On Empirical Estimation of the Production Function under Imperfect Capital Markets

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The econometric approach to estimating the production function introduced by Olley and Pakes (1996) is widely used in empirical work. One drawback in the Olley-Pakes approach is that the capital market is assumed to be perfect and that its estimators become inconsistent when the capital market is imperfect. Much empirical research indicates that capital markets are imperfect not only in developing countries but also in the developed countries. This paper extends the Olley-Pakes approach so that the estimators become consistent and robust even with imperfect capital markets. Empirical results based on the Japanese firms' data via our extended Olley-Pakes approach confirm the existence of estimation biases of underestimates of 8-43% in the original Olley-Parkes capital coefficients. That is not negligible.