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Industry-of-Origin Prices and PPPs:

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1 Industry-of-Origin Prices and PPPs:
A New Dataset for International Comparisons Bart van Ark & Marcel Timmer Groningen Growth and Development Centre Presentation for EU KLEMS Public Session on ”The Determinants of Europe’s Productivity Revival” 9 June 2005 Helsinki Thanks. Follow up to last year’s presentation  suggested idea of combining E-PPPs and O-PPPs for international comparisons by ioo. Now made quite some progress  apologize for incomplete version This paper is partly funded by an NSF research project on “Improved Methods of Estimating Production and Income across Nations” and by the EU 6th Framework Programme on EU KLEMS “Industry Productivity in the EU This work is partly funded by an NSF research project on “Improved Methods of Estimating Production and Income across Nations” and by the EU 6th Framework Programme on EU KLEMS “Industry Productivity in the EU”

2 Background Increased attention for PPPs (theory, methodology and practical applications) Largely based on expenditure PPP (E-PPP) concepts and databases (e.g., ICP and PWT) Various applications deserve use of PPPs by industry (productivity, price convergence, Balassa-Samuelson hypothesis, historical work) Use of output PPPs (O-PPPs) is hampered by a range of problems (small country coverage & bilateral nature, lack of readily available price surveys, double deflation, unit values, weak price measures for services, reconciliation problems with E-PPPs) Background: as appears from recent publications  increased attention for PPPs  both on theory, methodology and practical applications. Striking that most of the work is based on expenditure PPP (E-PPP) concepts and databases  clear path dependency here  in early 50s couple of approaches were tried  concluded that expenditure PPP approach was preferred over ioo approach for some obvious and some less obvious reasons  creation of good expenditure survey (e.g., ICP and PWT) But various applications (productivity, price convergence, Balassa-Samuelson hypothesis, historical work) deserve use of PPPs by industry Use of output PPPs (O-PPPs) is hampered by a range of problems: small country coverage & bilateral nature lack of readily available price surveys (census & industry surveys) double deflation of output and intermediate inputs to get at VA Much of output price information are unit values Measurement of output prices in services Reconciliation of E-PPPs and O-PPPs never got serious attention (e.g. only with work of Feenstra and others  serious focus on role of import & export prices in PPPs) Balassa-Samuelson hypothesis  one of the old workhorses

3 Double Motivation of Paper
Provide conceptual basis for system of PPPs by industry of origin: Based on system of supply-use tables Develop criteria for use of expenditure prices or output prices for construction of industry PPPs Provide new dataset of industry PPPs: 45 industries (aggregated from digit NACE industries) Based on a motivated mix of O-PPPs and adjusted (‘peeled’) E-PPPs 26 countries, including 19 EU member states New benchmark year 1997 Paper tries to do two things: 1)  lot of the work on industry of origin PPPs was ad-hoc and entirely based on data availability  need to provide conceptual basis for system of PPPs by industry of origin  do here on basis of system of supply-use tables  develop criteria for choosing between expenditure prices or output prices for construction of industry PPPs 2)  provide new dataset of industry PPPs that cover aggregate economy  45 industries (aggregated from digit NACE industries) Mix of O-PPPs and adjusted (‘peeled’) E-PPPs  motivated by our conceptual approach bigger set than before  26 countries (OECD) New benchmark year 1997

4 Supply-Use Tables is Useful Framework to Reconcile Expenditure & Output PPPs
Basic identity that equals use and supply of products: intermediate consumption + final consumption + gross capital formation + exports = domestic output + imports Products can be valued at three price concepts: Basic price of the product received by the producer Producer price = basic price + taxes on the product - subsidies on the product Purchasers’ price = producer price + trade and transport margins in delivering the product to the purchaser Take step back and look at SNA  use framework of supply-use tables is useful framework to reconcile expenditure & output PPPs & provide basis for our criteria: Balance between total supply and total use of a product: intermediate consumption + final consumption + gross capital formation + exports = domestic output + imports Relationship holds for quantities  but also for values provided that supply and use are valued at the same price concept (which is what we are after) Products can be valued at three price concepts: basic price: amount receivable by the producer from the purchaser for a unit of a good or service produced as output minus any tax payable, and plus any subsidy receivable, on that unit as a consequence of its production or sale; it excludes any transport charges invoiced separately by the producer. producer price  add net taxes purchasers’ price  add net taxes & margins on trade and transport. Supply is typically valued at basic prices & use is typically valued at purchasers’ price  but at various concepts (exports are valued at free on board (f.o.b.) prices and the imports at cost, insurance and freight (c.i.f.) prices.

