and

w and
r denote the constant growth rates of
the wage and profi t rates, respecti vel y.
4
Thi s i mpl i es that the i denti ty Equati on (2),
under these two assumpti ons, becomes:
(3) q aw a a a k a a k
t t t t t
= + + + = + + ( )

( ) ( ) 1 1 1 r ,
where = + aw a
(1- )r i s a constant. Now i ntegrate Equati on (3). Thi s yi el ds:
(4) Q
t
= Ae
t
(L
t
)
a
(K
t
)
1 a
,
where A i s the constant of i ntegrati on.
What i s Equati on (4)? Gi ven what we have done (that i s, di fferenti ate and i nte-
grate an i denti ty), Equati on (4) must be the i denti ty Equati on (1) rewri tten under the
two assumpti ons that the observed factor shares are constant and that the wage and
profi t rates grow at constant rates (Equati on (4) i s an i denti ty if and only if the two
assumpti ons about the shares are correct). Of course, the i nteresti ng poi nt i s that
Equati on (4) resembles the Cobb-Dougl as producti on functi on wi th el asti ci ti es equal to
the observed factor shares, and a neutral ti me shi ft.
This argument has several implications.
5
First, if the assumptions about the observed
factor shares and the wage and profi t rates are correct, and i f one esti mates an equa-
ti on l i ke Equati on (4) unrestri cted, i t wi l l yi el d a (suspi ci ous) perfect fi t wi th el asti ci -
ti es equal to the factor shares (and thus constant returns). On the other hand, i f the
assumpti ons are i ncorrect, esti mati on of Equati on (4) wi l l not yi el d perfect resul ts
(how good they are wi l l depend on how far the two assumpti ons are from the real i ty).
I f thi s i s the case, i t must be because one or both assumpti ons are empi ri cal l y wrong
(and thus we fi tted an i ncorrect functi onal form).
6
But thi s does not i nval i date the
argument. I t si mpl y means that we need other assumpti ons about the paths of the
factor shares and wage and profi t rates, thus potenti al l y l eadi ng to other functi onal
forms, such as the CES or the transl og (that i s, other aggregate producti on functi ons
that are no more than parti cul ar cases of the i ncome accounti ng i denti ty [Fel i pe and
434
EASTERN ECONOMI C JOURNAL
McCombi e, 2001; 2003]). I n other words, the i denti ty Q = wL + rK can al ways be
transformed i nto the form Q = F(L, K, t), where t i s a sui tabl e functi on of ti menot
necessari l y an exponenti al ti me trend. The esti mated functi on F() wi l l have al l the
properti es of a neocl assi cal producti on functi on.
Second, si nce what has been esti mated i s si mpl y an i denti ty, or a very good approxi -
mati on to i t, nothing can be i nferred. And from the econometri c poi nt of vi ew, i ssues
such as endogenei ty pr obl ems and the possi bl e i nconsi stency of the esti mates
[Levi nsohn and Petri n, 2000], the presence of uni t roots (and coi ntegrati on), or the
esti mati on method, are i rrel evant. I t i s an i denti ty!
Fi nal l y, Equati ons (3) and (4) i ndi cate that the putati ve el asti ci ti es must add up to
one (constant returns to scal e), and that they must be equal to the factor shares
(perfect competi ti on). No other resul t i s possi bl e. But i s thi s the resul t of Eul ers
theorem? Does thi s i mpl y that the economy i s characteri zed by constant returns and
competi ti ve markets? Nonsense, Samuel son [1979, 933] cl ai med. Thi s i s purel y the
resul t of the accounti ng i denti ty. We wi l l return to thi s i ssue i n a l ater secti on.
Thi s anal ysi s al so l eads us to questi oni ng the standard i nterpretati on of the coef-
fi ci ent of the ti me trend as a proxy for the rate of technol ogi cal progress. I f the aggre-
gate producti on functi on does not exi st because of the aggregati on probl ems, on what
grounds i s such a coeffi ci ent a measure of the rate of techni cal progress? What we
know wi th certai nty, because i t fol l ows from the i denti ty Equati on (4), i s that the sai d
coeffi ci ent equal s = = ( ) + a a

w r 1 (under the assumpti ons stated). Thi s magni tude
i s si mpl y a wei ghted average of the growth rates of the wage and profi t rates, where
the wei ghts are the observed factor shares. Thi s i s a measure of di stri buti onal changes
[Shai kh, 1980], al though not necessari l y i n a zero-sum sense.
Al ternati vel y, suppose that i nstead of fi tti ng econometri cal l y the aggregate pro-
ducti on functi on, one carri es out a growth accounti ng exerci se. For thi s, one woul d
assume that a fl exi bl e aggregate producti on functi on Q
t
= A(t)F(L
t
, K
t
) exi sts, where
A(t) i s the l evel of technol ogy (i n general i t need not be neutral ). Expressi ng i t i n
growth rates and further assumi ng profi t maxi mi zati on and perfectl y competi ti ve
markets i t yi el ds q
t
=
t
+ a
t
,
t
+ (1 a
t
)k
t
, where
t
i s the growth rate of techni cal
progress [Sol ow, 1957]. Note, however, that thi s expressi on i s i denti cal wi th Equati on
(2), the i denti ty i n growth rates, whi ch was deri ved wi thout maki ng any assumpti on
and any reference to a producti on functi on. Overal l , thi s anal ysi s supports Samuel sons
[1979, 935-36] cri ti cal eval uati on of the resi dual studi es.
7
After acknowl edgi ng the cri ti ci sms for hi s ti me seri es work, i n parti cul ar that the
regressi ons were fragi l e after droppi ng a number of years, Dougl as moved on to cross
secti on esti mati on. He thought that hi s resul ts were much more robust: I t i s hard to
bel i eve that these esti mates can be purel y acci dental [Dougl as, 1948, 40-41]. How-
ever, Samuel son [1979, 932-34] concl uded that they al so fol l owed purel y as a cross-
secti onal tautol ogy based on the resi dual computati on of the nonwage share. I t i s easy
to show that a Tayl or seri es approxi mati on of the val ue added accounti ng i denti ty
wri tten for a cross secti on, and assumi ng l ow di spersi on of factor shares, yi el ds a form
that resembl es a Cobb-Dougl as producti on functi on [Fel i pe, 2001a]. I n thi s case, the
transformati on of the cross-secti on val ue-added i denti ty Q
i
= w
i
L
i
+ r
i
K
i
yi el ds:
435
THE ESTI MATI ON OF THE COBB-DOUGLAS FUNCTI ON
(5) l n , l n l n l n Q w r L K
i i i i i
+ + + ( ) ( ) + B a a al n a 1 1
where B = a a al n a l n , l n l n l n Q w r L K ( ) ( ) 1 1 i s a constant and a bar over
the correspondi ng vari abl e i ndi cates the average of the cross secti on.
The Cobb-Dougl as for a cross secti on i s:
(6) Q L K
i i i
= A


