Introduction to econometric & input-output models

Introduction to econometric & input-output models

Local & Regional Economic Analysis Lecture 2b - Introduction to econometric & input-output models Regional and Local Economics (RALE) Lecture slides Lecture 2b 1 Local & Regional Economic Analysis RALE Lecture 2b Last session Multipliers & output models This session: Econometric & I-O models Aims To examine regional econometric models Introduce the concept of the I-O approach. Review selection of studies, look at the limitations & review extensions Objectives Be familiar with regional econometric models. Awareness of the I-O methodology. Ability to access a range of studies & be conversant with the limitations To have an awareness of improvements that have been made. Regional and Local Economics (RALE) Lecture slides Lecture 2b 2 Local & Regional Economic Analysis Econometric models Multiplier models estimate changes in TOTAL regional income and employment they do not detail the effects of alternative policies - so there is a need to use something else Requirements of econometric models Detailed enough to provide info on a wide range of data. Need to be able to model for different spatial areas. Models need to be internally consistent What are they?

An interdependent set of equations. Each equation determines the numerical value of one regional variable. Right hand side consists of both endogenous and exogenous variables e.g. tax, birth and death rates etc. Regional and Local Economics (RALE) Lecture slides Lecture 2b 3 Local & Regional Economic Analysis Regional econometric model (Conceptual) Competitiveness of regions exports World demand for goods and services Output of export sector Regions productivity Population of working age Net Migration Supply of labour Participation rate Adapted from Armstrong and Taylor (2000) pp 32 Regional unemployment Regional wage level Regional employment Wages & salaries Transfer payments Non-export sector

Regional income Taxes Regional and Local Economics (RALE) Lecture slides Lecture 2b 4 Local & Regional Economic Analysis Evaluation of Rival Regional Econometric Models Hunt (et al) found little or no consistency across the results Differences only explained by detailed analysis of the models underlying structures, the data sets used, derivation of regional data and treatment of regional and sector productivity. They suggest modellers may be attempting to model the impossible - lack of differentiated data on MPC. Follow up study of stand alone models Liverpool-Cardiff and Cambridge Econometrics Local Economy Forecasting Model L-C model subjected to academic scrutiny the LEFM has not. The LEFM is much more disaggregated than the L-C model The L-C model is supply-side driven the LEFM is demand driven. The L-C is based on a system of inter-linked equations whereas the LEFM has an input-output approach as its underlying philosophy. Regional and Local Economics (RALE) Lecture slides Lecture 2b 5 Local & Regional Economic Analysis The Input- Output concept labour Imports Raw materials Semi finished products

output Basis of approach is that production of an OUTPUT requires INPUTS . The input- output linkages are recorded in a transactions or flows matrix which records all payments TO and FROM a sector within a year. Works on basis of double-entry book keeping, so that Gross Outputs must equate to Gross Inputs. Regional and Local Economics (RALE) Lecture slides Lecture 2b 6 Local & Regional Economic Analysis Transaction Tables Main UK Input-Output table uses a 123 sector model but a simpler version can be used. Simpler versions used to demonstrate the concept e.g. 3 sectors. Cells in columns = purchases that a sector makes (inputs) Cells in Rows = Sales of Products from sector (outputs) Columns show purchase of inputs Input 100 Rows show sale of outputs Regional and Local Economics (RALE) Lecture slides Lecture 2b Output 100 7 Local & Regional Economic Analysis The Transaction Table Inputs purchased by Agri. Manu. Services Output produced by Agriculture Manufacturing Services Payments for Household services Government

Services Imports into region Gross inputs Hholds Final demand sectors Gov. Exports Investt Gross output 20 (0.2) 20 (0.2) 0 (0) 40 (0.2) 20 (0.1) 40 (0.2) 0 (0) 10 (0.1) 10 (0.1) 20 75 25 0 10 20 20 55 5 0 10 0 100 200 100 40 (0.4) 70 (0.7) 5 0

0 0 160 5 (0.05) 0 0 0 0 30 10 (0.1) 45 (0.225) 15 (0.075) 40 (0.2) 5 (0.05) 0 0 0 5 60 100 200 100 125 30 80 15 650

10 (0.1) () = technical coefficients GDP = C+G+I+(X-M) = 125+(30-30)+15+(80-60) = 160 Adapted from Armstrong and Taylor (2000) pp 39 Regional and Local Economics (RALE) Lecture slides Lecture 2b 8 Local & Regional Economic Analysis Two Ways to construct the Transactions Matrix The DOMESTIC flow & The TOTAL flows approaches Inputs purchased by Final demand sectors Agriculture Manufacturing Services Households Government Exports Investment Gross output Output produced by Agriculture Manufacturing Services 20 (0.2) 20 (0.2) 0 (0) 40 (0.2) 20 (0.1) 40 (0.2) 0 (0) 10 (0.1) 10 (0.1) 20 75

