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Market Structure, Competition and Productivity Growth:
Evidence from Canadian Manufacturing Industries




Ram C Acharya
Industry Canada



May 2005


Abstract
Using data for 86 Canadian manufacturing industries from 1990 to 2002,
this paper estimates total factor productivity (TFP) growth allowing for
non-constant returns to scale and imperfect competition. Somewhat
surprisingly, the results show that we cannot reject the null hypothesis of
constant returns to scale for 80 industries and that of perfect competition
for 55 industries. Although at the aggregate level the standard Solow
residual underestimates the actual TFP growth by only 0.2 to 0.4
percentage points, these two series vary substantially at the industry level.
The paper also shows that competition, as measured by lower level of
rents and markup and higher level of import penetration, is associated
with a significantly higher rate of TFP growth. Similarly, the fall in the
Herfindahl index and concentration ratio (proxies for a rise in
competition) lead to a higher productivity level effect.




Correspondence:
Ram Acharya
Industry Canada
235 Queen Street, 10
th
Floor East
Ottawa, ON K1A 0H5
Email: acharya.ram@ic.gc.ca

Views expressed in this paper are those of the author and do not necessarily reflect those of
Industry Canada. In the paper, I have benefited from discussions with Serge Coulombe, for
which I am thankful. Of course, all errors are mine.
2

Market Structure, Competition and Productivity Growth:
Evidence from Canadian Manufacturing Industries

Using data for 86 Canadian manufacturing industries from 1990 to 2002,
this paper estimates total factor productivity (TFP) growth allowing for
non-constant returns to scale and imperfect competition. Somewhat
surprisingly, the results show that we cannot reject the null hypothesis of
constant returns to scale for 80 industries and that of perfect competition
for 55 industries. Although at the aggregate level the standard Solow
residual underestimates the actual TFP growth by only 0.2 to 0.4
percentage points, these two series vary substantially at the industry level.
The paper also shows that competition, as measured by lower level of
rents and markup and higher level of import penetration, is associated
with a significantly higher rate of TFP growth. Similarly, the fall in the
Herfindahl index and concentration ratio (proxies for a rise in
competition) lead to a higher productivity level effect.


1. Introduction
The first theorem of welfare economics states that competitive economy generates an
efficient allocation of resources. As stated in Nickell (1996), the expectation regarding the effect
of competition is not limited to this well-known result; it has gone much further. The general
belief is that competition raises efficiency by exerting a downward pressure on production costs
and enhances innovation by providing incentives for firms to innovate. In a similar manner, Baily
and Gersbach (1995) state that vigorous global competition urges allocative efficiency and forces
structural change in industries. In contrast, there is also literature which argues that competition
may lead to lower productivity growth. This reasoning is more in line with Schumpeterian
hypothesis that monopoly rents enable firms to spend more on innovative activities and raise
productivity. For example, Kemien and Schwartz (2002) argue that a firm with monopoly power
is more likely to strive for persistent dominance than a firm without non-monopoly power.
1


1
The studies linking competition and innovation started with the work of Schumpeter (1942) where he stated that the
possibility of future monopoly rents is required to motivate firms to innovate. On the contrary, Boldrin and Levine
(2004) argue that monopoly is neither needed for, nor a necessary consequence of, innovation. In a recent study,
3

Which way does the relationship between competition and productivity go? Since
improvement in the productivity is the only long-term solution for a higher standard of living, if
more competition leads to higher productivity, then fostering competition would be a desired
economic policy.
2
In general, competition can affect productivity in three ways. First, it can make
existing firms more competitive. Second, as suspected by Nickell (1996) competition may work
not by forcing efficiency on individual firms but by letting many flowers bloom and ensuring only
the best survive. Third, with more firms competing in the market, the elasticity of substitution
among products may increase thereby raising the price elasticity of demand and hence increasing
the potential benefit for winners. The potentially larger profits induce higher managerial effort,
creating incentives for efficiency-enhancing activities such as innovation.
There are two main strands of literature on competition and productivity. The first examines
the effects of competition on the efficiency of firms managed by agents under imperfect
contracts.
3
This literature deals mostly with firms management aspects. The second strand of the
literature examines the effect of competition on total factor productivity (TFP). Nickell (1996) is
the first paper to study the relationship between competition and TFP directly. Using around 700
U.K. manufacturing companies over the period 1972-1986, he shows that competition measured
by increased numbers of competitors (information collected by surveys) or by lower levels of
rents is associated with a significantly higher rate of TFP growth. Recently, Zitzewitz (2003)
using data on U.K. and U.S. tobacco industries show that technological innovation and
consolidation of production were more rapid during competitive periods.

Aghion et al. (2002) find that the relationship between competition and innovation is of inverted U shape; innovation
rises with the rise in competition until a certain range; if competition rises further, innovation starts to fall.
2
Although productivity growth is not the same thing as welfare, if the resources released by productivity growth find
adequate employment in other economic valuable sectors including leisure, then productivity growth leads to higher
welfare (Griliches, 1994).
3
For this type of studies, see Aghion et al. (1997), Schmidt (1997), Horn et al. (1994) and literature cited in these
papers.
4

Using micro data for U.K. manufacturing establishments for 1980-1992, Disney et al.
(2003) study the impact of competition on TFP growth based on the framework developed by
Nickell (1996). They find that a fall in market share and rents, which they interpret as a rise in
competition, raises productivity levels. They also find that firms with a high level of rents will
have low productivity growth. In the Canadian context, using firms perceptions of their
competitive environment from Statistics Canadas 1999 Survey of Innovation, Tang and Wang
(2004) show that product market competition has a positive impact on the performance of
medium-sized and large-sized firms.
These are the only papers we came across in this field. Even though it may not be the
exhaustive list, it is quite evident that more research is required in this area. Furthermore, the
previous studies estimate the relationship between productivity growth and competition variables
without explicitly isolating the effects of potential non-constant returns and imperfect competition
from the TFP growth series. The mitigation of the impact of non-constant returns and imperfect
competition from TFP growth is important as we know from the seminal contribution of Hall
(1988) that in their presence, the usual Solow residual (TFP growth) is a bias estimate of actual
unobserved productivity growth.
The basic framework in Nickell (1996) starts with the assumption of constant returns to
scale. In the case of Disney et al. (2003), although they do not make any assumption regarding
competition and scale, their framework is not designed to take out the effects of markups and non-
constant returns from each economic unit. To address this subtle issue, in our estimation of
productivity and competition relationship, along with other two TFP growth series, we also use
TFP growth that is estimated by taking out the effects of non-constant returns and imperfect
competition from all industries separately.
5

This paper uses data based on North American Industrial Classification Systems (NAICS)
for 86 Canadian manufacturing industries from 1990 to 2002. With this data we have three main
objectives. As a first step, we estimate the markup (whether price is higher than marginal cost)
and scale effects (whether industry operates under increasing, constant or decreasing returns) for
each industry. To our knowledge, this is the first time such a study is done in such a disaggregate
level of industries.
4
Hence, the endeavor of explicitly measuring markup and scale effects at this
level of detail is a novelty of the paper. To our surprise, we find that out of 86 industries we
cannot reject the null hypothesis of constant returns to scale to 80 industries and that of perfect
competition to 55 industries. This finding indicates that the Canadian manufacturing sector is
overwhelmingly characterized by constant returns to scale, and one third of manufacturing
industries operate under imperfect competition, price higher than marginal costs.
Our second objective is to estimate TFP growth by isolating the markup and scale effects
and compare it with usual calculated TFP growth (based on the assumptions of perfect
competition and constant returns) to assess the latters biasness in measuring unobserved
productivity growth. Even though for few industries, these two series do not diverge widely; for
some others, they do and even are opposite in their signs. At the aggregate, however, it appears
that the TFP growth measured under the assumptions of perfect competition and constant returns
will be a reasonable indicator of unobserved productivity growth. The former underestimates the
latter only by a range of 0.2 to 0.4 percentage points (from 5 to 10 percent of TFP growth)
annually. Hence, even though at the aggregate level the calculated TFP provide a reasonable
measure of productivity growth, for individual industries these two series may diverge widely.

