Import Competition and Market Power:

Canadian Evidence
by
Aileen J. Thompson*
Federal Trade Commission
Washington, DC
December 20, 1999
* Most of this paper was written while I was an Associate Professor at Carleton University. I
am grateful to the Micro-Economic Analysis Division of Statistics Canada for a Visiting
Fellowship and support that allowed me to complete this project. I thank Bob Gibson and
Joanne Johnson for providing insight into the data and John Baldwin for many thoughtful
discussions. I also thank the University of Michigan for providing an interesting research
environment during my sabbatical visit, workshop participants at Carleton University, Clark
University, Statistics Canada, and the General Accounting Office for helpful comments, the
Social Science and Humanities Research Council of Canada (SSHRC) for financial support and
Ying Kong for research assistance. The views expressed in this paper do not necessarily reflect
those of Statistics Canada or the Federal Trade Commission.
1
Import Competition and Market Power:
Canadian Evidence
Aileen J. Thompson
Federal Trade Commission
1. Introduction
A number of international trade models have now been developed that account for
imperfect competition. Although some of these models provide insight into situations where
trade protection may be welfare improving, most indicate that imperfect competition provides
additional sources of gains from trade. Many of these gains result from the pro-competitive
effect of trade: import competition increases the perceived elasticity of demand for domestic
firms, leading them to reduce their mark-ups of price over marginal cost.
1
Applied general equilibrium models suggest that these effects may be important
quantitatively. Harris (1984) and Cox and Harris (1985) perform a number of simulations of
trade liberalization experiments calibrated for 1976 Canadian data. They find that the estimated
welfare gains based on models incorporating imperfect competition are substantially greater than
the estimated gains based on the corresponding perfectly competitive model. Similarly, in a
study of the potential impact of the Canada-United States Free Trade Agreement, Brown and
Sterns (1989) model suggests that the pro-competitive effects of Canadian tariff reductions
may be quite strong in many Canadian industries.

1
See Markusen (1981).
2
Early econometric studies analyzing the impact of trade on market power employ the
mark-up of price over average variable cost as a measure of non-competitive behavior. These
studies generally find that import competition reduces average cost mark-ups, particularly in
domestically concentrated industries.
2
Economic theory, however, predicts that import
competition reduces the mark-up of price over marginal cost, which is not directly observable.
Recent studies draw on the work of Roberts (1984) and Hall (1988) to estimate price-marginal
cost mark-ups from equations derived from profit maximizing conditions. Three studies apply
this approach to plant-level data to analyze the impact of trade reform on competition in
developing countries. Levinsohn (1993) finds that price-marginal cost mark-ups fell in Turkish
industries where trade was liberalized, and increased in industries where trade protection was
increased. Similarly, Harrison (1994) finds that mark-ups are negatively related to import
competition in the Cote dIvoire, and Krishna and Mitra (1998) present evidence that mark-ups
fell during the trade reform period in India.
This paper estimates price-marginal cost ratios using detailed establishment-level data
for manufacturing industries in Canada during the 1970s. The 1970s were chosen as the period
of study due to the substantial increase in trade during this time. The share of domestic
consumption of manufactured goods that was accounted for by imports rose from 26% in 1971
to 32.6% in 1979. The relationship between mark-ups and imports is estimated for two
separate cross-sections: the early 1970s and the late 1970s. In addition, the data for the two
periods are combined to analyze the impact of changes in import competition on mark-ups over
time. The primary conclusion that can be drawn from the analysis is that there is no consistent

2
See, for example, Caves, Porter, and Spence (1980), Jacquemin, de Ghellinck and Huveneers (1980), Pugel
(1980), de Melo and Urata (1986), and Domowitz, Hubbard, and Petersen (1986) and Katics and Petersen
(1994).
3
evidence that import competition has reduced the market power of firms operating in the
Canadian market.
2. Empirical Framework
2.1 Estimating Price-Marginal Cost Ratios
Profit-maximization with respect to output yields the following relationship between
price and marginal cost:
P
MC
s
it
it
it it
it
it
+

1
]
1

1
1

, (1)
where s
it
is the market share of the firm,
it
is the market elasticity of demand in industry i,
and
it
is the conjectural variations parameter ( ) Q q
t it
/ . As defined above,
it
is the
profit-maximizing ratio of price to marginal cost. The estimated value of this parameter can be
used to calculate the Lerner index, the mark-up of price over marginal cost:

