How Sound are the Foundations of the Aggregate Production Function?.
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. .
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".
