Effects of Terms of Trade Gains and Tariff Changes on the Measurement of U.S. Productivity Growth Rob Feenstra, UC Davis Marshall Reinsdorf, BEA Matt Slaughter, Dartmouth 2008 World Congress on National Accounts and Economic Performance Measures for Nations Rosslyn, Virginia May 13, 2008

Motivation for Paper ▪US productivity speedup of 1 percent per year starting in 1995, with ITC as key driver. ▪Trading gains can look like productivity gains. ▪Growth of imports may have price driver. ▪Multilateral elimination of tariffs on ITC goods over under the WTO Information Technology Agreement. ▪Improvement in non-petroleum terms of trade coincided with the productivity speedup. 2

Globalization of ITC Industry

5 Trade in GDP ▪In current dollars, GDP = D + X – M, where D = C+I+G, “gross domestic purchases” or “domestic absorption.” ▪Diewert and Morrison’s (1986) GDP function treats M as intermediate inputs and D and X as outputs. ▪Can also think of GDP as consolidated Value Added for the whole economy in which the domestic intermediate inputs cancel out (but note that M is measured at tariff-free prices in calculating GDP.)

6 Terms of Trade Effects can Resemble Productivity Effects Terms of Trade defined as P X / P M, where P GDP  s D P D + s X P x – s M P M. ▪Real income depends on production (GDP) and on gains from trade, which grow when terms of trade improve. ▪Improved terms of trade raise nominal GDP and the real D attainable for a given current account balance, ceteris paribus.

7 Change in Terms of Trade from PP to PP Reduces Real Consumption from D to D but Shift in Production from A to A has no Effect on Real GDP

Theory of Productivity Measurement with International Trade

Tariff Revenue in GDP

10

Theoretical Measures of Productivity

Measure of True Productivity

Adjustment for Net Entry of Varieties from New Supplying Countries

Conventional TFP – True Productivity

Estimation of Influence of Unmeasured Gains from Trade on GDP/Productivity ▪BEA aggregates Laspeyres indexes from BLS to find deflators for exports/imports in GDP. ▪We calculate alternative versions of the indexes used by BEA to construct deflators. ▪To aggregate our indexes, we use weights from the NIPAs and Fisher index formula. ▪Removing nonmarket sectors of GDP leaves Value Added of Private Business, the output part of aggregate productivity calculation. 15

Three Kinds of Corrections Tested 16 ▪Törnqvist rather than Laspeyres formula for deflators of trade components of GDP. ▪Tariff-inclusive weights and index for M. ▪Adjust P M for net entry of new countries supplying imports using CES formula.

Nonpetroleum terms of trade before taking account of BEA’s use of Fisher

Example of Detailed Indexes: Semiconductor Imports

Example of Detailed Indexes: Semiconductor Exports

Telecom Equipment Imports

Telecom Equipment Exports

Effects on Price Indexes (Averages for ) Corrections R evision to Exports Index R evision to Imports Index R evision to Terms of Trade Törnqvist formula 0.4 %/year 0.6 %/year 0.2 %/year Add: Tariff- inclusive prices 0.7 %/year 0.3 %/year Add: New import suppliers 1.5 %/year 1.1 %/year

23

Effects on Measures of GDP and Productivity ▪Reduction in real GDP growth is about 0.1 percent per year after 1995 (allowing for lack of effect of capital goods & tariffs.) ▪Growth rate of price index for private business value added increased by 0.2%/year. ▪Growth of productivity reduced by almost 0.2 %/year, a fifth of the productivity speedup.

25 Price and Volume Indexes for GDP and Value Added of Private Business

End

27

Economic Theory Conclusions of Paper ▪Correctly measured terms of trade gains raise real consumption possibilities, but not real GDP. ▪Unmeasured gains in terms of trade would be counted as real GDP and productivity growth. ▪In presence of tariffs, terms of trade gains will be measured as GDP and productivity growth, and likewise for the efficiency effect of reducing tariffs. ▪SNA concept of Value Added at Basic Prices is better suited than GDP for measurement of productivity. 28

Empirical Conclusions of Paper ▪Correcting export index for formula and import index for formula and variety reduces real GDP growth by 0.1 percent per year and productivity of private business by 0.2 percent per year after ▪A fifth of the productivity speedup may be due to unmeasured gains in terms of trade. ▪Warning: Domestic deflators are beyond the scope of this research, but if similar corrections were made to them offsetting effects might be found. 29

30

Functional Form Assumptions