A New Approach to Testing Marginal ProductivityTheory

We address the long standing question of whether production factors are paid their marginalproducts. We propose a new approach that circumvents the need to specify productionfunctions and to compare marginal products to factor payments. Our approach is based on asimple equation that directly relates firms’ profits to discrepancies between factor paymentsand marginal products. Our empirical application using data on manufacturing firms suggeststhat capital receives more than its marginal product, intermediate inputs receive less, andlabor receives about its marginal product. Although there are differences with respect to firmsize, deviations from marginal productivity theory generally seem limited. Our results haveimportant implications for the distribution of income, the presence of optimizing behavior, andthe existence of market power....