MEASURING GROSS OUTPUT AND VALUE ADDED MFP
There are a number of issues to consider in the choice of output measure for estimating industry level MFP. With regard to interpretation, gross output based MFP estimate is intended to measure the 'Hicks neutral technological progress in an industry' whereas the value added based MFP growth reflects
'...the industry's capacity to translate technological change into income and into contributions to final demand' (OECD 2001a).
Ideally MFP measures disembodied technical change attributable to improved use of factor inputs. In the case of gross output this efficiency can be attributed to improvements in not only the use of primary inputs, capital and labour, but also in the use of intermediate inputs. The value added measure of MFP removes the value of intermediate inputs, which has the effect of attributing productivity improvements gained through the more efficient use of intermediate inputs to capital and labour. For this reason the value added measure of MFP shares drawbacks associated with the partial productivity measures, as it does not account for all factor inputs. This is the case for any approach that does not measure every single input separately.
Further, the exclusion of intermediate inputs from value added based MFP presents problems when there are changes in the proportion of intermediate inputs relative to primary inputs. On the other hand, gross output based MFP estimates would be less sensitive to events such as an increase in outsourcing.
An advantage of the value added MFP measure is its ease of aggregation across industries and the conceptual link between industry-level and aggregate MFP growth (OECD 2001a). Value added is derived directly from national accounts data and is available earlier than gross output and for a longer time series.
Overall, these two measures can complement each other to reflect an industry's performance. For this reason, the paper provides both estimates for each industry.
Equations 1 and 2 show how the two measures of MFP are calculated.
is gross output
I is intermediate inputs
L and K are labour and capital inputs
IKL is a combined index of capital and labour
IKLI is a combined index of capital, labour and intermediate inputs.
When estimating productivity growth rates the gross output MFP estimates will be flatter than the value added MFP estimates (Equations 3 and 4) since the contribution of intermediate inputs in the gross output measure will reduce the MFP growth estimate.
Equations 3 and 4 calculate growth in value added and gross output MFP, with all factor inputs remaining constant.
A different way to express the difference between the two measures is that gross output MFP is equal to value added MFP multiplied by the ratio of nominal value added to nominal gross output. Since the ratio is smaller than one, growth in gross output MFP is flatter than growth in value added MFP. Equation 5 shows this relationship.