25 0 10 20 20 55 5 0 10 0 100 200 100 Payments for Household services Government Services Imports into region 40 (0.4) 10 (0.1) 10 (0.1) 45 (0.225) 15 (0.075) 40 (0.2) 70 (0.7) 5 (0.05) 5 (0.05) 5 0 0 0 0 0 0 0 0 0 0 5 160 30 60

100 200 100 125 30 80 15 650 Gross inputs () = technical coefficients -10 -40 -5 KEY ASSUMPTIONS: Production Technology is in fixed proportions therefore if demand doubles inputs will have to double. There are no constraints on productive capacity thus the supply of factor inputs is perfectly elastic Regional and Local Economics (RALE) Lecture slides Lecture 2b 9 Local & Regional Economic Analysis Technical Coefficients The Technical Coefficients allow us to estimate the effect of a change in final demand. TC = the flow of output from industry i to industry j divided by the gross output of industry j. The matrix of technical coefficients allows us to see the effect of an increase in final demand throughout the whole system. If Agricultural demand increases by 10 then it will require Inputspurchasedby Finaldemandsectors additional input of: Agriculture Manufacturing Services Households Government Exports Agriculture 0.2*10 = 2 Outputproducedby Agriculture 20(0.2) 40(0.2) 0(0) 20 0

20 Manufacturing 0.2*10 = 2 Manufacturing 20(0.2) 20(0.1) 10(0.1) 75 10 55 Services 0(0) 40(0.2) 10(0.1) 25 20 5 Services 0.0*10 = 0 Households 0.4*10 = 4 Paymentsfor Householdservices 40(0.4) 45(0.225) 70(0.7) 5 0 0 Government 0.1*10 = 1 GovernmentServices 10(0.1) 15(0.075) 5(0.05) 0 0 0 Importsintoregion 10(0.1) 40(0.2) 5(0.05) 0 0 0 Imports 0.1*10 = 1 Grossinputs ()=technicalcoefficients 100 200 Regional and Local Economics (RALE) Lecture slides Lecture 2b 100

125 30 80 Investment Gross output 0 10 0 100 200 100 0 0 5 160 30 60 15 650 10 Local & Regional Economic Analysis The Process In it ia l in c r e a s e in d e m a n d fo r a g r ic u ltu r a l g o o d s b y 1 0 r a is e s a g r ic u ltu r a l o u tp u t b y 1 0 10 A g r ic u lt u r e (A ) 0 .2 *1 0 = 2 A; 0 .2 * 2 = 0 .4 A; 0 .0 8 M ; 0 .0 8 S e r v ic e s ( S ) 0 .0 *1 0 = 0

M a n u fa c tu r in g (M ) 0 .2 *1 0 = 2 M ; S; 0 .2 * 2 = 0 .4 0 .0 * 2 = 0 A; 0 .2 * 2 = 0 .4 S; 0 A; M ; S; 0 .0 8 0 .0 4 0 .0 8 A; 0 .0 8 M ; 0 .0 8 S; 0 A; 0 A; M ; S; 0 .0 4 0 .0 2 0 .0 4 In je c tio n F ir s t r o u n d Second R ound T h ird R o u n d A A A A =10 = 2, M = 2 = 0 .8 , M = 0 .6 , S = 0 .4 = 0 .2 8 , M = 0 .0 2 6 , S = 0 .1 6 Adapted from Armstrong and Taylor (1993) pp 38 S; 0 .2 * 2 = 0 .4 M ;

0 .1 * 2 = 0 .2 M ; 0 .0 4 S; 0 .0 4 Agriculture 13.26 Manufacturing 3.02 Services 0.67 Total 16.95 Multiplier 1.69 Regional and Local Economics (RALE) Lecture slides Lecture 2b 11 Local & Regional Economic Analysis The inverse Matrix 1 0 0 0 1 0 0 0 1 - 0.2 0.2 0 0.2 0.1

0.1 0 0.2 0.1 Identity matrix = A matrix 0.8 -0.2 0 -0.2 0.9 -0.1 0 -0.2 0.9 1- A matrix Invert the Matrix 1.326 0.302 0.034 0.302 1.208 0.134 0.067 0.268 1.141 Matrix of multipliers

