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Editor's Note: The Office of Technology Assessment recently published an interesting and useful study of some key aspects of national economic statistics. Several highlights are present in this month's contribution by Andrew Wyckoff of the OTA staff. The full study is available from Superintendent of Documents, Government Printing Office, Washington, DC, 20402-9325; (202) 783-3238. Ask for GPO Stock No. 052-003-01162-0, Statistical Needs for a Changing U.S. Economy -- Background Paper, September 1989. Joseph W. Duncan, Editor, The Statistics Corner.

GOOD DECISIONS, whether in the public or the private sector, require good information. The information generated by the $1.5 billion spent this year by federal agencies on statistical programs is a key resource for government policymakers as well as for private investors, public interest groups, academic researchers, and labor organizations. Our federal statistical system is one that the nation can be proud of, but the U.S. economy is changing in ways that make the challenge of documenting economic performance much more difficult.

Cognizant of these changes, the Subcommittee on Government Information and Regulation of the Senate Committee on Governmental Affairs asked the Office of Technology Assessment (OTA) to provide a perspective on areas where better data would improve economic policy analysis and identify areas where changes in the economy are not well tracked by the existing statistical system. This study culminated in a report recently released to the Congress entitled Statistical Needs for a Changing U.S. Economy. Based on that longer report, this article focuses on two areas of particular interest to the business economist: allocating economic growth by sector and tracing the effects of international trade.

ALLOCATING ECONOMIC GROWTH BY SECTOR

Tracing the source of growth in the economy to individual business sectors requires an ability to describe the complex business networks that now operate in virtually every part of the economy. Each business in a network delivering a final product or service to a consumer adds some value (value added) to the product. The sum of "value added" in all businesses in the United States sums to the GNP. As a basic as are the data on the composition of GNP, they have been the subject of a considerable amount of criticism. The Bureau of Economic Analysis, the source of data, concedes ". . . that real gross product by industry cannot be measured precisely." By and large, the data problems revolve around the question of how to adjust the value of the dollar and improvements or deterioration in the quality of the good or service being produced -- a process called deflation.

As arcane as constant dollars and the deflation process sound, they have a direct relationship to public policy. The so-called "deindustrialization" debate (where economists have been arguing over whether or not the contribution of manufacturing industries to the GNP is declining) depends upon an accurate deflation procedure. Questions concerning the pace of GNP growth and productivity also hinge on being able to compare estimates of value added by industry in constant dollars over time.

Deflation

Understanding the method by which value added is deflated is important in recognizing the problems associated with deflators. The goal of deflation is to compare apples to apples, allowing a consistent comparison over time. To accomplish this, products valued in current dollars must be revalued into a constant set of prices that adjust not only for the effects of inflation, but also make products comparable over time by adjusting for changes in quality. This process is hard enough for products; it gets even more difficult for the value-added portion of the product's sale price. Simply put, value added is the difference between the sales price (gross output) of a product and the materials and services purchased (inputs) to produce that product.

To calculate value added by sector in constant dollars, the inputs purchased by each business are deflated separately, and the total is subtracted from a deflated level of industry sales (total or gross output), creating a residual that is deflated value added or "gross product originating." This technique, called "double-deflation," is recognized as a preferred method by the Department of Commerce because of its use of a consistent set of price indexes.(1) In practice, however, because of incomplete data this technique can be used in only 29 percent of the 1986 GNP -- the manufacturing, farm, and construction sectors.

Data Deficiencies

An essential component of the deflation process involves an accurate accounting for intermediate inputs, which are usually obtained from input-output tables produced by the Department of Commerce's Bureau of Economic Analysis. Because of the nature of the calculation where value added is a residual, any error in the inputs will result in an error in the calculation of value added. Shifts in the economy toward the use of more services and more foreign-sourced inputs have exposed weaknesses in the intermediate input data and the deflation process. Thus, to obtain better estimates of each industry's contribution to GNP, improvements have to be made to the intermediate input data.

Intermediate Inputs from the Service Sector. The fastest growing intermediate input in the economy, particularly to the manufacturing sector, is the purchase of a group of services collectively called business services, which contains services like accounting, advertising, legal help, computer services, and temporary help services. As of the 1982 input-output table, Business Services was the third largest intermediate input to manufacturing -- greater than commodities like steel, rubber, paper, and transportation.