.
I f one now esti mates a l ogari thmi c regressi on of output on l abor and capi tal for a
cr os s s ecti on of i n du s tr i es , r egi on s , or cou n tr i es , i t i s obv i ou s th at i f
N B a a = + + ( ) l n l n w r
i i
1 i n Equati on (5) i s approxi matel y constant (i f w
i
and r
i
do
not vary too much), the regressi on, whi ch takes the form of Equati on (6), wi l l work
econometri cal l y. I f that i s the case, one wi l l fi nd a a = , b a = ( ) 1 . As we have argued
before, si nce there i s no reference to a producti on functi on i n the deri vati on of Equa-
ti on (5), the econometri c resul ts shoul d not be i nterpreted as those stemmi ng from
any such functi on.
A REEVALUTAION OF THE EMPIRICAL EVIDENCE AND A
PARSIMONIOUS EXPLANATION
The second step i n answeri ng the questi ons posed at the end of the second secti on
i s to provi de empi ri cal evi dence. Fi rst, one must real i ze that, as shown above, the
equati ons esti mated i n Tabl e 2 can be deri ved from the i ncome i denti ty. I n order to
deri ve Equati on (4) from the i denti ty, we made two assumpti ons about the data. Fi rst,
that the observed factor shares are constant; and second, that wage and profi t rates
grow at constant rates. I f we had data on factor shares, both hypotheses coul d be
tested. Si nce we do not, the most we can do i s conjecture. Most l i kel y, the fi rst assump-
ti on i s correct. Al though factor shares were not exactl y constant for the peri od of
esti mati on, probabl y they were sufficiently constant for regressi on purposes.
8
The
second assumpti on i s the one that i s, most l i kel y, i ncorrect, and the one that makes
the regressi on wi th the ti me trend turn out wi th such i nexpl i cabl e resul ts. I t i s not
true that wage and profi t rates i ncreased at a constant rate. Thi s i mpl i es that the
exponenti al ti me trend provi des a poor approxi mati on to the evol uti on of
t
and i ts
i ncl usi on i n the regressi on bi ases the esti mates of the el asti ci ti es.
The path of
t
i s si mpl y an empi ri cal i ssue. Once we approxi mate i t, we woul d pl ug
i t i nto Equati on (2) and proceed as above. We have graphed
t t t t t
w r = +
( )
a a

1 for a
seri es of pl ausi bl e val ues. I t di spl ays a saw tooth shape around zero. Thus, for exampl e,
a tri gonometri c functi on wi th si nes and cosi nes shoul d provi de a much better approxi -
mati on than that provi ded by the si mpl e l i near ti me trend (nothi ng i n neocl assi cal
economi cs says that techni cal progress must be approxi mated through a l i near ti me
trend). Through tri al and error we fi tted the fi rst regressi on i n Tabl e 3, whi ch i ncl udes
as a regressor the vari abl e A(t) = [si n(T
5
) + cos(T
4
) cos(T
2
) si n(T
2
)] (where T denotes
ti me, si n i s the si ne functi on, and cos i s the cosi ne functi on), wi th esti mated coeffi -
ci ent = 0.032, stati sti cal l y si gni fi cant. Surel y thi s approxi mati on can sti l l be i mproved.
436
EASTERN ECONOMI C JOURNAL
TABLE 3
Cobb-Douglas Regression, II
(1899-1922 unless otherwise indicated;OLS estimates unless otherwise indicated)
1. l nQ
t
= A(t) + l nL
t
+ l nK
t

0.032 0.726 0.274
(3.48) (18.83) (7.71)
R
2
= 0.973; D.W. = 1.95;
1
2
= 0.02
2. q k q k VA L K
t t t t t t t t
= + + + + + + +


1 2 3 1 4 1 5 1 6 1 7 1 8
l n l n l n
tt1

1

2

3

4

5

6

7

8
1.00 0.98 0.31 0.56 0.95 0.78 0.59 0.19
(8.18) (1.70) (1.65) (2.19) (1.72) (3.24) (3.24) (2.76)

L
= 0.758 (14.95);
K
= 0.249 (5.30); R
2
= 0.952; D.W. = 2.31;
1
2

= 0.56
3. ESTI MATI ON PERI OD 1899-1920:
l nQ
t
= A(t) + l nL
t
+ l nK
t

0.023 0.756 0.246
(2.50) (15.84) (5.52)
R
2
= 0.977; D.W. = 1.76;
1
2
= 0.43
4. I N PER CAPI TA TERMS:
l n(Q
t
/L
t
) = A(t) + ( + 1)l nL
t
+ l n(K
t
/L
t
) + 1
0.029 0.001 0.259
(2.39) (0.43) (6.64)
R
2
= 0.768; D.W. = 1.95
5. NON-LI NEAR LEAST SQUARES:
Q
t
= e
A(t)
L
t