4
For U.S. industries, Hall (1988) measures the markup and Basu and Fernald (1997) measure the scale coefficients.
Hall (1988) is based on SIC 2-digit 26 industries, whereas Basu and Fernald (1997) is based on 34 industries. Kee
(2004) estimate both markup and scale effects for nine Singapores industries.
6

Therefore, one should be cautious in relying solely on calculated TFP to study the relationship
between productivity growth and other economic variables at the industry level.
Third, we estimate the relationship between TFP growth and competition, using three types
of TFP growth series. They are: (1) series allowing to vary the coefficients of all inputs but
restricting them to be the same across industries (which we consider as taking out the common
effects of non-constant returns and imperfect competition from TFP growth) as done in Disney et
al. (2003), (2) series based on the assumptions of constant returns and perfect competition (called
calculated TFP), and (3) series allowing to vary coefficients of inputs by industry (which is taking
out the effect of non-constant returns and imperfect competition from each industries separately).
In measuring competition, we use Herfindahl index, concentration ratio at 4, 8, 12, 16, 20 and 50
leading enterprises, rent share in revenue and markup. We consider them as reverse measures of
competition. On the other hand, we also use variables such as firms entry rate, exit rates and
import penetration as direct measure of competition.
Our finding is that the competition, as measured by lower level of rents and markup and
higher level of import penetration, is associated with a significantly higher rate of TFP growth.
Similarly, the fall in the Herfindahl index and the concentration ratio (proxies for a rise in
competition) lead to higher productivity level effect. This result is more or less robust whether we
use TFP growth computed under the assumptions of constant returns to scale and perfect
competition or estimated by relaxing them. The higher level of entry rate may also lead to higher
rate of productivity growth, however, the exit rate does not have any impact on productivity
growth. Furthermore, an increase in import penetration will lower productivity level.
The rest of the paper is organized as follows. In the next section, we develop a theoretical
framework for testing markup and returns to scale. In Section 3, we briefly discuss the data used
7

in the paper. In Section 4, we test the validity of perfect competition and constant returns in
Canadian manufacturing, using the model developed in Section 2. In Section 5, based on the
estimates in Section 4, we estimate the TFP growth which are free of the effect of non-constant
returns and imperfect competition. In this section, we also compare these TFP measures with the
usual TFP growth that would arise under the assumptions of constant returns and perfect
competition. In Section 6, we develop an equation for estimating productivity-competition relation
and presents results of this relationship in Section 7. And lastly in Section 8, we conclude the
paper.

2. Framework for Testing Market Structure and Returns to Scale
In this section, we develop an equation to test the market structure and returns to scale,
which can also be reduced to a framework that could be used to calculate standard Solow residual.
We begin with industry level production function where industry is gross output Q is produced
using production workers , non-production workers
i
(
i
U ) ( )
i
S , fuel and energy ( , other non-
energy materials , and capital stock
)
i
E
(
i
M ) ( )
i
K . Hence for each industry i at time period t, the
production function is given by
5

(1) , i = 1, , 86; t = 1, , 12. (
it it it it it i it it
K M E S U F A Q , , , , = )
Note that the productivity is represented by a Hicks Neutral augmentation , of aggregate
output.
it
A
6
is assumed to be homogenous of degree
i
F
i
. Taking logarithm and then totally
differentiating equation (1) with respect to time yields:

5
There is literature treating production workers as unskilled and non-production workers as skilled. In the same
tradition, we denote production workers by U (index for unskilled) and non-production workers by S (index for
skilled).
6
Although the Hicksian A measures the shift in production function at given levels of inputs, it is almost always
identified with technical change. But this is not generally an appropriate interpretation. The difference between the
8

. ln ln
ln ln ln ln ln
it
i
i
i
i
it
i
i
i
i
it
i
i
i
i
it
i
i
i
i
it
i
i
i
i
it it
K
F
K
K
F
M
F
M
M
F
E
F
E
E
F
S
F
S
S
F
U
F
U
U
F
A Q

+ =

Noting that
i
i
i
i
i
i
i
i
Q
J
J
Q
F
J
J
F

, and denoting it by
Ji
for J = U, S, E, M and K, we have
(2)
it Ki it Mi it Ei it Si it Ui it it
K M E S U A Q ln ln ln ln ln ln ln + + + + + = ,
where
Ji
is the average of two periods that we consider in estimating growth in the output and
inputs in the ith industry. Note that the sum of elasticity of output with respect to all inputs
measures the elasticity of scale. Given the assumption that is homogenous of degree
i
F
i
,
according to Eulers theorem,
i Ki Mi Ei Si Ui
= + + + + . If
i
is larger than 1, we have
increasing returns to scale, equal to 1 yields constant returns to scale and smaller than 1 implies
decreasing returns to scale. Unless we are ready to make assumptions on market structure, the
value of s, the elasticity of output with respect to inputs, are not observable from the data.
Let us denote the log difference of the variable by corresponding lower case letter, such as
, and incorporate
it it
Q q ln =
i
into Equation (2) such that:
(3) ( )
it Mi Ei Si Ui i it Mi it Ei it Si it Ui it it
k m e s u a q + + + + + = .

Hicksian shift parameter, A, and the rate of technical change arises for many reasons. The most important is that the
shift parameter captures only costless improvements in the way an economys inputs are transformed into real GDP.
For example, technical change that results from R&D spending will not be captured by A unless R&D is excluded
from inputs which it generally is not (Hulten, 2002, p. 9).
Another issue is implied nature of technical change. In general, the Hicksian formulation of the production
function is valid if innovation improves the marginal productivity of all inputs equally. However, if (costless)
improvements in technology augment the marginal productivity of each input separately (Hicks biased technological
change), then the productivity growth depends on the input shares as well as the parameters of innovation. A change
in income share can cause output per unit input (TFP) to increase, even if the underlying rate of technical change
remains unchanged. This enforces the basic point that productivity growth is not the same thing as technical change
(Hulten, 2002, p. 13).

9

If the firms in industry i are price takers in the input markets, conditions for cost
minimization yields that
i
Ji
i
i
p
J
Q

, where
i
is the Lagrange multiplier, which by Envelop
theorem is the marginal cost, and is the price of input J.
Ji
p
7
Throughout the paper, we maintain
that firms face perfectly competitive factor markets. Hence,
Ji
takes the following form:
(4)
i
i
i
Ji
Ji
Q
J
c
p
= J = U, S, E, M, K,
where c is the marginal cost. Multiply and divide the right-hand side expression of Equation (4)
by , the price of output, to obtain
Q
p
(5)
Ji i
i
Qi
i Qi
i Ji
Ji
r
c
p
Q p
J p
= = J = U, S, E, M, K,
where is the markup ratio, c p
Q
= , and is the share of input J in total revenue, , and
is observable from the data. Replacing information in Equation (5) into Equation (3) and
rearranging it we have:
J
r Q p
Q
(6) ( ) ( ) ( ) ( ) | |
it i it it Mi it it Ei it it Si it it Ui i it it
k k m r k e r k s r k u r a q + + + + + = .
We will be using Equation (6) to test market structure and returns to scale. However before
proceeding further, let us see how this expression is different from the regular expression that is
used in TFP growth accounting literature, which is based on the assumptions of constant returns
and perfect competition. In that literature, since and are assumed to be one, Equation (6) can
be rearranged such that the TFP growth, which is equal to unobserved productivity growth, a, is
defined as

7
Instead, if the firms are monopsonists, the first order condition of cost minimization leads to the situation that
|
|
.
|

\
|
|
|
.
|

\
|
+ =

J
p
J
Q 1
1 , where is the price elasticity of factor supply.
10

(7) ( ) ( ) ( ) ( )
it it it Mi it it Ei it it Si it it Ui it it
k k m r k e r k s r k u r q P F T =

,
where P F T

is substituted for a.
8
Next, to see what happens when neither nor is equal to one,
let us replace in Equation (7) by expression in Equation (6), such that Equation (7) becomes
it
q
(8) ( ) ( ) ( ) ( ) ( ) | | ( )
it i it it Mi it it Ei it it Si it it Ui i it it
k k m r k e r k s r k u r a P F 1 1

+ + + + + = T .
This equation is similar to that of Hall (1988) except that Hall does not consider the scale
parameter. Klette (1999) have estimated somewhat similar equation for manufacturing firm level
data for Norway from 1980 to 1990. Recently, Kee (2004) uses similar equation to compare
primal and dual productivity growth in Singapores manufacturing sector.
Looking at Equation (8), we see that the TFP growth rate and unobserved actual
productivity growth may differ due to either imperfect competition ( 1 ) or non-constant
returns to scale ( 1 ), or any combination of these two. The usual TFP measure may bias the
unobserved productivity growth in either direction, depending on types of market imperfection,
nature of returns to scale and growth rates of factors of production. By looking at Equation (8),
one could find the direction of biasness easily.
To calculate TFP growth under the assumptions of perfect competition and constant returns,
we can use Equation (7) or Equation (3). To estimate TFP growth relaxing these two assumptions,
we can use Equation (6). Without loss of generality, we assume that the Hicks neutral
technological progress is a random variable such that the growth rate of industry i in period t
consists of an industry-specific growth rate,
i
, and a period specific growth rate,
t
, which
captures the macroeconomic shock that is common across industries in the same period, plus a
white noise, u . Hence, for each industry i at time t, Equation (6) takes the following form:
it

8
Solow (1957) recommended evaluating the right-hand side in order to measure the Hicks-neutral technical progress.
This measure has come to be known as TFP growth because it accounts for output and all inputs.
11

(9) ( ) ( ) ( ) ( ) | |
it it i it it Mi it it Ei it it Si it it Ui i t i it
u k k m r k e r k s r k u r q + + + + + + + =
2 1
.
Looking at Equations (6) and (9), it is clear that the estimated value of
1
will be industry specific
markups, and the estimated value of
2
will be industry specific returns to scale coefficients.
The estimation of TFP growth using Equation (9) serves our four purposes. First, this will
enable us to find out how many of these industries have market power and how many of them
operate under non-constant returns to scale. Second, by comparing the TFP growth estimated
based on this equation with TFP calculation under perfect competition and constant return to
scale, we can assess the magnitude of biasness of Solow residual (the latter) to unobserved
productivity growth (the former). Third, we could use the estimated industry markup,
i 1
, as a
measure of inverse competition in the next section. Fourth, the TFP series obtained from (9) can
be used for the robust check in the relation between TFP growth and competition. The estimation
results will be provided in Section 4 after a discussion on the data in the following section.