In spite of its fast growth, this intermediate input is poorly measured, leading to mismeasurement of constant dollar input in industries that use business services as an input. The basic data source on intermediate inputs for the manufacturing sector, the quinquennial Census of Manufacturing, does not collect data on purchased business services. The smaller, sample-based Annual Survey of Manufacturing collects data on only a few purchased services, such as repair and communication services once very five years.

A variety of scaling techniques and other methods are used to compensate. For example, BEA calculates deflators for several service sectors by extrapolation using jobs as a proxy for increases in quantity. By definition, this means that no labor productivity growth can occur, resulting in an overstatement of the rise of prices in this industry and a subsequent underestimate of the quantity of services purchased an inputs. The underestimate of inputs means that the value added of industries that purchase services as an intermediate input, such as manufacturing, is overstated. Because these value-added-by-industry data are used by the Bureau of Labor Statistics (BLS) to calculate business sector productivity, productivity measures for manufacturing are probably overestimated.

Imported Intermediate Inputs. Currently, the BEA does not distinguish between imported and domestically produced intermediate inputs, even though these inputs are deflated using domestically based deflators based primarily on the producer price index. Thus, if the prices of imported inputs do not move in the same direction and at the same rate as domestic prices, a distortion will occur. Years ago, when few inputs to U.S. production processes came from foreign sources and the exchange rate of currencies was stable, this distortion did not present much of a problem. But from 1979 to 1985, due to the high value of the dollar, the prices of imported inputs grew much more slowly than domestic inputs. Thus by using faster rising domestic price series on imported inputs, the level of intermediate inputs was overstated and the level of value added or output was understated, especially in the early, 1980s. This process resulted in an overestimate of value-added growth during this period of roughly 0.5 percent per year between 1979 and 1985. That correction is nearly equivalent to eliminating the growth in output of the electrical equipment industry -- the second largest contributor to manufacturing's growth during the period.

Valuations of Quality: Computers and Services. Coupled with this problem of fixed weights is the broader dilemma of how to adjust constant prices for changes in quality. Accurate conversion from current to constant dollars is only possible where indexes can be based on measurable, fungible commodities like corn and oil that have somewhat constant characteristics over time. But the bulk of GNP is composed of goods and services whose various characteristics and specifications do not stay constant over time, making direct comparisons without some type of quality adjustment inappropriate. The question of adjusting for quality becomes extraordinarily complex when diverse products are entertaining the market and many products are new. The computer is a prime example.

Working with IBM, BEA has attempted to find a way to adjust the prices of computers for quality changes.(2) The deflator uses an index not strictly tied to the price of products, but instead makes adjustments by comparing specific characteristics over time, such as how many million of instructions are executed per second (MIPS) or how memory capacity has change to get an indication of the change in the value of computer power. Not surprisingly the change has been dramatic. For example, the price of one megabyte of main memory fell by a factor of 20 between 1972 and 1984. Changes of this magnitude have a large effect on the deflator. While the deflator for all producer durable equipment (PDE) was 1.078 in 1987 (1982 = 1.00), the deflator for the "office, computing, and accounting machinery" (OCAM) category was 0.55. Combine this quality adjustment with the use of fixed weights and the impact of the computer industry on economic statistics is enormous, causing an upsurge in the "real" purchases of PDE measured, the real growth of GNP, and the productivity growth rate of manufacturing.

Although the method of deflation used for computers has drawn some criticism -- whether right or wrong -- it has not been consistently applied to other high-tech sectors, causing some distortions. For example, in the semiconductor industry the output price deflators for microelectronics actually rose from 1972 to 1982 while the index for computers fell drastically.

Measuring changes in the quality of computers, however, can seem easy in comparison with the challenge of measuring changes in the quality of services. Services are a growing fraction of the GNP before adjustments are made of inflation. Changes in the quality of health care (10 to 11 percent of the GNP) and education (7 percent of the GNP) are poorly measured or not measured at all. Fundamental conceptual problems must be confronted in developing deflators

for these sectors. The Bureau of Labor Statistics (BLS) has reached projects underway in health care and other difficult service sectors. But currently, no productivity estimates for these sectors are published by BLS because of shortcoming in the data.