1- A-1 matrix Regional and Local Economics (RALE) Lecture slides Lecture 2b 12 Local & Regional Economic Analysis Summarising changes in demand To summarise the effect of a change in demand, multipliers are used - there are 2 types TYPE 1 & TYPE 2 TYPE 1 multipliers treat the household sector as exogenous Direct Indirect The key to calculating multipliers is the matrix Direct of multipliers (I-A)-1 and the row of household coefficients Type 1 Matrix of multipliers Agriculture Manufacturing Agriculture 1.326 0.302 Manufacturing 0.302 1.208 Services 0.067 0.268 Output Multipliers 1.695 1.779 Agriculture Manufacturing Household coefficient 0.400 0.225 Household income multiplier 1.613 2.580 Services 0.034 0.134 1.141 1.309 Services 0.700 1.203 HH inc mult (1.326 * 0.4); (0.302 * 0.225); (0.067 * 0.7) 0 .4 Regional and Local Economics (RALE) Lecture slides Lecture 2b

1.613 13 Local & Regional Economic Analysis TYPE 2 multipliers treat the household sector as endogenous Direct Indirect Direct induced A Output 1.74 1.13 0.48 A HH inc. 1.33 / 0.40 Type 2 Matrix of multipliers Agriculture Manufacturing Agriculture 1.7417 0.6766 Manufacturing 1.1344 1.9571 Services 0.4833 0.6430 Households 1.3319 1.1985 Sectoral output multipliers 3.3595 3.2767 Agriculture Manufacturing Household coefficient 0.400 0.225 Household income multiplier 3.330 5.327 Services 0.5770 1.2210 1.6843 1.7389 3.4824 Services 0.700 2.484

Households 0.6452 1.2903 0.6452 2.0645 Commentators suggest that the Type 2 multipliers overestimate the scale of additional spending because it assumes all additional income is spent Regional and Local Economics (RALE) Lecture slides Lecture 2b 14 Local & Regional Economic Analysis Applications of input-output analysis Often used to study island economies ( they are relatively self-contained) see Lewis & McNicholl for study of the Shetlands. Harris, Urban Studies Vol. 34 No.4 pp 605-626 looks at the University of Portsmouth, contains a discussion about the merits of using the partial survey method and type 1 & 2 multipliers. Hill looks at the effect of overseas students on the Welsh economy. Bishop et al. look at the impact of the naval base at Plymouth and its impact on the economy of Devon and Cornwall. Clark & Grainger, et al Portsmouth Naval Base4 Regional and Local Economics (RALE) Lecture slides Lecture 2b 15 Local & Regional Economic Analysis Strengths Shows the supply chain linkages Captures the full system effects The methodology is transparent Produces more detailed sectoral results Applicable to scenario (what if) analysis Weaknesses

Availability and reliability of data Production techniques are assumed fixed Import propensities may chane Changes in industry linkages Assumption of constant returns Assumption of no supply constraints Regional and Local Economics (RALE) Lecture slides Lecture 2b 16 Local & Regional Economic Analysis New directions To get over the problem of fixed technology and excess supply the I - O model is expanded to include a supply-side and is linked to an econometric model This allows for price & quality adjustments to be incorporated Time dimension allows adjustment of output/labour ratio and changes in consumption patterns Advantages The sectoral diversity of I-O is maintained and the dynamic, price responsiveness and forecasting abilities of the EC model are captured. See Integrated Econometric and I-O models Issues and Opportunities by Rey (2000) (Papers in Regional Science Vol. 79 pp271 292) Regional and Local Economics (RALE) Lecture slides Lecture 2b 17 Local & Regional Economic Analysis Integration of Input Output and regional econometric models F in a l d e m a n d fo r r e g io n s o u t p u t R e g io n a l o u tp u t In v e r s e m a tr ix (in p u t-o u tp u t m o d e l) D e m a n d fo r r e g io n s la b o u r S u p p ly o f la b o u r R e g io n a l e m p lo y m e n t U n e m p lo y m e n t R e g io n a l h o u s e h o ld in c o m e

R e g io n a l w a g e le v e l Net m ig r a t io n P a r tic ip a tio n ra te R e g io n a l d e m a n d fo r c o n s u m e r g o o d s In te g r a tin g th e in p u t-o u tp u t m o d e l in to th e e c o n o m e tr ic m o d e l S o u r c e : A r m s tr o n g a n d T a y lo r (2 0 0 0 ) R e g io n a l E c o n o m ic s a n d P o lic y Regional and Local Economics (RALE) Lecture slides Lecture 2b 18 Local & Regional Economic Analysis Summary econometric and Input - Output modelling More complex relationships can be modelled by using econometric models problem which model to use. More robust than economic base or Keynesian multipliers Transparent Interaction between a region's industries More precise tool for forecasting exogenous shocks. Used in a wide range of studies and seen as reliable Problems restrictive assumptions and data availability Integration with econometric models improves performance in the short-run and creates a dynamic model Next week: Regional growth disparities - the Neoclassical and Keynesian perspectives Regional and Local Economics (RALE) Lecture slides Lecture 2b 19

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