OECD Workshop on Measuring Education and Health Volume Output, Paris, 6-7 June 2007 Draft Chapter 1 – Terminology and Concepts Paul Schreyer and François Lequiller, OECD

Contents of presentation Value measures Volume measures –some definitions –a simple case –quality change and new products –cost and value weights Five conclusions on volumes Two conclusions on consistency

Value measures Aim of NA: reflect production of all producers, market or non-market Non-market: prices are not economically significant Market: prices are formed on markets and economically significant Value of output for market producers = observed sales, or prices x quantities (p·Y)

Value measures Accounting identity for market producers p·Y = p M M + wL + CFC + Taxes + NOS Accounting identity for non-market producers p·Y = p M M + wL + CFC + Taxes Value of output for non-market producers = sum of costs, with NOS=0

Volume measures – a few definitions upfront Utility = satisfaction that consumers derive from consuming goods or services This definition actually takes a short-cut, it leaves out outcome Outcome = measurable state that consumers value (eg health status, state of knowledge), influenced, inter alia, by the consumption of goods and services Output = goods and services supplied by producers and transformed from inputs by way of a production process Output of services = quality-adjusted and suitably differentiated count of activities (actions) Activity = the observable action associated with output of services such as one treatment of a heart attack, one year of third grade schooling, one haircut

Volume measures – a few definitions upfront Example health and education Utility = f (health status, state of knowledge, …) Health status = g (services provided by health system, lifestyle, environment, …) State of knowledge =h (services provided by education system, socio-economic background,…) Health services = k (labour, capital,…) Education services = z (labour, capital, …) Outcome OutputsInputs

Volume measures – simple case Starting point: market situation with a well-defined, stable set of products Economic theory tells us that in a functioning market: price = marginal cost to producers and = value of marginal utility to consumers Price ratios contain information about relative valuation of products by consumers and producers Measurement of volumes can then proceed via deflation (i.e. with a price index) or via direct volume index

Volume measures – simple case Simple Laspeyres-type formulae are:

Volume measures – simple case These indices could readily be used (price index for market producers, volume index for non- market producers) if: –Quantities are comparable between periods –Prices are comparable between periods –Those prices/quantities that are followed in a sample, are representative for the product group as a whole Under these conditions – stable and representative sample, no quality change – volume output for health and education services is relatively easy to be measured:

Volume measures – simple case Volume change in teaching services = weighted average of the change in pupil hours, differentiated by level of education Volume change in health services = weighted average of the change in health care activities, suitable differentiated by type of treatment Similarly, a price index could be constructed and used for deflation

Volume measures – simple case Note: –No explicit introduction of utility or outcome in this case –But even in the simple case, utility or outcome considerations may play a role how to group and stratify individual goods or services –The result is different from an input-based price or volume index where the price or volume changes of inputs are followed and used to approximate price or volume changes of outputs –But the resulting output measure may be biased if there has been quality change and if the set of products has changed

Volume measures – quality change and new products In practice, there is quality change of goods and services, new products enter the market and old products exit Consequence: Y i t may be different from Y i t-1, making direct comparison of quantities difficult, or P i t may be different from P i t-1, making price comparison difficult  quality adjustment needed Matching may be impossible or give rise to non- representative index

Volume measures – quality change and new products Explicit quality adjustment: example of PCs –The quantity of ‘computer’ represented by 1 computer box today ≠ quantity of ‘computer’ represented by 1 computer box a year ago because performance has changed –Quality adjustment is made by looking at differences in performance characteristics (speed, storage capacity, number of drives etc.) The market values these characteristics because they contribute to outcome –Statistical analysis of market data provides information on which performance characteristics to choose and how to value each of them (hedonic techniques) –PC price = a + b·speed + c·storage capacity + … –Thus, hedonic techniques are an excellent example how information on outcome is captured via product characteristics that are valued by market participants