3. Data
This paper studies the NAICS 4-digit level manufacturing industries from 1990 to 2002, and
there are 86 industries at this level. The data used for the estimation of Equation (9), except capital
stock, come from the Annual Survey of Manufactures (ASM), a sample survey of manufacturing
establishments carried out by Statistics Canada. This survey, which covers manufacturing
industries at a very detail level, has data on shipments, number of production workers and hours,
number of administrative employees, wages to production workers, salary to administrative
employees, cost of fuel and electricity, expenditure on materials (non-energy) and value added.
9


9
In ASM, value added figure deduct only purchased commodities and products, including energy but do not exclude
purchased services since information on purchase of services (except subcontracting) is not collected as a regular part
12

The data from ASM are at current price. To convert these current price series into constant
price, we use deflators based on Link-Level rectangular input-output tables at current and Paasche
constant prices. Since these tables have only 45 manufacturing industries, we have only 45
deflators. For computing these deflators, we aggregated all output produced by each of these 45
industries at both current and Paasche constant price. We did the same for input used by these
industries. Then we computed the ratio of current to constant for both output produced and input
used for each of these 45 industries. Finally, we adjusted output series in ASM by output price
ratio and input series in ASM by input price ratio to convert ASM series into constant price.
For 24 ASM industries, the deflators have one-to-one correspondence. Four of the 45
industries fell into a single 86 ASM group of industries. The remaining 17 industries price
deflators were used for the remaining 61 ASM industries. Some of these 17 industries were at
NAICS 3-digit and some of them were at NAICS 2-digit. For 57 industries, price deflator at 3-
digit was used and for the remaining 5 industries, price deflator at 2-digit level was used. Since
the input-output tables for year 2002 were not available, we have used the 2001 deflators for 2002
as well.
The capital stock data are obtained from the Investment and Capital Stock Division of
Statistics Canada. Among different series of capital stock based on different depreciation
methods, we use the geometric infinite end-year net stock data series in 1997 price. Even though it
would be preferable to use data on capital input rather than capital stock, we use the latter series,
as the former is not available.

By using capital stock data we are assuming that capital input is
proportional to the measured capital stock, so capital stock growth rate is used to measure capital
input growth. Hence, there is no adjustment for capacity utilization.

of the annual census. Value added also includes any indirect taxes (such as property taxes). Therefore, the value
added is overestimated.
13

In the second part of the paper, besides ASM and capital stock data, we use other data to
measure competition. Among them, Canadas imports from the world and exports to the world are
taken from Industry Canadas website. However, since the trade data based on NAICS do not go
prior to 1992 and those based on SIC do not extend beyond 2000, for years 1990 and 1991 we use
the data on SIC 4-digit industries and convert them into NAICS 4-digit (86) industries using
Statistics Canadas conversion table from SIC to NAICS.
10

The other data used in the paper such as Herfindahl index, firms entry rate, firms exit rate
and shipment concentration ratio at leading 4, 8, 12, 16, 20 and 50 enterprises come from
Statistics Canada.

4. All about Markups and Returns to Scale
To estimate Equation (9), for q, we use the ASM data series called total value of shipments
and other revenue at constant price; for u, we use total number of production workers; for s, we
use total number of non-production workers; for e, we use cost of fuel and electricity at constant
price; for m, we use total costs of materials and supplies at constant price. For k, we use capital
stock data at constant price.
11
For the revenue share parameters, we use ratio of each input cost to
total value of shipment and revenue at current price. Since we are computing TFP growth not

10
In case when one SIC industry fell into more than one NAICS 4-digit industries, we distributed the trade data in
that SIC industry to all NAICS industries that the particular SIC industries is spread out using the shares of NAICS
industries that constitute the total output of that given SIC industries as given in the Statistics Canadas concordance
table.
11
The measure of industry output (total value of shipments and other revenue) is actually a sales measure, not a
production measure. This series consists of shipment of goods of own manufacturer and non-manufacturing
shipments and revenue. Production workers are those who works in production in manufacturing activity only.
Administrative employees include all employees not included in production and related workers. Thus the production
and related workers engaged in non-manufacturing activity are included in administrative employment component.
The series total cost of material and supplies and cost of fuel and electricity include cost of both manufacturing
and non-manufacturing sectors.
14

level, we take the log difference between two consecutive years for the input use and average of
two years for share parameters.
A summary of the aggregate annual growth of all inputs and output along with inputs
shares in revenue is presented in Table 1. During 1990-2002, the gross output, value added and
material input grew almost at the same rate of about 4.5 percent annually. Over this period, the
fastest growing inputs have been material use followed by fuel and energy which grew by 4
percent annually in real terms. Annual capital growth rate was higher than growth rates of both
types of labor implying increased capital intensity over time. The slowest growing input in
manufacturing over this period was non-production worker (dubbed as skill labor in the
literature), whose annual growth was less than 1 percent, and the salary bill of these employees
occupied less than 6 percent of total revenue. Intermediate input constitutes more than half of
gross output (52 percent), and the remaining 48 percent is shared almost equally by labor and
capital.
Table 1. Average Annual Growth Rates and Shares of Revenue (in Percent), 1990-2002
Q
Y U S E M K
( ) L Y

100 ln
4.5 4.47 0.82 0.44 4.00 4.52 2.03 3.83
Share
100 48.4 13.8 5.7 2.1 54.6 23.8
-
Note: All numbers are average annual percentage growth rates estimated by taking the log difference and multiplying
them by 100. The numbers are computed using information for the entire period rather than the period end years.
With 13 years of data, we have 12 growth rates. is the real value of shipment; Y is the real value added; U is total
number of production workers; S is total number of non-production workers;
Q
E is cost of fuel and energy, and M is
the total cost of material inputs. The sum of U and S is L, total number of employees. Labor productivity is given by
( L Y )

. We have used employment share of each industry as weight for all other variables.

For estimation of Equation (9), we pool all 86 industries for 12 years and use pool least
square and feasible generalized least square (weighted pool least square correcting for cross-
section heteroskedasticity).
12
We allow the coefficients for each industry to vary along with

12
With 86 2 coefficients, 11 years of dummy and 86 industry fixed effects, there will be a total of 253 parameters to
estimate.
15

industry fixed effects and time dummies. For 86 industries, the estimated coefficients and their t-
test under the null hypothesis that the coefficients are equal to unity using feasible generalized
least square method are reported in columns 1 through 4 in Table 5. Results show that for 73 out
of 86 industries, the estimated markup coefficient is greater than one indicating the possibility of
price higher than marginal cost (Column 1). The magnitude of these coefficients ranges from as
low as 0.56 for fruit and vegetable preserving (NAICS-3114) industry to 3.5 for aerospace product
and parts NAICS-3364) industry. On the other hand, 44 industries have scale coefficients greater
than one (Column 3). The magnitude of this coefficient ranges from 0.12 for navigational and
medical instruments (NAICS-3345) industry to 3.85 for pharmaceutical and medicine (NAICS-
3254) industry.
13

However, in terms of statistical significance, the results are somewhat surprising. Out of 73
industries for which the markup coefficients are greater than one, only for 30 the coefficients are
significantly greater than one. Among them, the t-test is significant at 1 percent level for 10
industries, at 5 percent level for another 13 industries, and at 10 percent level for additional 7
industries (Column 2). Thus for 30 industries, the null hypothesis of perfect competition can be
rejected. Among the 13 industries whose markup point estimates are less than one, only one
industry has markup significantly less than one. That industry is beverage (NAICS-3121), and its
markup coefficient is 0.57, implying that price is almost half of its marginal cost.
Among the 44 industries whose scale coefficients are greater than one, it is significantly
greater than one for only one, the textile and fabric finishing (NAICS-3133) industry (Column 4).
And among the remaining 42 industries for which the scale estimates are less than one, they are
significantly less than one only for three industries. These three industries are: (1) other textile and