1
1

P
MC P
.
To estimate price-marginal cost ratios, I follow the approach employed by Levinsohn
(1993). Consider the production function for a representative firm i:
q f L
it it it
( ) (2)
where L
it
is a vector of j factors of production, and
it
is a firm- and period-specific
productivity shock that is assumed to follow a random walk:

it i t it
+
, , 1
,

it
N ( , ). 0
2
4
Furthermore, it is assumed that
it
is composed of a time-specific productivity shock that is
common to all firms within a given industry and a productivity shock that is specific to the
individual firm:

it t it
+
.
.
To derive an estimating equation for
it
, totally differentiate (2),
( ) ( ) dq f L dL f
it it it jit jit
j
it t it

1
]
1
+ +

/ . (3)
Profit-maximization with respect to input markets implies that the firm employs each input until
its marginal revenue product is equal to its price. Thus,

it it
it
ijt
it
ijt
p
f
L
w

1
, (4)
Solving (4) for ( / ) f L
it it
and substituting it into (3) yields:
( ) dq
w
p
dL f
it it
ijt
t j
ijt it t it
+ +

. (5)
Thus,
it
can be estimated by estimating the relationship between changes in output and factor
price-weighted changes in inputs.
Price-marginal cost mark-ups are estimated for individual Canadian industries at the 3-
digit Standard Industrial Classification (SIC) level for two years during the early 1970s and two
years during the late 1970s. Following Levinsohn, three econometric issues are addressed.
First, the term
t
is modeled as a time-period fixed effect.
3
Second, the output price, p
t
, is

3
It is likely that
t
is correlated with the changes in inputs. In this case, the fixed effects specification will
lead to unbiased and consistent, but inefficient estimates. An alternative approach is to employ
5
potentially endogenous since an individual firm (and shocks affecting that firm) may affect the
industry price level. To address this concern, the wholesale price index is used as an instrument
for the industry-level price index. The final concern is that the disturbance term of equation (5),
( ) f
it t it
+ , is heteroskedastic owing to the presence of the f
it
term, which is a function of
firm size. To address this issue, it is assumed in the estimation that the variance of the
disturbance is proportional to the square of labor expenditures.
2.2 Estimating the Relationship between Price-Cost Ratios and I mport Competition
In the second stage of the analysis, the impact of import competition on price-marginal
cost ratios is estimated. It is assumed that the relationship between price-cost ratios, imports
and other explanatory variables can be expressed as:
h
k
hk k h
x +

, (6)
where
h
is the ratio of price to marginal cost for industry h, x is a vector of industry
characteristics, including a measure of import competition, and
h
is the disturbance term,
assumed to have a zero mean and constant variance of

2
.
In addition to import competition, two other industry characteristics are included in the
benchmark regression: export intensity and domestic market concentration. As discussed by
Caves (1985), theoretical models lead to ambiguous predictions about the impact of exports on

instrumental variables estimation although, as discussed by Levinsohn, appropriate instruments are not
readily available.
6
profitability. Due to the high correlation between imports and exports (see below), it is
important to control for the potential impact of exports so that the impact of imports can be
isolated.
Domestic concentration is employed to control for the degree of competition in the
domestic market. It is well known that it is difficult to capture differences in market structure by
a single measure (or a manageable set of measures).
4
The four-firm concentration ratio is the
most frequently employed indicator of domestic competition for studies of import competition
and profitability and is therefore used here for comparability.
5
The fact that price-marginal cost ratios are estimated (with error) rather than observed
raises the issue of heteroskedasticity. Replacing
h
with
$

h
, we have the following equation,
h
k
hk k h
x +

, (6)
where
h h h
+ , and
h
is the estimation error of
$

h
. The disturbance term is likely to be
heteroskedastic owing to the fact that the variance of
h
is not constant across industries.
Equation 6 is therefore estimated using feasible generalized least squares (GLS) following the
procedure described in Appendix A.
3. Data
Price-marginal cost ratios are estimated for individual Canadian industries at the 3-digit
Standard Industrial Classification (SIC) level over the periods 1971-2 and 1978-9 (based on