K
t

+ u
t

0.033 0.722 0.277
(3.65) (16.12) (6.80)
R
2
= 0.964; D.W. = 1.90;
1
2
= 0.00012
Notes: Chi -square test (
1
2
): H
0
: + = 1 (cri ti cal val ue 5 percent si gni fi cance l evel : 3.84). t-stati sti cs i n
parentheses. I ni ti al val ues for nonl i near l east squares: = 0.03; = 0.75; = 0.25.
Why does A(t) wor k? Assume i n Equati on (2) above that the factor shar es a
t
and
(1 - a
t
) ar e constant and i ntegr ate i t. Thi s l eads to Q
t
= (w
t
)
a
(r
t
)
1 a
(L
t
)
a
(K
t
)
1 a
. I f i ndeed
factor shares were exactl y constant, thi s expressi on woul d be the i denti ty, and so al l
A(t) i n the fi rst regressi on i n Tabl e 3 does i s approxi mate the term (w
t
)
a
(r
t
)
1 a
. We can
therefore compute the val ue of (w
t
)
a
(r
t
)
1 a
through the rati o Q
t
/ (L
t
)
a
(K
t
)
1 a
. The graph
of thi s rati o i s shown i n Fi gure 2, and the approxi mati on through A(t) = [si n(T
5
) +
cos(T
4
) cos(T
2
) si n(T
2
)] i s gi ven i n Fi gure 3. Al though the approxi mati on i s not
perfect (the correl ati on between A(t) and Q
t
/ (L
t
)
a
(K
t
)
1 a
i s 0.588), i t i s certai nl y much
better than that provi ded by the exponenti al ti me trend and, as argued above, i t sug-
gests that fi ndi ng the exact path i s si mpl y a matter of tri al and error and a dose of
pati ence i n front of a computer.
9
437
THE ESTI MATI ON OF THE COBB-DOUGLAS FUNCTI ON
FIGURE 2
Q/[(L
0.75
)*(K
0.25
)]

1.1883
1.0967
1.0051
.91357
1899 1905 1911 1917 1922
FIGURE 3
A(t) = sin(T
5
) + cos(T
4
) cos(T
2
) sin(T
2
)

2.1885
.36396
1.4606
3.2852
1899 1905 1911 1917 1922
Summi ng up: what was the probl em wi th the regressi on wi th the l i near trend?
Whi l e i t appears that the factor shares were suffi ci entl y constant for the Cobb-Dougl as
form to work as a way to approxi mate an accounti ng i denti ty, the l i near trend was a
bad choi ce to approxi mate the wei ghted average of the wage and profi t rates.
Regardi ng the equati on i n growth rates, the second equati on i n Tabl e 3 shows a
good approxi mati on to Equati on (2) (note the i ncrease i n fi t wi th respect to the regres-
si on i n growth rates i n Tabl e 2). Noti ce that thi s i s a dynami c regressi on. The i nter-
esti ng aspect of thi s regressi on i s that i t can be easi l y deri ved as a dynami c parameter-
i zati on of a Cobb-Dougl as producti on functi on i n l evel s wi th two l ags [Brdsen, 1989].
The l ong-r un output el asti ci ti es of l abor and capi tal ar e gi ven by
L
= (
7
/
6
) and

