Explaining Cost Differences Between
Germany, Japan, and the United States
This chapter explains differences in the unit cost of production between the United States, Japan, and Germany for twenty-five industrial sectors for the period 1960- 1979. My colleagues and I consider the differences in the level of total factor productivity (TFP) and in input price as two major factors generating these differences in the level of unit production costs. We thus break down intercountry differences in unit production cost into the differences in TFP and in input price.
We use the methodology that was originally developed by Jorgenson and Nishimizu ( 1978) in terms of the production function within a bilateral framework; this methodology has been extended by Caves, Christensen, and Diewert ( 1982) within a multilateral framework. Our approach represents a dual extension in terms of the cost function. We estimate TFP on the basis of cost function instead of production function. While the choice between production function and cost function is quite irrelevant for the measurement of TFP itself, the cost function has the advantage of relating the unit cost level to the level of TFP and input price directly.
Using the same set of data as ours, Jorgenson, Kuroda, and Nishimizu ( 1985) measured TFP for the United States and Japan, whereas Conrad and Jorgenson ( 1984) and Conrad ( 1985a) measured TFP for all three countries. All these studies used the index number approach based on the production function, and the main concern was the measurement of TFP per se. For five manufacturing sectors taken from the same data set, Conrad ( 1985b), using the index number approach, measured TFP differences between the three countries on the basis of the cost function. However, he made no attempt to explain intercountry unit cost differences. Hence the study reported here can be said to be the first with the explicit aim of explaining unit cost differences between the United States, Japan, and Germany at the level of disaggregation of twenty-five sectors.
Since the data for each of the three countries are measured in the domestic currency, it was necessary to convert them into a common unit of measurement, for example U.S. dollars, to make an international comparison. We used purchasing power parities (PPP) for this purpose.