5 Basic identity reveals relationship between expenditure and output prices (see also Table 1)
(1) With Xij = the quantity of product i used as intermediate input by industry j pXij = the purchasers’ price paid by industry j for intermediate consumption of product i Ci = quantity of product i for final domestic demand pCi = the purchasers’ price for final domestic demand of product i Ei = quantity of product i exported pEi = the purchase (f.o.b) price of exported product i Yij = the quantity of product i produced by industry j pYij = the basic price received by industry j for selling product i Mi = the imported quantity of product i pMi = the basic (c.i.f) price of imported product i TY = total taxes net of subsidies on domestically produced products TM = total taxes net of subsidies on imports. R = total trade and transport margins Express the identity above in total values, which are product of prices and quantities  On left hand side we got the use On right hand side we got the supply  is row identity  also column identity  equates income of production factors and intermediate inputs with output leave that aside & focus on output side With this identity it is clear that if we need prices for Y  output PPP is the obvious approach  problem is that it is not always easy to obtain output prices that can be used for international comparisons (for reasons explained earlier & come back to later)

6 Relationship between O-PPPs and adjusted E-PPPs (1)
Assumption 1: basic price of a product i is equal in all its uses: Assumption 2: trade, transport margins and taxes of product i do not depend on their uses: Result 1: basic output price of supplied product i equals final expenditure price adjusted for net average taxes and margins: so we need to take a broader approach  what prices could possibly be used as measure for PY  more precisely: in which circumstances, adjusted expenditure prices are a reasonable proxy for basic output prices to get handle on this  make a couple simplying assumptions: There is only one basic price for each single product  basic output price of a single product i is the same across industries & the same as the import price of the items. More tricky (& unrealistic  but relax in a minute): margins and net tax rates are equal across all uses  % margin & net tax rate is the same for intermediate consumption, final expenditure and exports If these assumption hold  then it is easy to relate the expenditure price  namely through average margins and net taxes on suppllied product This in fact is what is done a lot in studies that use expenditure price to proxy industry price, e.g. in Jorgenson and associates (6)

7 Relationship between O-PPPs and adjusted E-PPPs (2)
Result 2: when relaxing assumption on equality of trade, transport margins and taxes of product i in all their uses: Implications of result 2: adjustment of expenditure price to proxy output price depends on: Size of differences between final expenditure prices and other purchasers’ prices (on exports, imports and intermediate consumption Ratio of exports, imports and intermediate consumption to total domestic output (7) But assumption (2) does probably not hold  as margins and taxes are likely to differ across its uses  if we relax assumption (2)  see that simple 1st result changes in a more complex second result, where simple original result is only a good proxy if: 1) Difference between tax & margin adjusted-final expenditure prices (PC) and other purchasers’ prices on exports, imports and intermediate consumption (PE, PM, PX) are small 2) Ratio of exports, imports and intermediate consumption to total domestic output (Y) are close to 1

8 Relationship between O-PPPs and adjusted E-PPPs (3)
Assumption 3: margins and next taxes on intermediate consumption and exports are lower than for final expenditure: Result 3: purchasers’ prices for intermediate consumption and exports and basic price for imports after adjustment for margins and net taxes are all lower than final expenditure price: But what do we know about margins and net taxes on intermediate consumption and exports?  Likely that both are lower than the final expenditure prices  trade margins will be typically higher for final expenditure than for intermediate consumption or exports  retail industry is capturing part of margin Also for exports this is probably true  although we need to assume here that we are looking at exactly same good i and undifferentiated markets But on this assumption  result 3  after adjustment for margins and net taxes (and with assumption 1)  export and intermediate consumption prices are lower than final expenditure prices + margin adjusted import price is lower than expenditure price