4
See Bresnahan (1989) for a discussion of this issue.
5
For previous versions of the paper, the model was also estimated using market share turnover between
1970 and 1980 as a measure of domestic competition. This variable is measured as the percentage shift of
7
changes from 1970-1 and 1971-2 for the first period and 1977-1978 and 1978-9 for the
second period). Data for two years are combined for each estimate to reduce the sensitivity of
the estimates to the particular year chosen as well as to increase the number of observations for
each 3-digit industry.
To estimate equation (5), price and quantity data are required for output and factors of
production. Five factors of production were initially considered: production workers, non-
production workers, materials, fuel, and capital. Establishment-level data were obtained from
the annual Census of Manufactures survey for: value of manufacturing production, hours worked
by production workers, number of non-production workers, value of materials used in
manufacturing production, and expenditures on fuel and energy. This survey covers every
establishment assigned to the manufacturing sector. However, only establishments for which
manufacturing activity accounts for at least 90% of total activity and for which there were no
missing data for at least two consecutive years are included in the estimation. In addition, the
analysis for each time period is based on the industries that had at least 20 observations. The
final sample for which all data are available (including the international trade variables and other
industry characteristics) consists of 97 industries for 1971-2 and 99 industries for 1978-9.
Data for capital investment were obtained from the Statistics Canada Capital
Expenditures Survey. When the capital expenditures file was merged with the Census of
Manufactures file, however, the sample size was significantly reduced. Preliminary analysis
indicated that including capital as a factor of production did not significantly alter the estimates of

market share from declining establishments to growing establishments. The results were not substantially
altered.
8
the mark-ups for the sample of plants for which capital data were available.
6
Capital was
therefore not included as a factor of production in the estimates below so that a larger sample
could be used.
Quantities for production, materials, and fuel were computed by dividing the values of
these variables by industry-level price indices. These indices were obtained from the KLEMS
database, made available through the Input-Output division of Statistics Canada. Industry-level
wages and salaries were calculated for each 3-digit SIC code by dividing total wages earned by
production workers by the number of hours worked and by dividing total salaries earned by
non-production workers by the number of non-production workers.
Data on imports and exports at the 3-digit SIC level were obtained from the publication,
Commodity Trade by Industrial Sector, Historical Summary, 1966-1983, published by the
Department of Regional Industrial Expansion, Canada. Both the import and export data were
corrected for re-exports. Import intensity is defined as the share of domestic consumption
accounted for by imports, where domestic consumption is calculated as (domestic shipments -
exports + imports). Export intensity is defined as the ratio of exports to shipments. The
shipments data were obtained from the Statistics Canada publication Manufacturing Industries in
Canada.
Table 1 summarizes the trade data by major manufacturing groups for the 3-digit
industries considered in this study.
7
Both import and export intensities increased in almost every

6
The correlations between the mark-ups estimated with and without capital were 97.8% and 98.8% for 1971
and 1979, respectively.
7
The data in this table represent only the 3-digit industries used in this study and therefore do not
correspond directly to trade data calculated at the 2-digit level.
9
major industry group.
8
As a result, the pattern of trade across industries is similar for both
periods. This suggests, unfortunately, that it may be difficult to distinguish a differential impact of
increased trade over the period on mark-ups. The industries with the greatest import intensities
in both the 1971-2 period and the 1978-9 period are leather, textiles, knitting mills, primary
metals, machinery, transportation equipment, electrical equipment, and chemicals. Three of
these industries, primary metals machinery, and transportation equipment, are also among the
industries with the largest export intensities. The correlations between import and export
intensities are 0.55 and 0.50 for the 1971-2 and 1978-9 periods, respectively.
Unless otherwise specified, the data were provided by the Micro-Economic Analysis
Division of Statistics Canada.
4. Results
4.1 Estimates of Price-Marginal Cost Ratios
Before discussing the results with respect to import competition, it is useful to summarize
the estimates of the price-marginal cost ratios. Table 2 reports the summary statistics for both
the 1971-2 and 1978-9 periods. The mean estimated price-marginal cost ratio for 1971-2 is
1.15 while the mean estimate for 1978-9 is 1.09, indicating a fall in the average mark-up from
12.7% to 8.6%. This is within the range of estimates reported by other studies based on plant-
level data. Harrison (1994), for example, reports an average mark-up across sectors of 8%.

