Errors in Type II IO Multiplier Values Tobias Emonts-Holley, Andrew Ross and Kim Swales Fraser of Allander Institute Economics Department University of Strathclyde Project Funding by the ESRC and the Scottish Government

Aggregated Industry-by-Industry Table, 2009 basic prices (£million)

Miller and Blair (1985) endogenise all household consumption The primary problem for the M&B method is that typically only around 60% of all household income comes from wages. Thus M&B can be criticised for assuming all income to households comes from wages Moreover, some elements of household income, such as pensions and some government transfers, are conventionally treated as being exogenous, that is independent of income generated in current production. This is not clearly identified in M&B where Household Consumption = Total Wage We would expect the M&B method to overestimate the true Type II multiplier values Miller & Blair Here:

The Type II multiplier approach outlined in Batey (1985) acknowledges the existence of exogenous household expenditure (this is the method employed by the Scottish Government for their Type II calculations) The Batey 1 method attempts to capture the addition to household consumption that comes through changes in wage income alone A criticism of Batey 1 is that there are sources of income generated in production, apart from wages, that enter household income either directly from other value added or indirectly through elements of corporate income that are subsequently distributed to households Therefore endogenising household expenditure as that consumption funded directly by wage income will give a multiplier that is too low A second problem is that the total household income is not a figure that is given in the IO accounts. It needs to come from some other source Batey 1 / Scottish Government Here:

Aggregated 2009 Scottish SAM, 2009 basic prices (£million)

Another method put forward in Batey (1985), referred to here as Batey 2, relies solely on data from the IO accounts This method does not incorporate non-wage household income generated in current production. By ignoring the non-wage elements of income generation in production the multiplier will be too small Furthermore, in calculating the consumption coefficients it ignores all the household income not spent on domestic and imported goods and services. Therefore it does not take into account expenditure by consumers on some taxes, savings and other transfers. This will result in the multiplier values being too big Thus, overall Batey II Here:

IO accounts fail to identify the way in which the flows of income earned by factors of production reach households, even if the IO accounts are amended as in Batey 1 The SAM multiplier endogenises household consumption based around a SAM. It can track such income flows, if the same sort of assumptions concerning linearity and exogeneity are made as imposed in IO The multiplier used in this paper endogenises wage and other value added payments together with household and corporate income, whilst holding the investment, government and export accounts exogenous Therefore, the direct link between household income and other value added, as well as the flow of other value added through corporations to households is endogenised in the SAM multiplier SAM Multiplier Here:

Aggregated 2009 Scottish SAM, 2009 basic prices (£million)

Baseline Comparison - Scotland

Descriptive Statistics

Batey 1 Comparison - Scotland

Baseline Comparison – UK

Using the traditional method of calculating the three Type II multiplier yields mean values variations of almost 40% of the most accurate measurement of additional multiplier effect, thus this is a serious problem Batey 1 is closest to, but consistently below, the SAM multiplier value (for Scotland), however it relies on household income information not available from data in the Input- Output Table alone If pure IO modelling is employed the Batey 2 method gives more accurate multipliers compared to the M&B approach Calculating the Type II multiplier using UK data, shows that Batey 2 is closest to the SAM baseline, therefore regional characteristics seem to result in varying closeness-of-fit However, a SAM multiplier is preferable over any of the Type II multiplier discussed here, due to the more inclusive treatment of household income and the effect that exogenous shocks can have on household consumption behaviour Conclusion

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