Volume measures – quality change and new products Explicit quality adjustment: is example of PCs transposable to health or education? –In principle, yes. The equivalent of a ‘computer box’ would be ‘a hip replacement’, ‘a treatment of a heart attack’ or ‘one year of third-grade schooling’, i.e., activities. –However, hedonic techniques require that market observations are available that can be related to a bundle of quality characteristics in health or education services –When there are no market observations, we cannot let ‘the data speak’ to identify service characteristics that are valued by market participants; we have difficulties dealing with multiple quality dimensions. Even when they are identifiable, it is not clear which weights should be attached to them

Volume measures – quality change and new products Consequence: in the non-market context, it may be necessary to stick with a single quality dimension One possibility is to look at outcomes directly, assuming (a) that multiple quality characteristics are captured by a single outcome indicator; (b) that this single indicator reflects the contribution of the product to the outcome only. Examples are test results for pupils or QALYs for patients. Outcomes also play a role in quality adjustment because substitutability of activities with regard to outcome should govern the grouping of activities. Eg, follow price or quantities of alternative treatments for the same disease in the same stratum.

Volume measures – quality change and new products Note that such a single-dimensional indicator –Should control for any other factors that affect outcome for consumers (e.g. socio-economic background of pupils, environmental impact on health) –Should not be influenced by the individual capacity of the consumer to transform a service into an outcome. For example, the same treatment applied to an old and to a young person should be counted as equal quantities of health care services.

Examples of inputs, outputs, utility

Cost and value weights: principles In a market context, changes in the price or quantity of products are weighted by their expenditure share  reflecting relative valuation by consumers/producers In a non-market context, only cost observations are available and there is no guarantee that cost weights reflect relative valuation by consumers

Cost and value weights: principles 2 possibilities to deal with this problem: –Assume that on average, cost shares reflect also relative valuation by consumers –Impute relative valuation by consumer but total value of non-market output ≠ costs; difficult measurement issues; asymmetry with regard to treatment of other products not within the scope of national accounts although value weights are useful for welfare analysis Handbook recommends use of cost weights

Cost and value weights: practice Note: –Compiling cost or value information in the required classification is not a trivial task –Example: no data may be available on the cost or value of medical care by disease because pricing mechanisms, or cost accounting are not defined over episodes of treatment

Five conclusions on volume measures (1) Conclusion 1: If there is no quality change, and if the set of products produced by the health and education service industry is stable, the rate of change of output is a weighted average of the rate of change of service activities.

Five conclusions on volume measures (2) Conclusion 2: For the process of quality adjustment of the quantities or prices of output it is necessary to ‘glance over the national accounts production boundary’ and invoke utility and outcome, because characteristics that matter for consumers have to be identified for quality adjustment.

Five conclusions on volume measures (3) Conclusion 3: In general, quality is multi-dimensional. For certain market health or education services, it may be possible to construct hedonic price indices that permit combining quality attributes into a single monetary measure. In many instances, this will not be possible and explicit quality adjustment has to be based on a single quality characteristic, which is directly linked to the impact on the “outcome”. The choice and measurement of this characteristic is key in the process and needs careful consideration.

Five conclusions on volume measures (4)  Conclusion 4: Volume measures of output could generally be defined as the quality- adjusted counts of activities.  Activities should be classified by consumer- relevant categories such as the completed treatment for a particular diseases or the level of education provided. In other words, those activities should be grouped that constitute substitutes from a consumer perspective.

Five conclusions on volume measures (5)  Conclusion 5: when there are no or inadequate market prices, there is no guarantee that relative consumer valuation and relative costs for producers of a product coincide. However, in the absence of strong conceptual reasons against cost weights and in the presence of many practical reasons in favour, cost weights emerge as the best way towards implementation.

Two more conclusions on consistency: (1) space and time  Volume (price) indices between periods and volume (price) indices between countries are similar in concept and are often used in conjunction with each other  Temporal and spatial indices should therefore be developed in parallel

Two more conclusions on consistency: (2) market and non- market producers  Problems of:  Quality adjustment  Classifications  Availability of current price information are not confined to non-market services.  Even in a market environment, prices for health and education services are often regulated and there are issues of moral hazard due to health insurance  Therefore, price and volume measures for market and non-market producers should be developed in parallel to ensure consistency