8
The exceptions are petroleum and coal, where import intensity fell and knitting mills where export
intensities fell.
10
Owing to the significant increase in trade during the 1970s, the general reduction in
estimated price-marginal cost ratios during this period is consistent with the hypothesis that trade
increases competition. In addition, the proportion of industries with ratios that were statistically
significantly greater than one fell from 70% to 44%. The increase in competition is not uniform,
however. Panel C of Table 2 provides summary statistics for the change in price-marginal cost
ratios. Although 29% of the industries experienced a statistically significant decline in their
mark-ups, 15% actually experienced a statistically significant increase.
9
Table 3 summarizes the 3-digit mark-ups according to 2-digit industry groups. Six
industries had average ratios above the median for both the early 1970s and the late 1970s:
tobacco products, electrical products, non-metal mineral products, petroleum and coal, rubber
and plastic, and miscellaneous; while six industries had average ratios below the median for both
periods: paper and related products, wood products, clothing, printing and publishing, knitting
mills, and food and beverages.
4.2 Cross-sectional Analysis: Benchmark Model
Table 4 presents the GLS results of equation (6) estimated separately for 1971-2 and
1978-9. The overall impact of import competition on price-marginal cost ratios is actually
positive (columns 1 and 3) for both periods, although only the estimate for 1971-2 is statistically
significant. This finding is inconsistent with the hypothesis that imports increase competition in
the domestic market and is in contrast to the results of similar studies that are based on
developing countries (e.g., Levinsohn (1993) and Harrison (1994)).

9
To estimate the correct standard errors, the data were combined for the two periods and a dummy variable
was employed to capture the change in mark-ups with the corresponding standard error.
11
As will be discussed more fully below, the non-negative relationship between mark-ups
and import competition may reflect, in part, the simultaneity problem that high mark-ups attract
imports. Another potential explanation is that the overall Canadian domestic economy is
sufficiently competitive that import competition does not have a significant impact. Import
competition can be expected to have the greatest impact on industries where domestic market
conditions are such that competition would otherwise be weak. When the interaction between
imports and concentration is included in the estimation equation (columns 2 and 4), the
coefficient on this variable is negative as predicted, although not statistically significant.
The relationship between mark-ups and export intensity is negative for all of the
equations in Table 4. Although not statistically significant, the negative relationship is consistent
with the hypothesis that participation in export markets places competitive pressure on domestic
exporting firms. Harrisons (1994) estimates of mark-ups in different sectors of the food
industry also suggest that export exposure may have a pro-competitive impact.
The results in Table 4 indicate that domestic concentration did not have a significant
impact on price-marginal cost ratios for the 1971-2 period. It did, however, have a significant
positive impact for the 1978-9 period. It is interesting that the estimated effect is stronger for
the 1978-9 period. Due to the increase in international trade during the 1970s, one could
predict that the level of domestic concentration would have been less important in the late 1970s
than in the early 1970s. This result may reflect the weakness of using a single measure to
capture the complex variations in market structure.
For purposes of comparison, Domowitz, Hubbard, and Petersen (1988) find that
concentration has a small, but significant, positive impact on estimated price-marginal cost mark-
ups for U.S. manufacturing industries. When the analysis is performed for different types of
12
industries, however, they find that the relationship between concentration and mark-ups is strong
for consumer goods and durable goods industries, but insignificant for producer goods and non-
durable goods industries. In addition, they find that the relationship varies over the business
cycle.
4.3 Instrumental Variables Estimates
As mentioned above, there is a potential simultaneity between price-cost ratios and
imports. If imports are determined endogenously, then the GLS estimates will be biased.
Instrumental variables estimates are reported in columns (4)-(8) in Table 4. Appropriate
instruments are correlated with imports, but uncorrelated with the error term of equation (6).
The set of excluded instruments consists of the nominal tariff rate and dummy variables for
natural resource and labor intensive industries.
10
Interactions between these instruments and
concentration are also included as instruments for the estimation equations that include the
interaction between concentration and imports. An alternative set of regressions was estimated
using the effective rate of protection as an instrument in place of the nominal tariff rate. The
results were very similar to those discussed below.
11
As discussed by Bound, Jaeger and Baker (1995), the finite sample bias of IV estimates
may be quantitatively important when the correlation between the endogenous variables and the
instruments is weak. In particular, a good approximation of the bias of IV estimates relative to

