Productive and Financial Performance in U. S. Manufacturing Industries: An Integrated Structural Approach

In the last few years, macroeconomists and industrial organization researchers have reexamined relationships among scale economies, markups, economic profitability and productivity growth. Paul Romer [14] has emphasized the importance of increasing returns for productivity growth at the aggregate industry or economy level. Empirical evidence supporting this at the industry level has been presented by Robert Hall [4;5], who reported both significant increasing returns and markups of price over marginal cost in various U.S. manufacturing sectors. Related evidence on the cyclical nature of markups in these industries, suggesting some procyclicality of markup behavior, has been presented by Domowitz, Hubbard and Petersen [3]. Analysis of the cyclical characteristics of Robert Solow's [16] productivity residual provided the basis for these empirical studies. The resulting framework is limited, however, by its dependence on a number of restrictive assumptions, which severely hamper analysis of interactions among these characteristics. The purpose of this paper is to extend this type of analysis to consider profit-maximizing markups, economic profitability, scale economies, capacity utilization and productivity growth within an integrated theoretical structural model, and to assess their interactions empirically for two-digit U.S. manufacturing data. More specifically, using the new industrial economics approach outlined by Timothy Bresnahan [2] in which marginal cost and therefore markups are unobserved but estimated econometrically, I specify an integrated cost and demand structure for each industry. The structure is quite general in that (i) markups and returns to scale are permitted to vary over time (they are not constant parameters); (ii) shortand long-run impacts are distinguished (by explicit recognition of adjustment costs); (iii) quasi-fixity of both capital and labor is incorporated (to accommodate labor hoarding as well as slow adjustment of capital); (iv) input substitution is not constrained a priori (a generalized Leontief restricted cost function based on gross output is employed); (v) nonstatic expectations are allowed for (through an instrumental variable estimation procedure); and (vi) the effects of cost and demand shocks are directly represented (by specifying and estimating industry-specific cost, output demand and input demand functions).