The Effect of Technological Change and Technical Inefficiencies on the Performance of Functional Forms

Abstract

Technological change is one of the most important determinants of the technological structure of the firm. Unfortunately, this crucial factor is often unobserved and must therefore be approximated. It is also well recognized that firms are not necessarily located on their efficient production frontier, a phenomenon known as technical inefficiency. This paper compares the performance of three flexible functional forms (the Translog, Symmetric McFadden and Symmetric Generalized Barnett) to properly infer theoretical properties and technology measurements when: (i) unobserved technological change is approximated by a time trend in the variable-cost-function specification and, (ii) firms may be technically inefficient. Our results indicate that no functional form dominates and that measuring the shifts of the production (cost) function has a clear and negative effect on the performance of the functional forms. Furthermore, we find that technical inefficiencies have a significant and negative effect on the measurement of, notably, returns to scale and the implicit rental price of capital. However, all forms over-reject theoretical properties and provide adequate technology measurements only on a sample-average basis. In addition, the performance of the functional forms is closely related to the true underlying rate of technological change.