K
= (
8
/
6
), respecti vel y.
10
Thei r val ues (wi th the t-val ues i n parentheses) are pro-
vi ded i n the fol l owi ng row, together wi th the summary stati sti cs. Once agai n, they
438
EASTERN ECONOMI C JOURNAL
equal the factor shares. And noti ce that the negati ve si gn on the stock of capi tal has
di sappeared. Pesaran, Shi n, and Smi th [1999] have proposed a framework to test
whether there exi sts a l ong-run rel ati onshi p among a number of vari abl es wi thi n the
current framework, i rrespecti ve of whether the vari abl es are i ntegrated of order zero,
I (0), or of order one, I (1). The test i s an F-stati sti c for the si gni fi cance of the l agged
l evel s of the vari abl es i n the autoregressi ve di stri buted l ag, that i s, H
0
:
6
=
7
=
8
.
Pesaran, Shi n, and Smi th [1999] have tabul ated the appropri ate cri ti cal val ues for
di fferent numbers of regressors, and have provi ded a band of cri ti cal val ues assumi ng
that the vari abl es are I (0) or I (1). The resul t of the test yi el ds F(3, 14) = 5.16. I n our
case, the correspondi ng band of cri ti cal val ues for a si gni fi cance l evel of 0.05 i s 3.79 to
4.85 [Pesaran, Shi n, and Smi th, 1999, Tabl e C1.i i i ]. Si nce our cal cul ated F-test exceeds
the upper bound of the band, we reject the nul l hypothesi s of no l ong-run rel ati onshi p
among output, l abor, and capi tal . These resul ts, from the stri ct econometri c poi nt of
vi ew, i mpl y that a l ong-run rel ati onshi p exi sts among the three vari abl es. However,
i n the context of an approxi mati on to an accounti ng i denti ty, thi s resul t does not have
any deep economi c i nterpretati on: i t i s the accounti ng i denti ty i n di sgui se.
The i mportance of the above resul ts can be further appreci ated by recal l i ng the
poor esti mates obtai ned i n the fi fth regressi on i n Tabl e 2, when the ori gi nal Cobb-
Dougl as equati on was esti mated for 1899-1920. Esti mati ng the thi rd regressi on i n
Tabl e 3 wi th the vari abl e A(t) for 1899-1920 does not yi el d fragi l e resul ts, however.
Thi s resul t i s corroborated by the forward and backward recursi ve esti mati on of thi s
equati on, shown i n Tabl es 4 and 5, respecti vel y. Thi s i s, of course, preci sel y what we
shoul d expect, as the speci fi cati on of the putati ve producti on functi on i s now a cl ose
approxi mati on to the underl yi ng i denti ty.
We have al so esti mated the Cobb-Dougl as form i n per capi ta terms i ncl udi ng the
tri gonometri c vari abl e. The fourth regressi on i n Tabl e 3 shows the si gni fi cant i mprove-
ment after i ts i ncl usi on i n the regressi on (compare i t wi th the second regressi on i n
Tabl e 2). The esti mate of l abor provi des a di rect test for the nul l hypothesi s of con-
stant returns, whi ch cannot be rejected.
Fi nal l y, we esti mated the regressi on usi ng nonl i near l east squares, as i n Pesaran
and Pesaran [1997, 251-53]. These resul ts are shown at the bottom of Tabl e 3. The
resul ts are very si mi l ar to those usi ng ordi nary l east squares, i ndi cati ng that the
esti mati on method i s not an i ssue.
A TEST OF CONSTANT RETURNS TO SCALE AND PERFECTLY
COMPETITIVE MARKETS?
Dougl as was so convi nced of the i mportance of hi s anal ysi s that towards the end of
hi s l i fe he concl uded that a consi derabl e body of i ndependent work tends to corrobo-
rate the ori gi nal Cobb-Dougl as formul a, but, more i mportant, the approxi mate coi nci -
dence of the esti mated coeffi ci ents wi th the actual shares recei ved al so strengthens
the competi ti ve theory of di stri buti on and di sproves the Marxi an [Dougl as 1976, 914].
I n thi s vei n, Sol ow [1974, 121] poi nted out that: When someone cl ai ms that aggregate
producti on functi ons work, he means (a) that they gi ve a good fi t to i nput-output data
wi thout the i nterventi on of factor shares and (b) that the functi on so fi tted has parti al
439
THE ESTI MATI ON OF THE COBB-DOUGLAS FUNCTI ON
deri vati ves that cl osel y mi mi c observed factor shares.
11
I t i s thus i mpl i ci t that i t i s
possi bl e to test whether the parti al deri vati ves, that i s, the fi rst-order condi ti ons,
cl osel y approxi mate the factor shares.
TABLE 4
Forward Recursive Estimation of the Equation
lnQ
t
= [sin(T
5
) + cos(T
4
) cos(T
2
) sin(T
2
)] + lnL
t
+ lnK
t
Per i od H
0
: + = 1 R
2
; D.W.
1899-1903 0.0025 0.525 0.472 0.09 0.938;
(0.10) (0.57) (0.51) 2.54
1899-1904 0.0005 0.665 0.333 0.12 0.946;
(0.03) (3.09) (1.57) 2.40
1899-1905 0.008 0.405 0.591 0.52 0.938;
(0.40) (1.83) (2.71) 2.51
1899-1906 0.007 0.340 0.656 0.81 0.955;
(0.40) (2.00) (3.94) 2.48
1899-1907 0.014 0.433 0.563 0.63 0.962;
(0.79) (3.05) (4.06) 2.47
1899-1908 0.033 0.674 0.324 0.007 0.919;
(1.45) (4.59) (2.28) 1.66
1899-1909 0.033 0.677 0.322 0.007 0.934;
(1.56) (5.47) (2.69) 1.81
1899-1910 0.031 0.668 0.331 0.006 0.943;
(1.59) (5.77) (2.97) 1.80
1899-1911 0.026 0.736 0.265 0.051 0.937;
(1.29) (6.70) (2.51) 1.59
1899-1912 0.030 0.705 0.295 0.004 0.948;
(1.67) (7.46) (3.25) 1.98
1899-1913 0.029 0.707 0.293 0.007 0.958;
(2.26) (9.33) (4.06) 2.00
1899-1914 0.027 0.733 0.267 0.09 0.959;
(2.15) (10.79) (4.14) 1.88
1899-1915 0.028 0.705 0.294 0.007 0.962;
(2.23) (11.36) (5.00) 2.05
1899-1916 0.031 0.689 0.310 0.002 0.970;
(2.53) (11.72) (5.58) 2.00
1899-1917 0.025 0.713 0.287 0.038 0.973;
(2.16) (12.43) (5.31) 2.01
1899-1918 0.023 0.749 0.252 0.27 0.971;
(1.85) (12.92) (4.62) 1.62
1899-1919 0.023 0.749 0.253 0.29 0.974;
(2.45) (14.12) (5.09) 1.77
1899-1920 0.023 0.756 0.246 0.43 0.977;
(2.50) (15.84) (5.52) 1.26
1899-1921 0.024 0.775 0.228 0.98 0.976;
(2.65) (19.15) (6.08) 1.71
1899-1922 0.032 0.726 0.274 0.02 0.973;
(3.48) (18.83) (7.71) 1.95
Chi -squar e test (
1
2
): H
0
: + = 1 (cr i ti cal val ue 5 per cent si gni fi cance l evel : 3.84). t-stati sti cs i n
par entheses.
440
EASTERN ECONOMI C JOURNAL
TABLE 5
Backward Recursive Estimation of the Equation
lnQ
t
= [sin(T
5
) + cos(T
4
) cos(T
2
) sin(T
2
)] + lnL
t
+ lnKt
Per i od H
0
: + = 1 R
2
; D.W.
1918-1922 0.035 0.591 0.389 0.37 0.738;
(1.42) (2.60) (1.98) 2.50
1917-1922 0.034 0.582 0.396 0.99 0.746;
(1.88) (3.69) (2.88) 2.64
1916-1922 0.037 0.659 0.331 0.23 0.639;
(1.99) (4.45) (2.55) 2.21
1915-1922 0.036 0.690 0.300 0.05 0.693;
(2.05) (5.02) (2.52) 1.85
1914-1922 0.036 0.677 0.317 0.17 0.816;
(2.19) (5.52) (2.93) 2.07
1913-1922 0.037 0.681 0.313 0.17 0.835;
(2.50) (6.20) (3.22) 2.12
1912-1922 0.036 0.701 0.290 0.03 0.849;
(2.53) (7.18) (3.31) 1.99
1911-1922 0.038 0.683 0.311 0.26 0.890;
(2.84) (7.63) (3.90) 2.17
1910-1922 0.033 0.712 0.285 0.02 0.900;
(2.76) (8.75) (3.92) 2.17
1909-1922 0.033 0.719 0.279 0.00 0.915;
(2.87) (9.70) (4.21) 2.16
1908-1922 0.035 0.710 0.287 0.05 0.941;
(3.30) (10.05) (4.52) 2.21
1907-1922 0.034 0.729 0.271 0.00 0.943;
(3.31) (11.33) (4.66) 2.22
1906-1922 0.035 0.755 0.248 0.33 0.942;
(3.33) (12.41) (4.50) 2.01
1905-1922 0.036 0.771 0.233 0.91 0.944;
(3.50) (13.55) (4.52) 1.91
1904-1922 0.036 0.760 0.243 0.63 0.953;
(3.54) (12.24) (5.01) 2.00
1903-1922 0.035 0.765 0.239 1.04 0.959;
(3.73) (16.15) (5.54) 2.03
1902-1922 0.034 0.754 0.49 0.71 0.963;
(3.73) (12.22) (6.21) 2.03
1901-1922 0.034 0.748 0.254 0.57 0.968;
(3.81) (18.42) (6.82) 2.02
1900-1922 0.032 0.726 0.273 0.02 0.968;
(3.39) (17.53) (7.17) 1.82
1899-1922 0.032 0.726 0.274 0.02 0.973;
(3.48) (18.83) (7.71) 1.95
Chi -squar e test (
1
2
): H
0
: + = 1 (cr i ti cal val ue 5 per cent si gni fi cance l evel : 3.84). t-stati sti cs i n
par entheses.
We pose the fol l owi ng questi on: I s there any way that esti mati on of the aggregate
producti on functi on or the margi nal producti vi ty condi ti ons can i ndi cate the exi stence
of i mperfect markets and returns to scal e di fferent from constant? The answer i s
cl earl y no. At the expense of l abori ng the obvi ous, i f one runs the putati ve producti on
functi on regressi on of output (q
t
) on the growth rates of l abor (