13
The scale coefficients are negative for basic chemical manufacturing (NAICS-3251) and aerospace product and
part. For the previous industry it is 1.5; for the latter, it is 7.8. We consider these two industries as outliers.
16

product mills (NAICS-3149), (2) clothing accessories and others (NAICS-3151), and (3)
navigational and medical instrument (NAICS-3345).
To sum up, for 30 industries the null hypothesis of perfect competition can be rejected in
favor of pricing higher than marginal cost and for one industry it could be rejected in favor of
price lower than marginal cost. For the remaining 55 industries, the null hypothesis of perfect
competition cannot be rejected. In terms of scale effect, only for one industry, the null hypothesis
of constant returns can be rejected in favor of increasing returns to scale; for another three
industries, the null hypotheses of constant returns can be rejected in favor of decreasing returns.
With the exception of two outlier industries, for the remaining 80 industries the null hypothesis of
constant returns cannot be rejected. Hence, it could be concluded that the Canadian manufacturing
sector is overwhelmingly characterized by constant returns to scale, and one third of Canadian
manufacturing industries enjoy market power (price greater than marginal cost).
14


5. TFP Growth: Estimated vs. Calculated
As mentioned in Section 2, we assume that TFP growth can be given by the estimates of
industry fixed effects ( )
i
, time dummies ( )
t
and residuals ( )
it
u . Hence, based on Equation (9)
TFP growth for industry i in year t will be given by the estimated value
t i
+ if residuals are not
included and by
it i
+
t
u + if they are included as part of technological change. Using this
method, we have TFP growth measures for 86 industries for 12 years. The average (across years)
TFP growth for all industries (based on generalized weighted pool and pool regressions) is given

14
Using markup and scale parameters, we can estimate the implied share of rents by industries. Cost minimization
condition implies that (given by in Equation 9) is equal to the ratio of average to marginal costs, and can be
expressed as
i 2

(
i i i i
c )
i
r

= 1 , where is the average cost; is given by in Equation (9); and is the

share of economic profits in total revenue. Rearranging it we have
i 1

r
( )
i i i
r

=1 . Our calculation based on this

17

in Columns 5 and 6 of Table 4. Note that since , the average TFP growth across time
will be the same whether residual is taken as part of TFP growth or not.
0
12
1
=

= t
it
u
Based on generalized least square regression, the annual TFP growth is positive for 70
industries; based on pool regression, it is positive for 65 industries. The annual growth rates of
most of the industries range between 0 to 2 percent.
Next we would like to compare these estimated TFP growth series with the one that is
calculated under assumptions of constant returns and perfect competition using Equation (7),
whose variables on the right-hand side are observable, except capital share in total revenue. Based
on the assumption of constant returns to scale, we take capital share as residual. The calculated
TFP growth is presented in Column 7 in Table 4, which is positive for 74 industries and negative
for the remaining 12 industries. The annual growth rate varied from a negative of 3.2 in
communication equipment (NAICS-3342) to a positive of 5.4 percent in aerospace product and
parts (NAICS-3364). For most of the industries the annual growth rate is in the range of 1 to 2
percent.
Comparing the estimated and computed TFP growth series (Columns 5, 6 vs. Column 7), we
find that for few industries the difference between the two series is small, whereas for majority of
industries, it is rather high; in some cases even the signs are opposite. We have plotted the average
estimated (with pool regression) and calculated TFP growth for 84 industries in Figure 1. The
wide difference between two TFP growth series for some industries make us cautious in using
only a single series if the objective is to relate TFP growth and other economic variable.


expression shows that out of 86 industries, 62 industries had average positive profits during 1990 to 2002, whereas for
the remaining 24 industries, the average profit was negative.
18

-6
-4
-2
0
2
4
6
10 20 30 40 50 60 70 80
Industry
Calculated TFP Growth Estimated TFP Growth
Figure 1. TFP Growth Accounting vs. Estimated Productivity Growth
Note: we have plotted this table for 84 industries. Two industries, pharmaceutical and medicine manufacturing
(NAICS-3254) and aerospace product and parts manufacturing (NAICS-3264) are taken out as outliers as their annual
TFP growth is respectively unusually low (in negative) and high. The estimated TFP growth is based on pooled
regression.


Interestingly however, at the aggregate level, the calculated TFP growth is not very different
from the estimated one, which we show in Table 2. To arrive into this table, first we obtained
Domar-weighted TFP growth of each series for each year and then took the average of this value
across 12 years. In other words, we obtained annual TFP growth using ( )
it
i
i t
a v a .
86
1

=
= , where
|
|
.
|

\
|
+ =


1 1
1 1
2
1
t yt
it Qit
t yt
it Qit
i
Y p
Q p
Y p
Q p
v
t yt
Y p
is the Domar weight, is the current dollar gross output in
industry i, and is current dollar aggregate manufacturing value added. Since in this case, the
average growth depends on whether we use residuals as TFP growth or not, we have reported both
series under two columns, without residuals and with residuals.
it Qit
Q p
15


15
Contrary to the industry level, the average of aggregate TFP differ whether we use residual as part of TFP or not. It
happens because
it t i t i
u + + + for each year. It means that ( ) ( )
it t i it t i it
u v v + + + .
19

Over the duration of 13 years, the computed TFP grew by 3.48 percent per annum. This rate
is somewhat higher than reported changes in official statistics. For example, for manufacturing,
the TFP growth during 1997-2000 was 4 percent annually and for 1997-2003, it was 1.8 percent.
16

Even though our measure of TFP growth should not be taken at face value and used as substitute
for Statistics Canadas measure, as a relative measures across time and industries they remain very
useful. Indeed, the estimation of TFP growth along with markups and scale effects at this level of
industry detail is a novel aspect of this paper.
Table 2. Calculated vs. Estimated Average Annual TFP Growth Rates, 1990-2002

Without
Residuals
With
Residuals
Calculated TFP 3.48 - -
Estimated TFP with pool regression - 3.65 3.76
Estimated TFP with weighted pool regression - 3.76 3.90
Average growth is obtained by weighting 86 industries TFP growth estimates by Domar weights.
Based on our results, if one adopts the TFP growth without including residuals, then the
estimated TFP growth is higher than computed TFP by about 0.2 percentage points in pool
regression and by 0.3 percentage points in generalized pool regression. On the other hand, if one
takes the TFP growth that also includes residuals, then the estimated TFP growth is higher than
computed one by a range of 0.3 to 0.4 percentage points. In any case, the range of difference
between these two series is 0.2 to 0.4 percentage points. That is, the estimated TFP growth is only
5 to 10 percent higher than the calculated annual TFP growth of 3.48 percent per annum.
At the aggregate, the calculated TFP is lower than the estimated TFP, no matter whichever
method we adopt. Hence, the usual measure of TFP underestimates actual unobserved TFP

16
In this respect, a cautionary note is in order saying that a TFP number for a particular industry in a particular year
from our series may not be precise, as data limitation precludes us from accounting several factors such as quality
differences of inputs, capacity utilization, use of more detail deflators and most importantly, the subtraction of
services input. Since the ASM data does not include cost of services input except the cost involved in services
subcontracting, our TFP measure will be larger than otherwise they would have been. Furthermore, we use shipment
data without adjusting for inventory change for output.
20

growth, but it does so by a very small margin. In terms of Equation (8), this means that TFP a < .
Hence, with roughly 0 = and 0 , this relation more or less implies that the expression inside
the square bracket in Equation (8) should have, on average, been negative for Canadian
manufacturing industries during 1990-2002.

6. Measuring Competition
Now we have two series of TFP growth, one computed and the other estimated allowing
each industrys coefficient to vary. The next task is to obtain measurements of competition so that
we can finally estimate the relationship between productivity and competition. Since there is no
single indicator for competition, we use a few of them. As in Nickell (1996) and Disney at al.
(2003), we categorize the competition variables into two groups, those that affect the level of
productivity and those that affect the productivity growth. We estimate the productivity and
competition relationship in the following form:
(11)
,
ln ln ln ln ln ln
2 2 1 1
5 4 3 2 1
it i t i it it
it it it it it it
e t t Z Z
K M E S U Q
+ + + + + +
+ + + + =



where, the first five variables on the right-hand sides are factors of production. We are implying
that determines the level of TFP, and determines the growth of TFP. All measures of
competition that affect the level of TFP will enter under , and those that affect the growth of
TFP will enter under . Unobserved factors that influence the level of productivity are covered
by industry fixed effects (
1
Z
2
Z
1
Z
2
Z
)
t
and time effects ( )
t
, and those that affect TFP growth are covered
by
i
. The problem of omitted variables will arise only if the unobserved shocks are not captured
by these three variables.
21

Since we are interested in estimating the TFP growth equation (which will also take out the
industry fixed effect), the productivity-competition relation in (11) becomes
(12)
it t i it i it i
it it it it it it
e Z Z
K M E S U Q
+ + + + +
+ + + + =