10
The tariff data were generously provided by Larry Schembri. These data were defined according to the
input-output PL level classification and concorded to SIC codes. The labor and natural resource dummy
variables are based on the OECD (1987) taxonomy adapted for the Canadian economy by Baldwin and
Raffiquzzaman (1994).
11
Effective rates of protection measures were generously provided by John Baldwin for 1970 and 1978.
13
OLS estimates is provided by (1/F), where F is the F statistic for the excluded instruments in the
first stage regression. The F-statistics for the excluded instruments employed here range from to
2.1 to 4.4, indicating that the potential bias of the IV estimates is small relative to the OLS
estimates.
The IV results are reported in columns (5) through (8).
12
The IV estimates differ in
magnitude from the OLS estimates and are estimated with larger standard errors. The
implications of the results, however, are similar. Based on the Hausman test, the hypothesis that
the two sets of estimates are the same cannot be rejected at the 5% level of significance for any
of the estimating equations. Therefore, the hypothesis that imports are exogenous cannot be
rejected.
4.4 The Impact of Multinational Corporations
In this section, the role of multinational corporations in determining the relationship
between import competition and mark-ups is examined. This is motivated by theoretical and
applied general equilibrium work by Markusen, Rutherford, and Hunter (1995) that suggests
that the pro-competitive effect of trade may be dampened by the presence of multinational
corporations. This is because an increase in imports may actually increase the market share and
mark-up of foreign-owned firms operating in the domestic market if imports originate from the
parent company. In this case, trade liberalization will not necessarily have the overall pro-
competitive effect that has been emphasized in much of the trade policy literature.

12
The IV estimates are also based on GLS estimation to account for the fact that the mark-ups are estimated
with error.
14
This is a potentially important issue in Canada. It has been estimated that foreign-
controlled importers accounted for approximately 70% of Canadian imports in 1978.
13
To
investigate the impact of multinational corporations on the potential pro-competitive effects of
trade, the estimation equation is augmented to include an interaction term between imports,
domestic concentration, and a measure of foreign ownership. The prediction is that the
coefficient on this variable will be positive, indicating that foreign ownership weakens the
potential for imports to increase competition in domestically concentrated industries. The
percentage of industry imports that were imported by foreign controlled firms is used as the
measure of the importance of foreign ownership. Unfortunately this variable is only available for
1978.
14
The 1978 value is used for both time periods based on the assumption that it was
relatively stable over time.
15
The results of the augmented regression are reported in columns (2) and (5) in Table 5.
The coefficient on the interaction between imports, concentration, and foreign ownership is
positive as predicted, although not statistically significant. Comparing these results to the
benchmark model (repeated in columns (1) and (5)), the coefficient on the interaction between
imports and concentration becomes larger in absolute value and is marginally significant at the
10% level for the 1971-2 period. These results provide some, albeit weak, evidence that the
potential disciplining effect of imports is diminished in industries with a relatively high degree of
foreign ownership. This is consistent with the predictions of Markusen, Rutherford, and Hunter
(1995), and has not previously been tested.

13
Statistics Canada, (1978) Canadian imports by domestic and foreign controlled enterprises, Catalogue 67-
509 Occasional. Ottawa: Minister of Supply and Services, Canada.
14
Statistics Canada, (1978) Canadian imports by domestic and foreign controlled enterprises, Catalogue 67-
509 Occasional. Ottawa: Minister of Supply and Services, Canada.
15

15
Alternatively, the equations were estimated using a dummy variable indicating whether the value of this
variable was greater than the mean. The results were not significantly affected.
16
4.5 Additional Control Variables
In this section, the estimation equation is augmented further to include additional control
variables. The first is demand growth, which is defined to be the industry-level percentage
change in demand during the relevant periods. For the 1971-2 period, for example, it is the
percentage change between 1972 and 1970.
16
The other additional control variable is a measure of entry into the industry. It is defined
as the mean over the period 1970 to 1982 of the proportion of new entrants in a year.
17
It is
hypothesized that mark-ups will be lower when new entry is relatively easy. The entry variable
is also interacted with concentration and the interaction between imports and concentration since
the effect of concentration on mark-ups should be reduced when there is potential entry in the
industry.
The results are presented in columns (3), (4), (7), and (8) in Table 5. The coefficients
for the growth variables are not statistically significant. Nor are the entry variables for the 1971-
2 period. For the 1978-9 period, the interaction between entry and concentration is negative
and significant, suggesting that entry reduces mark-ups in concentrated industries. The
coefficient on entry alone is positive and significant. The overall impact of entry on mark-ups,
however, is insignificant.
18
The important point to note from these results is that the conclusions
with respect to the international trade variables are not affected by the addition of these
variables.