9 Adjusted Expenditure PPP useful for industry PPPs in limited number of cases
No int. trade Only Export Only Import Both Only Final use (1) √ (4) overest (7) underest (10) ? Only Intermediate use (2) n.a. (5) n.a. (8) n.a. (11) n.a. Both uses (3) overest (6) overest (9) ? (12) ? Result 4: Only for final good, not internationally traded, the adjusted final expenditure price equals basic output price When only used for intermediate consumption, no final expenditure price is available In all other cases, the ‘adjusted component’ final expenditure price is biased What does that imply when choosing to use adjusted expenditure prices as proxy for industry output price  worked also through a range of possible cases  with 2 dimensions: 1) in product only used for final use, intermediate use or both; and 2) in product not traded int.ly, only exported or imported or both? 12 possible cases  3 major results: Only for final goods, which are not internationally traded, the adjusted final expenditure price are equal to the basic output prices (cell 1) When the product is only used for intermediate consumption, there is no final expenditure price by definition  affects entire second row In all other the adjusted expenditure PPP is somehow biased  e.g. in case 4  only export of final product   assume actual PE is lower than PC  adjusted expenditure price overstates basic output price (see result 2)  similarly is case 7 where we only import  import PE price is lower than PC  adjusted expenditure price understates the basic output price (see result 2)  many other cases are mixed

10 Pro’s and con’s of output prices & adjusted expenditure prices for industry PPPs
O-PPPs: In theory preferable for industry PPPs Often based on unit value ratios (product mix problems) Often biased towards relatively homogeneous products Problems with services output prices Adjusted E-PPPs: Based on separate price survey with consistent methodology When adjusted for margins and net taxes, still applicable to limited number of industries Detailed information on margins and net taxes is often lacking (only with detailed SUT in prices and quantities) Import and export adjustments are very problematic With application of SUT criteria better choices can be made, but remains largely empirical issue on industry by industry basis So now that we have conceptually clear how well adjusted expenditure prices proxy industry prices  when should we nevertheless use them  this of course depends on how big the biases are, but also involves additional considerations, largely of practical nature: O-PPPs  in theory preferable for industry PPPs as they should genuinely measure output prices  should always be first step  but ICOP studies have shown some tough problems: often based on unit value ratios (product mix problems)  essentially deal with unit values for product groups rather than prices for specified items (as in ICP, supposedly) output PPPs often biased towards relatively homogeneous products  quality problems are less problematic (cement, food products, steel, etc.) eell know problems, as in regular NA, with services output prices So adjusted E-PPPs need to be considered  strength is that they are based on separate price survey with consistent methodology below U& above basic heading level  but: as shown  when adjusted for margins and net taxes, still applicable to limited number of industries detailed information on margins and net taxes is often lacking (only with detailed SUT in prices and quantities) import and export adjustments are very problematic  some exercises, notably Hooper and Vrankovich, but it really requires individual prices of exports and imports of items that are matched with domestically used and supplied goods  has not been done  so: although better choices can be made with with application of SUT  it remains largely empirical issue  requires approach on industry by industry basis

11 Assessment of output PPPs & adjusted expenditure PPPs for industry comparisons
This table gives clue for major sectors on preferable approach on industry-by-country basis  graded on 0-5 scale. Issues of concern for E-PPPs: Size of final expenditure in total use  not good case for E-PPPs (agriculture, mining, distribution (???), transport, business services) High import share  not good case (e.g. durable and non-durable mnf.) Issues of concern for O-PPPs: product and quality problems (durable mnf., quite a few services industries) no output PPPs for non-market services, but then E-PPPs are largely input based, and also less useful Note: ranking indicates 0 (not useful), 1 (very poor), 2 ( poor), 3 (acceptable), 4 (useful) and 5 (very useful). Source: assessment based on E-PPPs for OECD from 1999 round and O-PPPs for 1997 from Groningen Growth and Development Centre.