2 2 1 1
5 4 3 2 1
ln ln ln ln ln ln

Note that those variables that affect the level of TFP will appear with first difference and
those that affect the growth of TFP will appear in level forms. If a certain variable could affect
both the level and the growth of TFP, it will appear in both forms.
To measure competition, we use Herfindahl index ( )
it
h , concentration index for leading 4,
enterprises ( )
1
it
C , leading 5
th
to 8
th
enterprises ( )
2
it
C , leading 9
th
to 12
th
enterprises ( )
3
it
C , leading
13
th
to 16
th
enterprises ( )
4
it
C , leading 17
th
to 20
th
enterprises ( )
5
it
C , and leading 21
st
to 50
th

enterprises ( )
6
it
C . The sum of all these six categories of concentration ratio is the concentration
ratio for the 50 biggest enterprises. We also use firms entry rate ( )
it
, firms exit rate ( ),
import penetration ( , estimated markups
it
x
)
it
( )
it
and rents ( )
it
r

to measure competition.
In a way, Herfindahl index and concentration ratio are measures of market power. In
Appendix A, we have shown that with homogenous products, and Cournot conjecture about the
output change by other firms in response to its decision to change output, and Cobb-Douglas
preferences, Herfindahl index is equal to price-marginal cost margin, the Learners index. Hence,
it is generally believed that higher Herfindahl index and concentration ratio means lower
competition. However, there are a number of problems associated with the use of Herfindahl
index and concentration ratio as a measure of market power (an inverse measure of competition).
The most notably is that the share of output in an industry does not really capture the true market
size. Furthermore, the same level of Herfindahl index and concentration ratio might mean
different levels of market power in different industries.
22

In this context, these measures are unlikely to be a cross section measure of the inverse
competition. However, changes in these measures are likely to be a good time series measure of
inverse competition. Hence, we will regard the change in the concentration ratio and the
Herfindahl index as a measure of change in market power.
In Table 3, we see that there is quite a variation of Herfindahl index and concentration ratio
across industries. For example, the average Herfindahl index varied from as low as 0.005 in an
industry to as high as 0.642. The similar variation is found in all groups of four-enterprise
concentration ratios. At four leading enterprises levels, there are industries ranging from as high
as 97.5 percent output share to as low as less than 10 percent.
Table 3. Average Herfindahl Index and Concentration Ratio, 1990-2002
Concentration Ratio at Leading Enterprises

Herfindahl
Index
4 8 12 16 20 50
Maximum 0.642 97.5 99.8 100 100 100 100
Minimum 0.005 9.8 14.7 18.5 21.5 24.0 37.9
Average 0.088 13.0 17.6 20.7 23.1 25.1 34.9
Note: the average of Herfindahl index is the simple average of 86 industries over 12 years.

The other variables that we use as control are firms entry and exit rates. Here, we will be
looking at cross section relation of entry and exit rates with productivity growth. As presented in
Table 4, the data shows that there is quite a variation of these rates across industries. The average
exit rate during 1991-2002 varied from a minimum of 3.6 percent to a maximum of 18 percent.
Similarly, the entry rate varied from a minimum of 5.2 percent to a maximum of 21.8 percent.
Table 4. Firms Exit Rate and Entry Rate
Exit Rate Entry Rate
Maximum Minimum Average Maximum Minimum Average
1991 33.1 1.2 13.2 13.6 0.9 13.2
2002 38.8 5.6 10.8 25.4 4.2 10.8
Average (1991-2002) 18.0 3.6 9.0 21.8 5.2 9.0
Entry rate is defined as the percent of new establishments in total establishments, and exit rate is defined as the share
of enterprises that exited in a given year in total number of establishments in that year.

23

Another variable that we would want to use as an inverse measure of competition is the rent
or the price-average cost margin. Rent is defined as a share of total revenue, where rent is revenue
less material, labor and capital costs, as given by the right-hand side expression below:
(13)
Q p
J p Q p
p
p
r
Q
J Q
Q
Q

,
where is the average cost; is total revenue and is total payment to factors of
production. We have data for this expression except for the cost of capital, which we compute, as
derived in the Appendix B, using the following expression.
Q p
Q
J p
J
(14) Cost of capital = ( ) + r p
K
,
where is the price of capital (value of capital stock), r is the real interest rate and is the
depreciation rate. For price of capital, we use total stock of capital at real price; we assume r to be
equal to 4 percent for all industries throughout the period and compute the depreciation rate for
each industry and year using capital stock and investment data using formula given in (B2) in
Appendix B.
K
p
In the literature, rent has been used both as factor affecting productivity growth and
productivity level. However, since rents are expressed in terms of revenue, we feel that it is more
sensible to use the level rather than change as a regressor. For competition and lack of it, what
matters is the level of rents (normalized by revenue) not the change in rents over time. We expect
the sign of level of rents to be negative.
The another variable that we use as an inverse measure of competition is markup. We
expand the markup for 12 years using Equation (9) as follows:
(15)
( ) ( ) ( ) ( ) | |
it it Mi it it Ei it it Si it it Ui
it i t i it
it
k m r k m r k s r k u r
k q
+ + +

=
2
1

24

where a hat above the variable means estimated value from the regression. Note that has no
time dimension; it is a vector of scale coefficients from Equation (9). By multiplying by
capital stock for 12 years, we obtain the series of (markup) for 86 industries over 12 years. So
the time-varying markup is derived under the assumptions that the scale coefficients is the same
across all 12 years.
i 2

i 2

i 1

To control for foreign competition, we use import penetration ratio which is defined as the
share of imports to total consumption, where consumption is obtained as shipments plus imports
minus exports. We consider import penetration as a factor affecting both the level and growth of
productivity.
We have completed the discussion on the variables that we will be using to measure
competition. Now a word on the possibility of endogeneity (the reverse causality problem) of TFP
growth with most of the measures of competition such as concentration ratio, rents and Herfindahl
index. Industries with higher productivity growth may, in the long run, end up with higher
concentration ratios and Herfindahl indices than those with lower productivity growth. However,
note that in this situation the relationship from TFP growth to concentration, Herfindahl index and
rents should be positive. For example, if there are more productive firms in one industry than in
others, then these productive firms will strengthen their market share and as a result (ceteris
paribus) the concentration ratios and Herfindahl indices would be higher in the industry with
more productive firms compared to others, thereby implying a positive relationship from TFP
growth to inverse measure of competition. Thus, as argued in Nickell (1996), if we find a negative
relationship between these inverse measures of competition and productivity growth, we might
argue that the true relationship is even stronger. In any case, to eliminate reverse causality we lag
25

most of the explanatory variables by one year as in Nickell (1996) and Disney at al. (2003), where
they lag these variables by 2 years.
Incorporating all these variables into Equation (14), our estimating equation is:
(16)
it t i it it it it
it it
j
j
it
j
it it it it it it
e x r
h C
K M E S U Q
+ + + + + + +
+ + + +
+ + + + =

=




1 24 1 23 22 1 21
13 1 12
6
1
1 11
5 4 3 2 1
ln ln ln ln ln ln

This equation is similar to Equation (9), except the competition variables were not present in
that equation. Also, here we do not allow the coefficients to vary by industry. In concentration
ratio, we have used six groups of enterprises whose sum provides the concentration ratio for the
50
th
largest enterprises.

7. Results and Interpretation
The main results are presented in Tables 6, 7 and 8. We have a sequence of estimated
equations to investigate the robustness of the results, with regard to both changes in specification
of the independent and dependent variables. In Table 6, we start with output growth as a
dependent variable. The first specification is a basic model where we have all explanatory
variables, except the Herfindahl index, entry rate and exit rate. We use rent as defined in Equation
(13), called rent 1 and is denoted by ( ) 1

r in the table. In specification (2), we replace the six

groups of concentration ratio by one single variable which in effect is the concentration ratio of
leading 50 firms. In specification (3), we use alternative measure of rents defined as total revenue
minus cost of all other inputs, except capital, and normalized by total revenue. In other words, the
numerator includes all revenue that is left after paying for labor, fuel, energy and material inputs.
We called it rent 2 and is denoted by ( ) 2

r in the table. Specification (4) adopts Specification (3),

26

but replaces the six groups of concentration by one aggregate series. Specification (5) uses the
markup estimated using Equation (9) as a proxy for rents. Specification (6) is similar to
Specifications (1) and (2) but replaces the change in concentration variable by the change in the
Herfindahl index. In Specification (7) we use entry and exit rates as measure of competition, and
consider higher level of both rates as higher levels of competition. In this specification, we take
out all other domestic measures of competition including rent, as it is considered a result of entry
and exit rate.
17

As expected, the rent variable in Specification (1) is highly significant, indicating that an
industry with high level of profit to revenue share in time (t 1) will have low productivity growth
in time t. The coefficients of all six groups of enterprises are negative but only those for the first
and fourth four largest enterprises are statistically significant. This means that fall in concentration
ratio one year ago (which we interpret as rise in competition) will raise productivity level this
year. This effect is significant for two groups of enterprises (the first and the fourth groups). In
Specification (2), the coefficient of 50 leading enterprises concentration ratio is negatively
significant, reinforcing that the relationship between change in market share and TFP level is
negative. All the other results of Specification (1) continue to hold in Specification (2).
By replacing rent 1 by rent 2 (comparing Specifications 1 vs. 3 and 2 vs. 4), almost all
results remain the same. In Specification 5, the markup is negatively significant and shows that an
industry with low level of markup (high competition) a year ago will have higher productivity
growth this year. In this test, the change in concentration ratio first time turns insignificant. When
we estimated this specification for all six groups of concentration ratios, the result was that the

