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ARE FIXED EFFECTS FIXED? Persistence in Plant Level Productivity

May 1996

Written by: Douglas W Dwyer

Working Paper Number:

CES-96-03

Abstract

Estimates of production functions suffer from an omitted variable problem; plant quality is an omitted variable that is likely to be correlated with variable inputs. One approach is to capture differences in plant qualities through plant specific intercepts, i.e., to estimate a fixed effects model. For this technique to work, it is necessary that differences in plant quality are more or less fixed; if the "fixed effects" erode over time, such a procedure becomes problematic, especially when working with long panels. In this paper, a standard fixed effects model, extended to allow for serial correlation in the error term, is applied to a 16-year panel of textile plants. This parametric approach strongly accepts the hypothesis of fixed effects. They account for about one-third of the variation in productivity. A simple non-parametric approach, however, concludes that differences in plant qualities erode over time, that is plant qualities f-mix. Monte Carlo results demonstrate that this discrepancy comes from the parametric approach imposing an overly restrictive functional form on the data; if there were fixed effects of the magnitude measured, one would reject the hypothesis of f-mixing. For textiles, at least, the functional form of a fixed effects model appears to generate misleading conclusions. A more flexible functional form is estimated. The "fixed" effects actually have a half life of approximately 10 to 20 years, and they account for about one-half the variation in productivity.

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estimation, production, economist, econometric, macroeconomic, estimating, estimates production, labor productivity, industry productivity, productivity differences, productivity measures, measures productivity, factor productivity, recession, regression, factory, estimates productivity, econometrician, plant productivity, productivity plants, regressing, plants industries, productivity dispersion, textile, productivity dynamics

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Census of Manufactures, Annual Survey of Manufactures, Standard Industrial Classification, Longitudinal Research Database, Center for Economic Studies, Ordinary Least Squares, Columbia University, Cobb-Douglas, Harvard University, New England County Metropolitan, Review of Economics and Statistics, Journal of Political Economy, American Economic Review, MIT Press, Princeton University Press, Princeton University, Cambridge University Press

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