12 A New ICOP Dataset for Industry-of-Origin PPPs
Improvements over previous ICOP studies: uses consistent criteria for the selection of the PPP method (O-PPPs or adjusted E-PPPs) uses a single set of industry weights (221 industries) applies multilateral (EKS) weighting system for all industries; country and industry coverage is much bigger Consistent approach: Above industry (“basic heading”) level use of EKS multilateral weighting system Weights are based on gross output or “matched output” depending on quality of prices (output coverage, variation, number of products covered) Below industry (“basic heading”) level use of best possible source on broad sector basis (agriculture, mining, manufacturing, public utilities, distribution, transport & communication and other services) New dataset: Improvements over previous ICOP studies: uses consistent criteria for the selection of the PPP method (O-PPPs or adjusted E-PPPs) uses a single set of industry weights (221 industries) at 3 digit level  quite a job in itself  because NA do not collect this applies multilateral (EKS) weighting system for all industries  move away from bilateral country and industry coverage is much bigger  26 countries (19 of 25 EU members) + other OECD members (US, Canada, Japan, Australia, Korea, Mexico) & Taiwan industries  here aggregated up to 45 major industries (between 2 and 3 digit) Consistent approach: Alike ICP  two levels  above industry (“basic heading”) level use of EKS multilateral weighting system Weights are based on gross output or “matched output” depending on quality of prices (output coverage <20-30%, coefficient of variation >0.1, number of products covered <3) Below industry (“basic heading”) level use of best possible data sources on broad sector basis (agriculture, mining, manufacturing, public utilities, distribution, transport & communication and other services)

13 Agricultural PPPs are based on off-farm prices from FAO database
Quickly run you through 3 examples of our approach for France-US comparison  agriculture strongly based on O-PPP approach  uses actual prices (much alike ICP)  cover 2 industries major share in input  for other industries we use output weighted average of crops & livestock

14 With exception of East European Countries, U. S
With exception of East European Countries, U.S. has lowest prices in agriculture Lots of applications  here in terms of analysis of relative price levels  for agriculture  with exception of East European Countries, U.S. has lowest prices in agriculture (Japan is big outlier)

15 Manufacturing PPPs for EU countries are now based on common database for manufacturing products (PRODCOM), matched through Germany with US In manufacturing mix of O-PPPs and adjusted E-PPPs  example for food strong emphasis on O-PPPs  for European countries benefit from PRODCOM database  run bilateral comparison through Germany  many products + industries  PPPs at 3 digit level are Fisher PPPs comparison each EU country through Germany with US (and other countries directly  use EKS PPPs.

16 Manufacturing PPPs show considerable larger output and product coverage than before
For aggregate manufacturing about 10% of 36% output coverage are ICP PPPs. In total for France-US comparison up to 700 product matches (compared to in past)  EKS PPPs not very different from Fisher PPPs as industry weights within manufacturing are not as strongly different as in some other sectors

17 Relative price spread in manufacturing is more than 2:1
Relative price spread in manufacturing is more than 2:1  suggesting no price equalization in mnf.

18 Derivation of PPPs in Retail Trade is now consistent with commonly applied approach in national accounts In retail sector  compared to earlier work (incl. work with double deflated sales and purchases of retail goods)  chosen approach that mimics approach in NA  use of sales prices (directly obtained from ICP)  adjusted to margin prices on basis of relative margin of two countries  gives purchase price effect  219 matches & 28% coverage

19 With exception of Eastern Europe and Japan, relative price spread in services is not larger than in manufacturing Manufacturing With exception of Eastern Europe and Japan, relative price spread in services is not larger than in manufacturing  implications for Balassa Samuelson hypothesis  suggest that price differences between services should be bigger than for manufacturing.

20 Conclusions and Next Steps
An economy-wide application of industry PPPs is now within sight Complementary to GDP PPPs with E-PPPs Extension with input PPPs (intermediate inputs, capital, labour) Application to complete valuation SUT (quantity and price table) New applications: EU KLEMS growth accounting and productivity Balassa-Samuelson hypothesis Price convergence Potential for replication of mixed approach for historical comparisons Extension to non-OECD countries Conclusions: An economy-wide application of industry PPPs is now within sight Complementary to GDP PPPs with E-PPPs Next steps: Extension with input PPPs (intermediate inputs, capital, labour) Application to complete valuation SUT (quantity and price table) New applications: - EU KLEMS growth accounting and productivity - Balassa-Samuelson hypothesis - Price convergence - Potential for replication of mixed approach for historical comparisons Extension to non-OECD countries


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