t
) and capi tal (k
t
), and
the correct approximation to
t
, Equati on (2) i ndi cates that the esti mated coeffi ci ents
441
THE ESTI MATI ON OF THE COBB-DOUGLAS FUNCTI ON
of

t
and k
t
must be the factor shares (same argument wi th the equati on i n l evel s).
The onl y way not to obtai n thi s resul t i s i f the approxi mati on to
t
i s i ncorrect; for
exampl e, i f i t i s a tri gonometri c functi on and one chooses a constant (as we saw above).
I n the case at hand, the Cobb-Dougl as form works because factor shares must be
suffi ci entl y constant. Al l the correct producti on-functi on regressi ons that we have
esti mated i ndi cate constant returns to scal e and perfectl y competi ti ve markets, i n-
cl udi ng i n countri es l i ke Si ngapore [Fel i pe, 2000; Fel i pe and McCombi e, 2003] or Chi na
[Fel i pe and McCombi e, 2002a].
What i f, i nstead of esti mati ng the producti on functi on, we esti mate the fi rst-order
condi ti ons? Thi s anal ysi s al so i mpl i es that these condi ti ons cannot be rejected. Under
the assumpti ons of profi t maxi mi zati on and competi ti ve markets, the producti on func-
ti on, together wi th the assumpti on that fi rms are profi t maxi mi zers, gi ves ri se to the
margi nal theory of factor pri ci ng. Thi s anal ysi s, whi ch i s stri ctl y mi croeconomi c [Fi sher,
1971b], has been equal l y appl i ed to the macro l evel i n the form of a di stri buti on theory.
The fi rst-order condi ti on for l abor states that the wage rate equal s the margi nal prod-
uct of l abor: w = Q/L (recal l that at the aggregate l evel the measure of output i s
val ue added). And the l abor share equal s the el asti ci ty of l abor: wL/Q = (L/Q)(Q/L).
12
Consi der agai n the i denti ty Q = wL + rK. I t fol l ows that w Q/L. How can thi s
be posed as a testabl e proposi ti on? For the Cobb-Dougl as producti on functi on, the
fi rst-order condi ti on for l abor i s w
t
= a(Q
t
/L
t
). Al though we do not have the wage rate
data for the Cobb-Dougl as [1928] data set, we know that thi s hypothesi s cannot be
rejected. The reason i s that the l ast rel ati on cannot be di sti ngui shed stati sti cal l y from
the defi ni ti on of the l abor share a
t
(w
t
L
t
)/Q
t
i f a
t
= a. Si nce we have argued that for
thi s data set factor shares must be (suffi ci entl y) constant, i t i s obvi ous that esti mati on
of the regressi on w
t
=
1
(Q
t
/L
t
) must yi el d
1
= a. But thi s does not provi de evi dence i n
favor of the competi ti ve theory of di stri buti on. I t i s a tautol ogy! We have checked thi s
usi ng data for the U.S. manufacturi ng sector for 1960-94 (OECD database). The regres-
si on of the wage rate (w
t
) on l abor producti vi ty (Q
t
/L
t
) yi el ds a coeffi ci ent of 0.688 (wi th
a t-statistic of 168.00), statistically not different from the average labor share (a