BEA has responded to some of the criticisms outlined above and has undertaken an effort to revise the constant-dollar value-added-by-industry series.(3) Currently, this revision process involved two steps: a reexamination of the procedure used to apportion adjustments among industries; and the inclusion of import prices in deflators. Exploration is underway to improve the timeliness of intermediate purchases of materials and services, but this process requires the assistance of other statistical agencies.

Although firm conclusions cannot be drawn about biases in the present series until the revised series are available, it appears likely that manufacturing's growth in output from 1979 to 1985 will be revised downward. In any event, constant dollar estimates of value added by industry and the corresponding productivity measurements should be interpreted with caution.

MAKING INTERNATIONAL COMPARISONS

A new challenge to the statistical system has come from the rapid and dramatic changes that have occurred in both the volume and nature of international trade. From the end of World War II to 1983 the amount of imports purchased on a per capita basis (real 1982 dollars) slowly crept from $300 to $1,500. By 1987, the amount was $2,300 -- a 50 percent increase in four years. This phenomenon is not limited to a few select products but now affects virtually every industry. Three changes facets of international trade are exposing deficiencies in the economics statistics in this area: the upsurge in direct investment, the increasing importance of intrafirm trade, and the use of imported products as intermediate inputs in domestic production processes.

Direct Investment

Global production networks have redefined the nature of trade. Direct foreign investment by the United States overseas increased by 43 percent between 1980 and 1987; foreign investment in the United States tripled during the same time. But these figures are deceptive because they are based on the book value of the assets, i.e., the price paid at the time of purchase. No attempt is made to adjust for inflation. Because 70 percent of U.S. direct investments owned overseas were purchased by 1980 at relatively low prices while over two-thirds of foreign direct investments in the United States were acquired after 1980 at higher prices, the net position of the United States is greatly underestimated. Estimates indicate that the failure to adjust for inflation undervalues U.S. overseas investments by $200 billion to $400 billion. In terms of policy, this undervaluation means that the rate of return associated with those foreign assets has been grossly overestimated and the alarm over the United States becoming the largest net debtor in the world might be misplaced. In addition to a more accurate valuation process, researchers argue that more detailed data on inputs, type of labor employed, and layoffs are needed for a more complete analysis of the effect of foreign direct investment on the U.S. economy.

Intrafirm Trade

The growth in investments around the globe is indicative of the emergence of worldwide production networks, leading to an upsurge in "intrafirm" trade where a division of a multinational corporation trades with another affiliate. In 1985, nearly one-third of all U.S. exports were exports from U.S. companies to overseas affiliates and more than a fifth of all imports to the United States came from these overseas U.S. affiliates. These global production networks transcend the idea of the sovereign state, obscuring the notion of what is meant by foreign trade.

Efforts are being made by the Census Bureau to ask more detailed questions about imports used in production, but in many cases the establishments simply do not know the national origin of the products they purchase because the products have passed through many middlemen.

Tracing the Effects of International Trade

Existing data make it difficult to trace the effects of imports or exports through the economy. The lack of data means that it is impossible to make firm estimates of the problems that might be created by a sudden change in trade -- such as a change in the import quotas of steel on the U.S. auto industry, a disruption of oil supply because of a war in the Middle East, or the effect low-priced or "dumped" semiconductors would have on the U.S. computer industry.

The analytical tool best suited for this type of analysis is input-output analysis. Recognizing this, the Japanese under the auspices of the Ministry of International Trade and Industry (MITI) are developing an integrated set of input-output tables that will link the major trading nations of the world.(4) In the case of the developing Pacific Rim countries that in some cases lack a strong statistical system, the Japanese are collecting and organizing the data as a part of Japan's foreign aid to those countries. The Japanese have started that they will use the model to "analyze bilateral and multilateral economic issues and conflicts," "analyze the economic impact of international economic activities," and "clarify the magnitude of international interdependence."

Obviously, the data could be an important competitive tool in identifying and targeting key industries. As the world gets increasingly carved up into large trading blocks (i.e., U.S. and Canada and Europe's 1992 agreement), the input-output tables also could be used to evaluate the costs and benefits of a Pacific Rim trading agreement.

