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Production and Cost in the Pulp and Paper Industry: A Translog Cost Function Analysis

The United States pulp and paper industry has experienced significant structural changes over the past twenty-five years, including reductions in the number of pulp and paper mills, lower rates of capacity growth, employment cutbacks, and a loss of market share to foreign competitors. These structural shifts portray an industry that increasingly has difficulty adapting to a more competitive environment and earning sufficient profits to generate a return on investment that covers opportunity costs. Based on aggregate data from 1965-1996, this paper estimates a translog cost function for the industry’s short run costs. Adjusting for first order serial correlation, the estimated model fits the data well and all sample points satisfy the monotonicity and concavity conditions. Among the findings, the industry operates at slightly increasing returns to capital utilization and labor and energy are complements in production whereas materials is a substitute in production for the other inputs. Technological progress generated 0.037% reduction in annual operating costs at the mean but the effect was asymmetric with a much larger impact during the early part of the period. Consistent with an ailing industry, estimated marginal costs approximated average operating costs until 1981 after which marginal costs significantly diverged from average operating costs.