= 0.692).
13
I f the exercise of estimating an aggregate production function (or the first-order
conditions) is correctly performed, one shoul d always be l ed to bel i eve that the evi -
dence i ndi cates that markets are perfectl y competi ti ve, and that the producti on func-
ti on i s homogeneous of degree one. Consequentl y, constant returns to scal e and per-
fect competi ti on are nonrefutabl e hypotheses.
16
CONCLUSIONS
Thi s paper has taken up Samuel sons [1979] i nvi tati on to veri fy empi ri cal l y hi s
cl ai m that al l the regressi on of the Cobb-Dougl as [1928] producti on functi on does i s to
reproduce the i ncome accounti ng i denti ty accordi ng to whi ch val ue added equal s the
sum of the wage bi l l pl us total profi ts. We concl ude that Samuel son was ri ght, and
believe that this argument has very serious implications for todays work in macroeconomics.
We have shown that si nce the data on output and i nputs used at the aggregate
l evel are l i nked through the accounti ng i denti ty that rel ates val ue added and factor
payments, aggregate producti on functi ons approxi mate thi s i ncome accounti ng i den-
ti ty. An al gebrai c transformati on of the i denti ty, under the appropri ate assumpti ons
442
EASTERN ECONOMI C JOURNAL
about the data, yi el ds a form that resembl es a producti on functi on. Thi s i mpl i es that i f
the correct form of the i denti ty, wri tten as a producti on functi on, were fi tted, one
shoul d al ways concl ude that the aggregate producti on functi on exhi bi ts constant returns
to scal e, and that factor markets are competi ti ve. Surel y thi s woul d be a suspi ci ous
resul t. The i mportant aspect of thi s argument i s that i t can parsi moni ousl y expl ai n
why, despi te the fact that aggregate producti on functi ons do not have a sound theo-
reti cal basi s, they appear to yi el d meani ngful resul ts at ti mes. Li kewi se, the poor
resul ts that qui te often appear (for exampl e, when a l i near ti me trend i s added) are no
more than the resul t of a poor approxi mati on to the i ncome accounti ng i denti ty.
The concl usi on i s that nei ther the exi stence of the aggregate producti on functi on,
nor the standard neocl assi cal hypotheses of constant returns to scal e or competi ti ve
markets, can be tested empi ri cal l y si nce they cannot be refuted.
NOTES
We are thankful to Frankl i n Fi sher, Nazrul I sl am, Dani el Levy, Joy Mazumdar, John McCombi e,
agl ar zden, Anwar Shai kh, and to the parti ci pants i n the Economi cs semi nars of Emory Uni -
versi ty and the Uni versi dade de Vi go, as wel l as to the parti ci pants i n the sessi on enti tl ed The
Producti on Functi on at the Eastern Economi c Associ ati on Meeti ngs (Boston, 15-17 March 2002)
for thei r comments and suggesti ons, especi al l y Per Gunnar Ber gl und. Two anonymous r efer ees
al so pr ovi ded ver y useful suggesti ons. Jesus Fel i pe acknowl edges fi nanci al suppor t fr om the
Center for I nter nati onal Busi ness Educati on and Resear ch (CI BER) at the Geor gi a I nsti tute of
Technol ogy (Atl anta, USA), where he was a facul ty member between 1999 and 2002. Thi s paper
represents the vi ews of the authors and shoul d not be i nterpreted as refl ecti ng those of the Asi an
Devel opment Bank, i ts executi ve di r ector s, or the countr i es that they r epr esent. The usual di s-
cl ai mer appl i es.
1. Thi s i s the ti tl e of Cobb and Dougl ass ori gi nal arti cl e i n 1928.
2. For a recent revi ew of the Cambri dge debates see Cohen and Harcourt [2003].
3. Some of the same poi nts made i n thi s secti on were previ ousl y made by McCombi e [1998].
4. The assumpti on of constant factor shar es need not i mpl y a Cobb-Dougl as pr oducti on functi on.
Fi sher [1971a], i n a si mul ati on study, showed that a very cl ose stati sti cal fi t coul d be obtai ned by
esti mati ng an aggregate Cobb-Dougl as producti on functi on, even though the data were such that
the condi ti ons for successful aggregati on of the underl yi ng mi cro Cobb-Dougl as producti on func-
ti ons wer e del i ber atel y vi ol ated. He showed that, i n these ci r cumstances, the constancy of the
factor shares gave ri se to the success of the aggregate Cobb-Dougl as producti on functi on, rather
than vice versa. He concl uded: the vi ew that constancy of l abors share i s due to the presence of
and aggregate Cobb-Dougl as producti on functi on i s mi staken. Causati on runs the other way and
the apparent success of aggregate Cobb-Dougl as producti on functi ons i s due to the rel ati ve con-
stancy of l abors share [Fi sher 1971a, 306]. And Samuel son wrote: A fol l ower of Dougl as mi ght
wi sh to deri ve the comfort from the fact that, i n many di fferent ti mes, a Bowl ey wi l l report pretty
much the same rel ati ve wage share for a parti cul ar country l i ke the Uni ted States or the Uni ted
Ki ngdom. But why cannot such a fact, or al l eged fact, stand on i ts own bottom, gai ni ng and l osi ng
nothi ng fr om bei ng coupl ed wi th an aggr egate neocl assi cal pr oducti on functi on? [Samuel son
1979, 931].
5. The same deri vati on appl i es i f the measure of output i s gross output. I n thi s case we have to wri te
the i denti ty for gr oss output, and pr oceed wi th a si mi l ar der i vati on. I t l eads to a pr oducti on
functi on wi th gross output on the l eft-hand si de, and l abor, capi tal , and i ntermedi ate materi al s on
the ri ght-hand si de, wi th the shares of l abor, capi tal , and i ntermedi ate materi al s i n gross output as
el asti ci ti es.
6. Natural l y, i n thi s case i t wi l l make a di fference whether the regressi on i s esti mated i n l evel s or i n
growth rates, as wel l as the esti mati on method. These are, neverthel ess, secondary probl ems and
do not affect the general i ty of the argument.
443
THE ESTI MATI ON OF THE COBB-DOUGLAS FUNCTI ON
7. I t must be emphasi zed that these resul ts stem from the fact that we are deal i ng wi th aggregates,
whi ch can onl y be expressed i n value terms (certai nl y quanti ty i ndi ces, as defi ned above, are not
physi cal vol umes, but the rati o of two val ues). The argument above does not appl y i f output and
i nputs were measured i n physi cal uni ts. See Fel i pe and McCombi e [2005] i n thi s i ssue.
8. Thi s assumpti on coul d be tested easi l y by fi tti ng the l eft-hand si de of Equati on (2) unrestri cted,
that i s, q w r k
t t t t t
= + + +
1 2 3 4