17
Note that in the long run profit might be zero, but still there could be difference between price and marginal costs.
Testing whether long run profits are positive is a test of free entry, not of (perfect) competition. Free entry guarantees
that long-run profits equal zero, but not that price equals marginal cost. Firms in a monopolistic competitive industry
27

coefficients were negative for three and positive for three, but none of them were significant (not
reported). The Herfindahl index, a measure of inverse competition, is negatively significant
(Specification 6), confirming the positive relationship between competition and productivity level.
In Specification (7), we see the entry rate affecting the TFP growth positively, implying an
industry with high level of entry rate in year (t-1) will have high productivity growth in year t.
Exit rate is not significant.
In neither of the specifications, the foreign competition variable the import penetration
rate (level or change) is found significant which means that Canadian manufacturing industries
do not have an impact of imports on their productivity level and growth.
The TFP growth series we have used in Table 6 were obtained without making any
assumption on market structure and returns to scale, but with the assumption that the coefficients
of all industries in Equation (16) are the same. In that sense, this estimation takes out only the
common (across industries) effect of potential markup and scale effects. In Table 7 (specifications
1 through 4), we present results by replacing this TFP series by calculated TFP under the
assumptions of constant returns and perfect competition. And in Specifications 5 and 6, we use the
TFP growth series estimated in the previous section as a dependent variable, in contrast to the
series in Table 6, where we have allowed all industries to have different slope coefficients, and
hence take out the markups and scale effects for each industry separately.
The explanatory variables in Specifications 1, 2, 3 and 4 in Table 7 are the same as
Specifications 2, 4, 5 and 6 respectively in Table 6. The coefficients for rents, concentration
ratios and the Herfindahl index are all negatively significant as in Table 6, ensuring the positive
relationship between level of competition and productivity growth and change in level of

may earn zero profit even though price is above marginal cost. Short-run profits reveal very little about the degree of
competition in an industry because, in all market structure, short-run profits can be either positive or negative.
28

competition and level of productivity. The only difference between the specifications in Table 6
and here occurred in the import penetration variable. In three of the four cases, the import
penetration coefficient is positively significant at the level form and on two occasions negatively
significant in change form. Thus, an industry with high level of import penetration has higher
productivity growth contemporaneously. However, it is likely that an increase in the import
penetration will lead to a fall in productivity level.
In Specifications (5) and (6), which are the same as Specifications (1) and (4) respectively
except that the dependent variables are different, the rent variable turns out positive (for the first
time) but is insignificant. However, the change in concentration ratio and change in Herfindahl
index are still negatively significant. The significant effects of both level and change in import
penetration that we saw in the first four specifications disappear.
18

As a last robustness check, we use labor productivity as a dependent variable in Table 8
and control for change in capital intensity. The specifications 1 through 4 in this table are similar
to Specifications (1), (3), (5) and (4) respectively in Table 6, with only a difference that in
Specification (3) here we have all six groups of change in the concentration ratio whereas in
Specification (5) in Table 6, we have aggregated them into one. More or less the same results
holds. Rent is negatively significant in all specifications. Regarding change in the concentration
ratio, it is negatively significant for three groups in Specifications (1) and (2), and negative
(positive) but insignificant for one (two) groups. In Specification (3), however, the coefficients are
negative for three groups and positive for another three groups. Only one coefficient in each group
is significant; this is the first time change in the concentration ratio has emerged as positively
significant. In another test (not reported), we replaced change in the concentration ratio of six

18
In none of the specifications in Table 7, when all domestic measures of competition were replaced by entry and exit
rates, they were not found significant, and we have not reported these results.
29

groups by their sum, and found that the coefficients were negative but insignificant for all
specifications. Hence, we conclude that for this type of dependent variable the impact of change in
level of concentration ratio to productivity level is somewhat negative but not significant. The
change in the Herfindahl index also turned insignificant for the first time (Specification 4).
Similarly, markup turned insignificant first time. The level and change in import penetration are
respectively positively and negatively significant in three of the four specifications. Again, entry
and exit rates were not significant and are not reported in the Table.

8. Conclusions
The novelty of this paper is to use a detail industry level data to estimate the markup
(market power) and returns to scale for North American Industrial Classification System (NAICS)
4-digit 86 industries from 1990 to 2002. In addition, using these estimates we refine the total
factor productivity (TFP) growth measurement by isolating the impact of non-constant returns and
imperfect competition. By doing so we have been able to mitigate the potential biasness of TFP
growth for representing unobserved productivity growth. Finally, we test the relation between
productivity growth and product market competition. Following the objectives set out at the start
of the paper, the main findings of the paper are as follows.
Out of 86 Canadian manufacturing industries, we were not able to reject the null hypothesis
of constant returns to scale to 80 industries, and the null hypothesis of perfect competition to 55
industries. Hence, Canadian manufacturing sector is overwhelmingly represented by constant
returns and one third of them have market power (price greater than marginal costs).
30

The estimated annual TFP growth during 1990-2002 was positive for a majority of
industries and negative for a few of them. The same was the case even if we use the calculated
TFP under the assumptions of constant returns and perfect competition.
For few industries, the TFP growth calculated under the assumptions of constant returns and
perfect competition were not very different from the TFP growth estimated relaxing these
assumptions, but for the majority of them these two series were substantially different with even
opposite signs. This indicates that at the industry level, while relating TFP growth with other
economic variables, one should be cautious in using single measure and should take into account
the biasness that the non-constant returns and imperfect competition may create.
However, at the aggregate level, the story is different. Even though the usual Solow residual
(TFP growth) computed under the assumptions of constant returns and perfect competition
underestimates actual unobserved productivity growth, it does so by a small margin of 0.2 to 0.4
percentage points. Hence for the aggregate TFP growth, even if there are non-constant returns and
imperfect competition, the calculated TFP will be a reasonable measure of actual productivity
growth. But that is not necessarily the case for individual industries.
The competition, as measured by lower level of rents and markup and higher level of import
penetration, is associated with a significantly higher rate of TFP growth. Similarly, the fall in the
Herfindahl index and the concentration ratio (proxies for a rise in competition) lead to higher
productivity level effect. On the other hand, higher the change in import penetration, lower will be
productivity level. The impact of entry rate indicates that the higher level of entry (a direct
measure of competition) lead to higher rate of TFP growth. The exit rate, however, has no impact
on productivity growth. These results are more or less robust.