A limiting factor for undertaking a similar effort with U.S. input-out tables is the fact that our input-output accounting system does not distinguish between imported and domestically produced products used as intermediate inputs. This accounting convention is adequate for aggregate measures of GNP -- the primary purpose of the input-output accounts. But as production networks expand across borders, separating imported from domestically produced intermediate inputs is essential to trace the effects of trade accurately; especially if the aim of the analysis is to pinpoint direct and indirect dependencies of U.S. industries on other countries.

A more fundamental problem than separating domestic from imported intermediate inputs involves identifying intermediate inputs. Some products shown as purchased "intermediate inputs" by businesses are in fact products produced by foreign subsidiaries. In many cases, U.S. components are shipped abroad for assembly and the reimported for final testing and sales. Nonetheless, the Census Bureau reports that many firms fail to report inputs receive from overseas affiliates as costs of business. As a result, the value of the input gets credited as value that was added domestically, overstating the true amount of U.S. production in that industry. Although this problem always has existed, the upsurge in intermediate inputs coming from foreign sources makes this a growing problem. For examples, in the semiconductors industry some analysts estimate that half of the value of the chip is added overseas in the assembly process.

CONCLUSION

The intent of this article is to call attention to the fact that holes in our statistical system limit our ability to analyze changes in the economy. These are not small, inconsequential areas of economic inquiry, but fundamentals such as knowing the industrial composition of the GNP economy and understanding the impact international trade has on the U.S. economy.

Although the field of economics has made great strides in improving methods that manipulate and analyze data, the data are badly in need of attention. In many cases the solution entails additional resources, a requirement that is hard to meet in the current budgetary environment, especially for an issue that does not command the front page. But the problem is also indicative of a lack of management and coordination. The statistical system suffers from the absence of any central leadership able to develop a coherent strategy for adjusting the system so that it can respond to the challenges presented by today's economy. Although the need for a centralized statistical system is not apparent, we do require a central body that articulates priorities in statistics and matches budgets to these priorities, anticipates future needs, and coordinates a response among the various decentralized statistical agencies.

Even if coordination is improved and resources for statistics are expanded, users have to realize that the economy is changing in ways that defy measurement. Increasingly, economic output depends critically on quality, timeliness, and sensitivity to diverse markets and where inputs depend critically on the skills and education of the work force. These are qualities that are inherently difficult to measure, both mechanically and conceptually. If nothing else, neither the products nor the inputs of today's complex economy can be measured with the precision possible in a traditional, less-sophisticated economy. Many of the measurement problems do not have an easy resolution. The nation will need to face the fact that uncertainties in key areas exist and, in some cases, are increasing.

FOOTNOTES

(1)Milo Peterson, "Gross Product by Industry," Survey of Current Business, vol. 67, No. 4, April 1987. (2)Cole, Y.C. Chen, J.A. Barquin-Stolleman, E. Dulberger, N. Helvacian, and J.H. Hodge, "Quality-Adjusted Price Indexes for Computer Processors and Selected Peripheral Equipment," Survey of Current Business, January 1986, pp. 41-50; David W. Cartwright, "Improved Deflation of Purchases of Computers," Survey of Current Business, March 1986; and David W. Cartwright and Scott D. Smith, "Deflators for Purchases of Computers in GNP: Revised and Extended Estimates, 1983-1988," Survey of Current Business, November 1988, pp. 22-23. (3)U.S. Department of Commerce, Bureau of Economic Analysis, "Gross Product by Industry: Comments on Recent Criticisms," Survey of Current Business, July 1988, p. 132. (4)The countries included are Japan, the United States, the United Kingdom, France, the Federal Republic of Germany, South Korea, Malaysia, Singapore, Thailand, the Philippines, Indonesia, China, and Taiwan, Sato, Japan's Ministry of International Trade and Industry, "Compilation of an International Input-Output Table," Paper Presented at the OECD Workshop on International I-O Tables and Performance Analysis of Structural Adjustment, Dec. 14, 1988, Paris, France.

Andrew Wyckoff is an Analyst in the Office of Technology Assessment (OTA), U.S. Congress, Washington DC.
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Title Annotation:Statistics Corner
Author:Wyckoff, Andrew
Publication:Business Economics
Article Type:column
Date:Jan 1, 1990
Words:3399
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