16
Domestic demand is defined as (domestic shipments-exports+imports) and is calculated at the 2-digit level
to minimize potential endogeneity problems. The data were taken from the Statistics Canada publication,
Manufacturing Trade and Measures, 1966-1984. Quantities were deflated by industry-level price indices
calculated from the KLEMS database.
17
These data were generously provided by John Baldwin.
18
The coefficients on entry are small and insignificant when the interaction terms are not entered into the
regressions.
17
4.6 Analysis Based on Changes Between 1971-2 and 1978-9
A well-known problem with cross-sectional analysis of industry performance is that
there are likely to be important industry characteristics that are either unobservable or difficult to
measure.
19
If unobserved characteristics are correlated with the explanatory variables, then the
cross-sectional estimates will be biased. If industry effects are relatively time invariant,
estimation based on changes over time can control for these fixed effects. As discussed above,
however, because trade increased in almost all industries, it may be difficult to distinguish a
differential impact of increased trade over the period on mark-ups.
Table 6 presents the results based on changes between the 1978-9 period and the
1971-2 period. Unless otherwise specified, all variables are expressed in terms of differences
between these two periods. Following Katics and Petersen (1994), it is assumed that all
industry characteristics other than the international trade variables are constant over time. This
includes the domestic concentration ratio.
20
As seen in column (1), the overall impact of import competition on mark-ups is positive,
but not significant. This is consistent with the cross-sectional results discussed above. In
column (2), the interaction between the concentration ratio and changes in imports is included to
determine whether import competition had a differential impact between concentrated and
unconcentrated industries.
21
The coefficient on this interaction term is positive and marginally
significant at the 10% level. Therefore, in contrast to the cross-sectional results, the results here

19
See Bresnahan (1989) and Schmalensee (1989) for discussions.
20
The domestic concentration ratio is relatively constant. The sample mean of this variable falls from 43.7 to
43.2 between 1970 and 1980, and the correlation between the two periods is 0.94.
21
The average of the 1970 and 1980 concentration ratios is employed to calculate this variable.
18
indicate that imports may have actually increased mark-ups in domestically concentrated
industries. The implications of these results are not changed when the estimation controls for the
impact of multinational imports (column (3)) or differences in growth rates between the two
periods (column 4).
To pursue these results further, the equations were estimated for the subsample of
industries for which the 1971-2 price-marginal cost ratio was statistically significantly greater
than one. These are the industries where one would expect increased import competition to
have the greatest effect. The results were generally the same as those reported in Table 6: there
is no evidence that increased imports led to a reduction in mark-ups.
An interesting result from Table 6 is that the coefficient for changes in exports is negative
and statistically significant at the 5% level for all four estimations. The negative relationship
between mark-ups and export orientation is consistent with the cross-sectional results and
suggests that participation in export markets may have a pro-competitive impact on domestic
Canadian firms.
5. Conclusion
This paper estimates price-marginal cost mark-ups for Canadian manufacturing
industries in order to assess the impact of import competition on domestic market power. The
results are mixed. Although the overall relationship between mark-ups and imports is positive
across industries for the early 1970s and insignificant for the late 1970s, there is some weak
cross-sectional evidence to suggest that imports reduce market power in domestically
19
concentrated industries. Changes in imports between the two periods, however, have a positive
impact on mark-ups in concentrated industries. Thus, there is no consistent evidence for
Canada that imports have had the beneficial impact on competition that has been emphasized in
much of the literature. In contrast, an interesting result of the paper is that increases in exports
are associated with reductions in mark-ups, suggesting that exports may have a stronger pro-
competitive impact on domestic firms than imports.
6. Appendix A
The disturbance term of equation 6 is
h h h
+
,
. It is assumed that
( ) E
h h
, . 0 The variance of
h
,
2
, is therefore equal to

2 2
+
h
. Let w
h
represent
the residuals from an OLS regression of equation 6. The variance of
h
can be estimated as
follows.
( )
p
w
n k n k
h
h
lim
var
$
2
2

_
,

(A1)
Thus,
( )
$
$ var
$

v
h
h w
n k n k

_
,

2

(A2)
The first term on the right hand side of equation (A2) can be calculated from the residuals of
equation 6 and the second term can be derived from the variance estimates of equation (5) for
the individual industries. Equation 6 is then estimated using feasible generalized least squares
20
where the observations are divided by
( )
$
v$ ar
$

+
h
.
21
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