31

Table 5. Regression Results and Calculated vs. Estimated TFP Growth by Industry, 1990-2002
Markup Scale effect TFP Growth
NAICS 4-digit Coef. T-test Coef. T-test GLS PLS Calculated
3111 Animal food 1.04 0.32 1.12 0.21 0.49 0.31 0.53
3112 Grain and oilseed milling 1.27 1.27 0.99 -0.03 0.80 0.87 1.18
3113 Sugar and confectionery product 1.31 1.71
c
1.31 0.55 0.65 -0.19 1.74
3114 Fruit and vegetable preserving 0.56 -1.51 0.73 -0.59 2.10 1.73 0.86
3115 Dairy product 1.50 2.57
b
1.55 0.71 -0.69 -0.79 0.42
3116 Meat product 0.95 -0.44 0.63 -1.10 1.80 1.85 0.61
3117 Seafood product preparation 1.28 1.17 2.42 1.34 0.89 0.82 0.45
3118 Bakeries and tortilla 1.61 2.51
b
1.61 1.17 0.57 0.58 0.78
3119 Other food 1.46 1.68
c
1.80 0.87 -1.13 -1.53 0.64
3121 Beverage 0.57 -2.44
b
0.44 -0.96 3.62 3.48 2.71
3122 Tobacco 1.16 1.69
c
0.45 -1.16 4.04 3.73 2.40
3131 Fiber, yarn and thread mills 0.91 -0.71 0.92 -0.26 1.29 1.08 1.00
3132 Fabric mills 1.13 0.81 1.06 0.13 1.04 0.79 0.91
3133 Textile and fabric finishing 0.94 -0.31 1.95 1.36 -0.02 -0.23 0.26
3141 Textile furnishings mills 1.14 1.16 1.61 2.05
b
2.29 1.97 1.12
3149 Other textile product mills 0.89 -1.06 0.46 -2.19
b
2.57 2.65 0.97
3151 Clothing knitting mills 1.06 0.27 0.15 -1.56 1.27 1.18 0.80
3152 Cut and sew clothing 1.08 0.89 0.82 -0.94 1.00 1.02 0.63
3159 Clothing accessories and other 1.10 0.84 0.71 -2.25
b
0.75 0.70 -1.70
3161 Leather and hide tanning 0.99 -0.05 0.94 -0.04 0.34 -0.26 0.26
3162 Footwear manufacturing 1.06 0.44 1.24 0.30 0.14 -0.57 -0.62
3169 Other leather and allied product 1.31 2.62
a
0.19 -0.84 1.05 0.63 2.31
3211 Sawmills and wood preservation 1.93 2.53
b
0.69 -0.40 -0.47 -0.43 2.02
3212 Veneer, plywood and engineered wood 2.07 2.65
a
0.55 -0.96 0.54 0.74 2.98
3219 Other wood product 1.60 2.74
a
1.36 0.96 -1.11 -0.98 0.93
3221 Pulp, paper and paperboard mills 2.71 4.12
a
1.38 0.18 -0.28 -0.51 0.18
3222 Converted paper product 1.17 1.45 1.50 0.88 1.16 1.02 2.32
3231 Printing and related activities 1.27 1.20 0.43 -0.61 3.52 3.26 1.96
3241 Petroleum and coal products 0.88 -1.37 2.48 1.20 2.85 2.77 1.85
3251 Basic chemical manufacturing 0.66 -0.87 -1.54 -2.43
b
-0.14 -0.42 1.33
3252 Resin, synthetic rubber, and fibres 1.54 1.60 0.84 -0.39 1.34 1.11 -0.44
3253 Pesticide, fertilizer and other ag. chemical 1.03 0.09 1.01 0.03 -1.44 -1.50 -1.47
3254 Pharmaceutical and medicine 1.31 1.16 3.85 1.63 -13.78 -15.56 1.40
3255 Paint, coating and adhesive 1.00 0.00 0.76 -0.47 2.01 1.88 1.21
3256 Soap, cleaning and toilet preparation 1.02 0.12 1.17 0.44 0.57 0.47 0.74
3259 Other chemical product 1.02 0.13 1.22 0.41 2.29 2.29 2.22
3261 Plastic product 1.17 0.92 0.90 -0.30 2.13 2.77 1.79
3262 Rubber product 1.05 0.41 0.13 -1.27 3.57 3.33 2.95
3271 Clay product and refractory 2.08 2.51
b
1.13 0.15 0.44 0.38 2.18
3272 Glass and glass product 1.30 0.35 1.29 0.22 3.28 2.71 3.17
3273 Cement and concrete product 1.61 4.24
a
1.26 1.02 1.45 1.26 2.11
3274 Lime and gypsum product 1.58 1.10 1.13 0.20 1.81 1.71 3.04
3279 Other non-metallic mineral product 1.61 1.74
c
1.39 0.46 2.16 2.01 2.44
3311 Iron and steel mills and ferro-alloy 1.35 1.47 0.46 -0.56 -0.25 -0.44 1.42
32

3312 Steel product from purchased steel 1.19 2.22
b
1.34 1.10 1.36 1.28 1.54
3313 Alumina and aluminum 1.43 2.12
b
1.21 0.50 1.54 1.43 1.88
3314 Non-ferrous metal (except aluminium) 1.05 0.38 0.36 -0.75 2.05 1.91 2.33
3315 Foundries 1.41 1.82
c
1.45 1.34 0.16 0.38 1.24
3321 Forging and stamping 1.37 2.23
b
1.24 0.59 1.47 1.28 1.64
3322 Cutlery and hand tool manufacturing 1.35 1.52 0.87 -0.56 0.89 0.85 0.54
3323 Architectural and structural metals 1.25 2.08
b
1.36 1.12 0.16 0.02 0.97
3324 Boiler, tank and shipping container 1.22 0.54 1.33 0.53 0.83 0.67 1.00
3325 Hardware 1.43 2.72
a
1.03 0.17 1.39 1.39 1.56
3326 Spring and wire product 1.13 0.85 0.60 -1.18 2.26 2.32 2.56
3327 Machine shops, turned product, and screw 1.28 2.58
b
0.89 -0.66 2.80 3.21 2.51
3328 Coating, engraving, heat treating 1.11 1.10 1.16 0.79 3.55 3.97 3.89
3329 Other fabricated metal product 1.13 1.22 1.16 0.61 1.02 1.03 1.55
3331 Ag., construction and mining machinery 1.20 1.35 1.07 0.19 1.75 1.79 2.14
3332 Industrial machinery 1.27 3.01
a
1.02 0.09 1.37 1.44 1.64
3333 Commercial and service industry machinery 1.36 1.93
b
1.25 0.40 1.79 1.58 2.61
3334 Venti., heating, air-cond. & refrig. equip 1.35 1.82
c
0.95 -0.27 1.71 1.61 1.83
3335 Metalworking machinery 1.11 0.39 1.17 0.55 1.59 1.74 2.45
3336 Engine, turbine and power transm. equip. 0.81 -0.40 0.90 -0.14 3.22 2.90 2.30
3339 Other general-purpose machinery 1.20 1.63 0.85 -0.60 2.35 2.58 1.61
3341 Computer and peripheral equipment 0.97 -0.20 0.26 -0.80 0.28 -0.03 -0.88
3342 Communications equipment 1.48 2.71
a
0.77 -0.70 -0.25 -0.61 -3.18
3343 Audio and video equipment 1.13 1.92
b
1.24 0.39 1.42 1.21 -0.57
3344 Semiconductor & other electronic compo. 1.21 1.59 1.52 0.88 -4.91 -4.93 -0.64
3345 Navigational, and medical instruments 1.91 2.18
b
0.12 -1.97
b
4.61 4.00 -1.16
3346 Magnetic and optical media 2.06 2.46
b
1.06 0.12 -0.85 -0.76 1.42
3351 Electric lighting equipment 1.05 0.20 0.91 -0.25 0.30 0.23 -0.16
3352 Household appliance 1.15 1.62 1.28 0.67 -0.24 -0.28 0.28
3353 Electrical equipment 0.91 -0.23 0.61 -0.81 2.29 2.21 1.77
3359 Other electrical equipment & component 1.34 1.46 1.01 0.02 0.37 0.02 -0.39
3361 Motor vehicle 1.17 1.20 0.88 -0.25 1.96 2.14 1.02
3362 Motor vehicle body and trailer 1.31 1.44 0.95 -0.10 -0.17 0.00 0.46
3363 Motor vehicle parts 1.13 0.52 0.95 -0.31 1.44 1.59 1.62
3364 Aerospace product and parts 3.46 1.89
c
-7.75 -1.35 20.50 20.20 5.41
3365 Railroad rolling stock 1.03 0.15 0.55 -0.31 -1.03 -1.01 0.45
3366 Ship and boat building 0.82 -0.54 1.17 0.10 0.15 -0.29 0.15
3369 Other transportation equipment 1.32 0.42 0.64 -0.29 3.05 3.10 1.14
3371 Household and institutional furniture 1.26 0.96 0.96 -0.12 2.02 1.93 1.95
3372 Office furniture (including fixtures) 1.45 3.14
a
0.94 -0.26 1.80 1.50 2.11
3379 Other furniture-related product 1.57 2.62
a
0.99 -0.06 1.22 0.86 1.22
3391 Medical equipment and supplies 1.09 0.45 1.32 0.86 -1.60 -1.51 -0.03
3399 Other miscellaneous 1.06 0.38 1.24 0.63 0.72 1.03 1.08
Average 1.16 10.02
a
1.01 0.30 3.76 3.65 3.48
Note: PLS means estimated using pool least square, and GLS means estimated using weighted pool least square. The
markup and scale effects are based on GLS estimation. The t-tests are based under the null hypotheses that markup is
equal to unity, and scale effect is equal to unity.
a
indicates significant at 1% level;
b
indicates significant at 5% level;
c
indicates significant at 10% level
33

Table 6. Dependent variable is
it
Q ln
Specification (1) (2) (3) (4) (5) (6) (7)
Inputs
it
U ln
0.11
(6.23)
a
0.11
(5.90)
a
0.12
(6.68)
a
0.11
(6.35)
a
0.10
(5.59)
a
0.10
(5.80)
a
0.10
(5.34)
a
it
S ln
0.07
(6.13)
a
0.07
(6.51)
a
0.06
(6.44)
a
0.07
(6.62)
a
0.07
(6.35)
a
0.07
(6.78)
a
0.07
(6.79)
a
it
E ln
0.06
(4.19)
a
0.06
(4.43)
a
0.07
(5.18)
a
0.07
(5.14)
a
0.09
(6.48)
a
0.07
(5.07)
a
0.07
(4.33)
a
it
M ln
0.70
(47.43)
a
0.70
(47.35)
a
0.72
(50.89)
a
0.72
(50.61)
a
0.66
(47.16)
a
0.70
(48.01)
a
0.68
(43.05)
a
it
K ln
0.09
(2.59)
a
0.10
(2.61)
a
0.12
(3.38)
a
0.12
(3.32)
a
0.10
(3.22)
a
0.11
(2.95)
a
0.06
(1.48)