and testi ng whether the coeffi ci ents equal the average factor
shares (that i s, H
0
:
1
= a;
2
= 1 a;
3
= a;
4
= 1 a).
9. Sti l l , at thi s poi nt one may argue that al l we are doi ng i s i nserti ng back i nto the equati on the Sol ow
resi dual and, therefore, we shoul d expect a perfect fi t. Thi s argument faces two objecti ons. Fi rst,
what we ar e i nser ti ng i s not the Sol ow r esi dual i tsel f, but a functi on of si nes and cosi nes that
tr acks such r esi dual better than the l i near ti me tr end that i s usual l y i ntr oduced. Second, the
exerci se shows that once thi s functi on i s found, we recover the i denti ty and, by i mpl i cati on, the
el asti ci ti es equal the factor shares (al ways!). See Shai kh [1980, 86].
10. Thi s dynami c Cobb-Dougl as i s Q Q Q L L L K K K
t t t t t t t t t
=

( ) ( ) ( ) ( ) ( ) ( ) ( ) ( ) A
1 2 1 2 1 2
1 2 1 2 3 1 2 3

,
wher e the l ong-r un output el asti ci ti es ar e gi ven by
L
=
7
/
6
= (
1
+
2
+
3
)/(
1
+
2
1) and

K
=
8
/
6
= (
1
+
2
+
3
)/(
1
+
2
1). And the dynami c regressi on rewri tten wi th the error
correcti on term i s: q c k q k Q L
t t t t t t t L t K
= + + + + + + + +


1 2 3 1 4 1 5 1 6 1 1
[l n l n l n n ] K
t1
.
The l ong-run sol uti on i s Q L K
t t t
= ( ) ( )
+ + + +

( )/( ) ( )/( )
1 1 2 3
1
1 2 2 3
1
1 2
, where i s a constant.
Compare thi s expressi on now to the i denti ty Equati on (2) under the assumpti on of constant factor
shares. Thi s i s (i ntegrati ng): Q
t
= (w
t
)
a
(r
t
)
1 a
(L
t
)
a
(K
t
)
1 - a
. I f the term
w r
t t
( ) ( )
a a 1
happens to be a
constant A, thi s becomes Q
t
= A(L
t
)
a
(K
t
)
1 a
. I f, as di scussed above, thi s constant works empi ri cal l y,
no wonder one wi l l fi nd (
1
+
2
+
3
)/(1
1

2
) a, and (
1
+
2
+
3
)/(1
1

2
) (1 a).
11. Thi s paper i s a severe cri ti ci sm and di smi ssal of Shai kh [1974]. We ask the reader to see Shai kh
[1980] for a ful l repl y to Sol ow.
12. On thi s see al so Fel i pe [2001b] and Fel i pe and McCombi e [2002b].
13. I t i s far from surpri si ng that recent ti me seri es work does fi nd the exi stence of a l ong-run rel ati on-
shi p between the wage rate and l abor producti vi ty based on the regressi on l nw
t
= c + l n(VA
t
/L
t
)
wi th = 1 [Darby and Wren-Lewi s, 1993]. That i s exactl y the coeffi ci ent i n the l abor share i denti ty,
and thus i t means nothi ng.
14. Dhrymes [1965] proposed to esti mate the degree of homogenei ty parameter from the equati on w
= AQ

