A Generalized Control Function Approach to Production Function Estimation

Abstract: We generalize the control function approach to production function estimation. Our generalization accommodates scenarios in which productivity evolves jointly with other unobservable factors such as latent demand shocks and the invertibility assumption underpinning the traditional proxy variable approach fails. We provide conditions under which the output elasticity of the variable input -- and hence the markup -- is nonparametrically point-identified. A Neyman orthogonal moment condition ensures oracle efficiency of our GMM estimator. A Monte Carlo exercise shows a large bias for the traditional proxy variable approach that decreases rapidly and nearly vanishes for our generalized control function approach.