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The Measurement of Output, Prices, and Productivity

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The Measurement of Output, Prices, and Productivity THE BROOKINGS INSTITUTION | JULY 2018 The Measurement of Output, Prices, and Productivity: What’s Changed Since the Boskin Commission? Brent R. Moulton FORMERLY OF THE BUREAU OF ECONOMIC ANALYSIS The mission of the Hutchins Center on Fiscal and Monetary Policy is to improve the quality and efficacy of fiscal and monetary policies and public understanding of them. It provides independent, non-partisan analysis and draws on the expertise of Brookings Institution scholars and of experts in government, academia, think tanks and business, as well as the guidance of its Advisory Council. By commissioning research, convening private and public events and harnessing the power of the Internet, it seeks to generate new thinking, promote constructive criticism and provide a forum for reasoned debate. This report is available online at: https://www.brookings.edu/research/the-measurement-of-output-prices-and-productivity ABOUT PRODUCTIVITY MEASUREMENT INITIATIVE This report is the product of the Productivity Measurement Initiative under The Hutchins Center on Fiscal and Monetary Policy at The Brookings Institution. The Intiative responds to the need and appetite for (a) examination and clarification of the concepts, purpose and relevance to policy debates of the “output” that comprises the numerator in the productivity measure, e.g. GDP vs welfare and (b) particular attention to the difficult measurement issues in rapidly changing, harder-to-measure and growing sectors of the economy, e.g. health care and information services. ACKNOWLEDGEMENTS Thea author appreciates the helpful comments received from Karen Dynan, Louise Sheiner, David Wessel, Katharine Abraham, David Byrne, Abe Dunn, Matt Russell, David Friedman, Bill Thompson, Jeffrey Hill, Claudia Sahm, Greg Ip, Matthew Shapiro, Marshall Reinsdorf, Carol Corrado, Vivien Lee, Susan Kellam, and other participants at the authors’ conference hosted by the Brookings Institution’s Hutchins Center on Fiscal and Monetary Policy. DISCLOSURE The author did not receive financial support from any firm or person with a financial or political interest in this article. He is not currently an officer, director, or board member of any organization with an interest in this article. _______________________________________________________________________ THIS PAPER IS ONLINE AT https://www.brookings.edu/research/the- measurement-of-output-prices-and-productivity Glossary Chain-type index – A price or quantity index that updates the weights period by period, thereby maintaining weights that are based on each period’s expenditure patterns. A chain-type index is calculated by multiplying, period-by-period, the indexes for each pair of periods, where the indexes for each pair of periods could be Laspeyres, Fisher, or Tornqvist, etc. Cost-of-living index – A theoretical price index that measures the change in the cost of obtaining a fixed level of economic well-being, or utility. Although it’s not possible to directly measure a cost-of-living index, it can be closely approximated using a superlative index. Divisia index – A theoretical price or quantity index that is measured in continuous time. In practice, a Divisia index is approximated by chain-type price or quantity indexes where the chaining takes place at the highest practical frequency. Fisher index – A price or quantity index formula that compares prices or quantities from two periods, using weights that are drawn from expenditures for both periods. The Fisher index is calculated as the geometric mean of the Laspeyres index (which uses weights from the earlier period) and the Paasche index (which uses weights from the latter period) and is a superlative index that closely approximates the conceptual cost-of-living index. GDP, expenditure approach – The sum of final consumption spending by households, nonprofit institutions serving households, and general government, plus private and government gross investment, plus exports, less imports. GDP, income approach – The sum of incomes derived directly from the use of capital or labor by resident producers—compensation of employees, gross operating surplus, and taxes (less subsidies) on production and imports. GDP, production approach – The sum of the gross value added of all producers that reside within the nation’s economy. Conceptually, the three approaches to measuring GDP should be the same. Geometric mean index – A price index that is used at the lowest level of aggregation in the CPI (that is, for one of the basic item/area categories below which there is no expenditure information available for aggregating individual prices). For example, if there are N prices each with equal sampling weights, the geometric mean index would be the Nth root of the product of the items’ relative price changes. Labor productivity – Output per hour worked. Laspeyres index – A price or quantity index that measures the relative change in the price of a fixed basket of goods and services reflecting expenditures in an earlier period, or the change in quantities _________________________________________________________________________________________________________ The Measurement of Output, Prices, and Productivity 3 HUTCHINS CENTER ON FISCAL & MONETARY POLICY holding prices fixed at their values in an earlier period. The Laspeyres index does not take account of a buyer’s ability to substitute between items when relative prices change. Lower level substitution bias – A bias that arises when prices at the lowest level of item classification are aggregated using a formula that systematically overstates the price change. Lower level substitution bias has been addressed by switching to the geometric mean index. Matched-model index – A price index in which, to the extent possible, the sample of models being repriced is held fixed. Multifactor productivity – Output per unit of combined inputs, including labor and capital services. Offshoring bias – The bias arising from not accounting for the benefits accruing to domestic buyers from the opportunity to switch to lower cost new imported sources. Outlet bias – The bias arising from not accounting for the benefits accruing to domestic consumers from the opportunity to switch to lower cost new retail outlets. Paasche index – A price or quantity index that measures the relative change in the price of a fixed basket of goods and services reflecting expenditures in the later period, or the change in quantities holding prices fixed at their values in the later period. The Paasche index (like the Laspeyres index) does not take account of a buyer’s ability to substitute between items when relative prices change. Private nonfarm business sector – The sector of the economy that consists of private nonfarm businesses and excludes government, nonprofit institutions, and household and domestic employees. Sample rotation – The periodic replacement or updating of a sample of items or outlets in a price index. When a sample is rotated, the index for the new sample is “linked” to the index from the old sample. Superlative index – A price or quantity index that is associated with a “flexible” aggregator function— that is, an aggregator that provides a second-order approximation to an arbitrary production, cost, or utility function. This property means that a superlative price index (such as the Fisher or Tornqvist index) can provide a close approximation to a cost-of-living index even if we don’t know the functional form of the underlying utility index, or that a superlative quantity index can accurately measure productivity even if we don’t know the functional form of the underlying production function. Tornqvist index – A price or quantity index formula that compares prices or quantities from two periods, using weights that are drawn from expenditures for both periods. The Tornqvist index is calculated as a geometric mean of the relative changes in prices or quantity, using weights that averages of the expenditure shares in the two periods. Like the Fisher index, the Tornqvist index is a superlative index that closely approximates the conceptual cost-of-living index. _________________________________________________________________________________________________________ The Measurement of Output, Prices, and Productivity 4 HUTCHINS CENTER ON FISCAL & MONETARY POLICY Upper level substitution bias – The bias of a price index that arises from use of a fixed-weight or Laspeyres price index, in comparison with a superlative price index that allows consumers to substitute between higher and lower cost items while keeping utility constant. _________________________________________________________________________________________________________ The Measurement of Output, Prices, and Productivity 5 HUTCHINS CENTER ON FISCAL & MONETARY POLICY Introduction In a dynamic economy, the nation’s statistical system faces a perennial challenge in accounting for the effects of innovation on new products and quality changes. Despite efforts to stay abreast of these changes, the view of many economists is that mismeasurement has led to long-term understatement of changes in living standards and productivity. For example, Feldstein (2017) writes that official GDP statistics provide “at best a lower bound on the true real growth rate with no indication of the size of the underestimation.” Furthermore, since 2004, and especially since 2010, productivity growth has substantially slowed, raising concerns about the prospects for long-run growth in living standards (Baily and Montalbano, 2016). This productivity slowdown
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