(esti mated i n l ogar i thms), wher e w i s the wage r ate, Q i s output, and L i s l abor (the
equati on i s deri ved from a CES producti on functi on). The degree of homogenei ty h i s cal cul ated
fr om the esti mates as h = (1 + )/(1 ). Thi s equati on suffer s fr om exactl y the same pr obl em
di scussed above, however, namel y, that i t can be deri ved from an i denti ty. To see thi s, note that
the defi ni ti on of the l abor share i s a
t
= (w
t
L
t
)/Q
t
, where, as before, a i s the l abor share. Assume
that i n thi s economy the l abor share i s constant. Thi s expressi on can then be rewri tten as w
t
= aQ L
t t
1
,
whi ch i s i denti cal to Dhrymes [1965] regressi on. What thi s resul t i ndi cates i s that the regressi on
of the l og wage rate on l og output and l og l abor must yi el d coeffi ci ents = 1 and = 1, unl ess the
l abor share has a l arge vari ati on, i n whi ch case the regressi on resul ts wi l l be poor. But wi th these
theoretical values for and , the degree of homogeneity implied by this regression is h = (1 + )/(1 )
= 0/0, i ndetermi nate.
REFERENCES
Brdsen, G. Esti mati on of Long Run Coeffi ci ents i n Er r or Cor r ecti on Model s. Oxford Bulletin of
Economics and Statistics, August 1989, 345-50.
Brown, M. On the Theory and Measurement of Technological Change. Cambr i dge: Cambr i dge Uni -
versi ty Press, 1966.
Cobb, C. W. and Douglas, P. H. A Theor y of Pr oducti on. American Economic Review, December
1928, 139-65.
Cohen, A. J . and Harcourt G. C. Whatever Happened to the Cambri dge Capi tal Theory Controver-
si es? J ournal of Economic Perspectives, Wi nter 2003, 199-214.
Darby, J . and Wren-Lewis S. I s There a Coi ntegrati ng Vector for U.K. Wages? J ournal of Economic
Studies 20 (1-2) 1993, 87-115.
444
EASTERN ECONOMI C JOURNAL
Dhrymes, P. H. Some Extensi ons and Tests for the CES Cl ass of Pr oducti on Functi ons. Review of
Economics and Statistics, November 1965, 357-66.
Douglas, P. The Theory of Wages. New York: Macmi l l an, 1934.
____________. Ar e Ther e Laws of Pr oducti on? American Economic Review, Mar ch 1948, 1-41.
____________. Comments on the Cobb-Dougl as Pr oducti on Functi on, i n The Theory and Empirical
Analysis of Production: Studies in I ncome and Wealth, edi ted by M. Brown. New York: Nati onal
Bur eau of Economi c Resear ch, 1967, 15-22.
____________. The Cobb-Dougl as Producti on Functi on Once Agai n: I ts Hi story, I ts Testi ng, and Some
Empi ri cal Val ues. J ournal of Political Economy, October 1976, 903-15.
Felipe, J . On the Myth and Mystery of Si ngapores Zero TFP. Asian Economic J ournal, June 2000,
187-209.
____________. Aggr egate Pr oducti on Functi ons and the Measur ement of I nfr astr uctur e Pr oducti vi ty:
A Reassessment. Eastern Economic J ournal, Summer 2001a, 323-44.
____________. Endogenous Growth, I ncreasi ng Returns and External i ti es: An Al ternati ve I nterpreta-
ti on of the Evi dence. Metroeconomica, November 2001b, 391-427.
Felipe, J . and Fisher, F. M. Aggregati on i n Producti on Functi ons: What Appl i ed Economi sts Shoul d
Know. Metroeconomica, May/September 2003, 208-62.
Felipe, J . and McCombie, J . S. L. The CES Pr oducti on Functi on, The Accounti ng I denti ty and
Occams Razor. Applied Economics, August 2001, 1221-32.
____________. Pr oducti vi ty Gr owth i n Chi na Befor e and After 1978 Revi si ted. Zagreb I nternational
Review of Economics & Business, May 2002a, 17-43.
____________. A Probl em wi th Some Recent Esti mati ons and I nterpretati ons of the Markup i n Manu-
facturi ng I ndustry. I nternational Review of Applied Economics, Apri l 2002b, 187-215.
____________. Methodol ogi cal Pr obl ems wi th the Neocl assi cal Anal ysi s of the East Asi an Mi r acl e.
Cambridge J ournal of Economics, August 2003, 695-721.
____________. How Sound ar e the Foundati ons of the Aggr egate Pr oducti on Functi on? Eastern Eco-
nomic J ournal, Summer 2005, 467-488.
Fisher, F. M. The Exi stence of Aggregate Producti on Functi ons. Econometrica, October 1969, 553-77.
____________. Aggr egate Pr oducti on Functi ons and the Expl anati on of Wages: A Si mul ati on Exper i -
ment. The Review of Economics and Statistics, November 1971a, 305-25.
____________. Repl y. Econometrica, Mar ch 1971b, 405.
____________. Aggregation. Aggregate Production Functions and Related Topics. Cambr i dge, Mass.:
MI T Press, 1993.
Griliches, Z. and Mairesse, J . Producti on Functi ons: The Search for I denti fi cati on, i n Econometrics
and Economi c Theory i n the 20
th
Century, edi ted by S. Str om. New Yor k and Mel bour ne:
Cambri dge Uni versi ty Press, 1998, 169-203.
Klette, T. J . and Griliches, Z. The I nconsi stency of Common Scal e Esti mators when Output Pri ces
ar e Unobser ved and Endogenous. J ournal of Applied Econometrics, Jul y-September 1996,
343-61.
Levinsohn, J . and Petrin, A. Esti mati ng Pr oducti on Functi ons Usi ng I nputs to Contr ol for
Unobservabl es. NBER Worki ng Paper No.7819, 2000.
Lucas, R. Capaci ty, Overti me, and Empi ri cal Producti on Functi ons. American Economic Review, May
1970, 23-27.
McCombie, J . S. L. Are There Laws of Producti on?: An Assessment of the Earl y Cri ti ci sms of the
Cobb-Dougl as Pr oducti on Functi on. Review of Political Economy, Apri l 1998, 141-43.
Pesaran, M. H. and Pesaran, B. Microfit 4.0. Cambri dge: Camfi t Data Ltd., 1997.
Pesaran, M. H., Shin, Y., and Smith, R. J . Bounds Testi ng Approaches to the Anal ysi s of Long-Run
Rel ati onshi ps. Cambri dge Uni versi ty, 1999.
Phelps Brown, E. H. The Meani ng of the Fi tted Cobb-Dougl as Functi on. Quarterly J ournal of
Economics, November 1957, 546-60.
Robinson, J . The Pr oducti on Functi on and the Theor y of Capi tal . Review of Economic Studies,
Wi nter 1953-54, 81-106.
Romer, P. Cr azy Expl anati ons for the Pr oducti vi ty Sl owdown, i n NBER Macroeconomics Annual
1987. Cambri dge, Mass.: MI T Press, 1987, 163-202.
Samuelson, P. Paul Dougl ass Measur ement of Pr oducti on Functi ons and Mar gi nal Pr oducti vi ti es.
J ournal of Political Economy, October 1979, 923-39.
445
THE ESTI MATI ON OF THE COBB-DOUGLAS FUNCTI ON
Sandelin, B. On the Or i gi n of the Cobb-Dougl as Pr oducti on Functi on. Economy and History 19 (2)
1976, 117-25.
Shaikh, A. Laws of Producti on and Laws of Al gebra: The Humbug Producti on Functi on. The Review of
Economics and Statistics, February 1974, 115-20.
____________. Laws of Producti on and Laws of Al gebra: Humbug I I , i n Growth, Profits and Property,
Essays in the Revival of Political Economy, edi ted by E. J. Nel l . Cambri dge: Cambri dge Uni ver-
si ty Press, 1980, 80-95.
Simon, H. A. Rati onal Deci si on Maki ng i n Busi ness Or gani zati ons. American Economic Review,
September 1979, 493-513.
Simon, H. and Levy, F. A Note on the Cobb-Dougl as Functi on. Review of Economic Studies, June
1963, 93-94.
Solow, R. Techni cal Change and the Aggr egate Pr oducti on Functi on. Revi ew of Economi cs and
Statistics, August 1957, 312-20.
________. Laws of Pr oducti on and Laws of Al gebr a: The Humbug Pr oducti on Functi on: A Comment.
Review of Economics and Statistics, February 1974, 121.