Competition variables
( )
1
1
it
r

-0.48
(12.63)
a

-0.48
(12.72)
a

-0.48
(12.72)
a

( )
1
2
it
r

-0.83
(17.66)
a
-0.83
(17.65)
a

1 it

-0.01
(2.63)
a

1
1

it
C
-0.07
(2.68)
a
-0.05
(2.37)
b



2
1

it
C
-0.06
(1.43)
-0.06
(1.51)



3
1

it
C
-0.04
(.52)
-0.10
(1.08)



4
1

it
C
-0.30
(2.66)
a
-0.27
(2.40)
b



5
1

it
C
-0.01
(0.26)
-0.02
(0.43)



6
1

it
C
-0.03
(0.93)
-0.03
(1.15)

=

=
6
1
1
50
1
j
j
it it
C C

-0.06
(2.33)
b

-0.05
(2.25)
b
-0.01
(0.36)

1

it
h

-15.36
(1.92)
c


1 it
entry



0.08
(2.41)
b
1 it
exit




0.07
(1.44)
it
imports 0.01
(1.26)
0.01
(1.31)
0.01
(1.06)
0.01
(1.13)
0.004
(0.49)
0.01
(1.37)
0.004
(0.35)
it
imports -0.004
(0.68)
-0.004
(0.69)
-0.004
(0.53)
-0.004
(0.56)
0.001
(0.23)
-0.004
(0.74)
0.001
(0.20)
Constant 1.07
(6.35)
a

2
R
0.90 0.90 0.92 0.91 0.85 0.91 0.89
D-W 2.24 2.24 2.03 2.03 2.34 2.23 2.42
Note: The number of industries is 86, and the number of observations is 946. All regressions are weighted pool least
square. They all have industry and time dummies included, except Specification (5).
T-ratios are in parentheses
34

a
indicates significant at 1 percent level;
b
indicates significant at 5 percent level;
c
indicates significant at 10 percent level.


Table 7: Using Calculated and Estimated TFP Growth as Dependent Variable
Dependent variable calculated
it
TFP ln Dependent variable
estimated
it
TFP ln
Specification (1) (2) (3) (4) (5) (6)
Competition variables
( )
1
1
it
r

-0.44
(11.52)
a

-0.44
(11.52)
a

0.02
(1.52)
0.02
(1.37)
( )
1
2
it
r

-0.75
(15.86)
a



1 it
-0.01
(2.16)
b

=

=
6
1
1
50
1
j
j
it it
C C
-0.11
(3.60)
a
-0.09
(3.23)
a

-0.05
(1.69)
c


-0.03
(1.89)
c

1

it
h -23.02
(2.79)
a


-10.71
(1.65)
c
it
imports 0.02
(2.97)
a
0.02
(2.03)
b
0.01
(0.92)
0.02
(3.06)
a
0.001
(0.17)
0.001
(0.23)
it
imports -0.01
(1.72)
c
-0.01
(1.18)
-0.00
(0.04)
-0.01
(1.75)
c
-0.001
(0.17)
-0.001
(0.28)
Constant 1.64
(10.97)
a


2
R
0.34 0.42 0.04 0.33 0.50 0.50
D-W 2.22 2.08 2.27 2.20 2.45 2.46
Note: The number of industries is 86, and the number of observations is 946. All regressions are weighted pool least
square. They all have industry and time dummies included, except Specification (3).
T-ratios are in parentheses
a
indicates significant at 1 percent level;
b
indicates significant at 5 percent level;
c
indicates significant at 10 percent level.
35


Table 8. Dependent variable is ( )
it
L Y ln
Specification (1) (2) (3) (4)
Inputs
( )
it
L K ln 0.23
(6.15)
a
0.23
(6.38)
b
0.21
(6.62)
a
0.23
(6.43)
a
Competition variables
( )
1
1
it
r

-0.63
(8.97)
a




-0.64
(9.08)
a
( )
1
2
it
r

-1.21
(12.69)
a

1 it
-0.01
(0.93)

1
1

it
C
-0.14
(2.58)
a
-0.14
(2.52)
b
-0.05
(0.98)


2
1

it
C
-0.15
(1.67)
c
-0.14
(1.65)
c
-0.01
(0.12)


3
1

it
C
-0.03
(0.13)
-0.04
(0.20)
0.28
(1.25)


4
1

it
C
-0.44
(2.31)
b
-0.40
(2.44)
b
-0.46
(2.09)
b

5
1

it
C
0.08
(0.90)
0.07
(0.90)
0.18
(2.05)
b

6
1

it
C
0.07
(1.07)
0.08
(1.27)
0.10
(1.62)

1

it
h

-17.43
(0.88)
it
imports 0.04
(2.87)
a
0.04
(2.40)
b
0.02
(1.02)
0.04
(2.99)
a
it
imports -0.02
(1.98)
b
-0.02
(1.73)
c
-0.01
(0.42)
-0.02
(2.06)
b
Constant 3.99
(13.39)
a

2
R
0.34 0.39 0.09 0.33
D-W 2.25 2.16 2.24 2.25
Note: The number of industries is 86, and the number of observations is 946. All regressions are weighted pool least
square. All specifications have industry and time dummies included, except Specification 3.
T-ratios are in parentheses
a
indicates significant at 1 percent level;
b
indicates significant at 5 percent level;
c
indicates significant at 10 percent level.

36

References

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37

Appendix A: Herfindahl Index
The Herfindahl index is defined as the sum of the squares of each enterprises share of the industry total. For each
industry i, Herfindahl index is calculated as follows:

=
n k
ki i
h
2

where i index industry and k index all firms in that industry, n is the number of firms in the industry and
ki
is the
share of firm ks in industry is output. For an industry with n firms the index varies between n 1 and 1. It assumes its
lower value when all n enterprises have the same market shares, i.e., they each have a market share of n 1 . Then the
index has the value of n 1 . It approaches its maximum value of 1 when one of the enterprises has virtually the whole
share of the industry and the index is virtually 1 squared, which is 1.

As we will show below, Herfindahl index can be linked to price cost margin. Let the assume that the firm k
in industry i maximizes the following profit function:
(A1) ( ) (
ki ki ki i Q ki
Q C Q Q p = )
where industry output is given by Q and firms output is given by . The sum of all firms Q in an industry is
equal to . Of course, we are assuming homogenous product across firms in an industry. And C is the total cost of
production of firm k. The first order profit maximization for each firm leads (we have suppressed industry subscript
for brevity) to
i ki
Q
ki
ki i
Q
k
k
k
Q
k Q
k
k
c
Q
Q
Q
p
Q p
Q

(

+ =

Note that conjectural derivative,
k k
Q Q

, is the way firm k thinks all other firms output changes (given by
k
Q

)
as its own output changes. Let us suppose that the conjectural variation of all firms in an industry is constant, such
that for all k, =
k k
Q Q . In this case, the above equation can be written as
( )
k
k
Q
Q
Q
c
Q
Q
p
Q
Q
p
p =
(
(

+ 1 1
This function can be written as
( )
k
k
Q
c p =
|
|
.
|

\
| +

1
1 , where Q Q
k k
= is the share of firm ks in industry output,
and Q p p Q
Q Q
= is the market price elasticity of demand. This expression can be simplified to
(A2)
( )

+
=

1
k
Q
k Q
p
c p

Multiplying both sides of Equation (B2) by the market share
k
and summing over the n firms, we obtain the
expression relating weighted-average industry price-cost margin to a measure of market concentration, the Herfindalh
concentration index and conjectural variation.
( )

+ =

1
2
k
k
Q
k
k
k
k
k Q
p
c p

It can be written as follows
( )

+ =

1
h
p
c p
Q
Q

where c is the firms share weighted industrys marginal cost. The relation between Herfindahl index and price-cost
margin depends on the nature of conjectural variation and price elasticity of demand. It we assume Cournot conjecture
( = 0) and Cobb-Douglas preferences ( = 0), Herfindahl index is equal to Learners index of market power.
h
p
c p
Q
Q
=

or

1
1 = h . Hence, higher Herfindahl index means higher markup.
38


Appendix B. Cost of Capital

We calculate the cost of capital using the following mechanism:

Cost of capital = ip ,
K K K
p p +
where i is the nominal interest rate, is the price of capital; is the rate at which capital prices are changing and
is the depreciation rate. Rearranging it, the cost of capital is given by
K
p
K
p
|
|
.
|

\
|
+

K
K
K
p
p
i p . If we assume that the price
of capital goods rises with the price of other good, then
K
p
K
p equals the overall rate of inflation, and cost of
capital takes the following form:
(B1) Cost of capital = , ( ) + r p
K
where r is the real interest rate. We compute the depreciation rate for each industry using the following formula.
(B2)
( )
|
|
.
|

\
|
+
+
=

2
1
1
t
it
it it it
it
I
K
I K K
,
where I index investment.