Below are the first 10 and last 10 pages of uncorrected machine-read text (when available) of this chapter, followed by the top 30 algorithmically extracted key phrases from the chapter as a whole.
Intended to provide our own search engines and external engines with highly rich, chapter-representative searchable text on the opening pages of each chapter.
Because it is UNCORRECTED material, please consider the following text as a useful but insufficient proxy for the authoritative book pages.
Do not use for reproduction, copying, pasting, or reading; exclusively for search engines.
OCR for page 88
The Measurement
of Output
Any measure of productivity relates output to the input of a single factor
or to a weighted average of inputs of several factors. Spurious movements
in productivity measures can be avoided by limiting the output in the
numerator of the productivity ratio to those activities in which the inputs
are used. Measuring output also requires constructing the price indexes
needed to adjust the output numerator for the most important changes in
the quality of the output. This chapter begins with a discussion of criteria
for selecting particular activities for inclusion in the output numerator; it
then reviews the procedures now used to measure quality change and
considers possible alternative procedures.
THE OUTPUT MEASURE
DEFINING THE ACTIVITIES TO BE INCLUDED
A productivity ratio, whether labor productivity, capital productivity, or
multi-factor productivity, is intended to identify shifts in a production
function linking output to one or more inputs.) The measurement of
output for use in productivity ratios should be based on criteria that
minimize spurious changes in productivity not caused by shifts in the
production function. Goods and services included in the numerator of the
productivity ratio must be those produced by the inputs included in the
denominator. To exclude an output produced by an included input would
cause a spurious decline in productivity whenever that input increased and
88
OCR for page 89
The Measurement of Output
89
vice versa. Conversely, to include an output produced by an excluded
input would cause a spurious increase in productivity when that output
increased and vice versa. The principle is equally valid for the measure-
ment of productivity in individual activities or industries and in the whole
economy. If one wants to understand technological change in a single
activity, one must make sure that the measure of output includes
everything produced by included inputs and excludes anything produced
by excluded inputs. Once this test of consistency has been applied, a
productivity index can be computed for any type of activity.
The measurement of productivity for the economy raises a set of issues
about the selection of the activities to be included. In recent years, broad
welfare-oriented output concepts have been proposed that would exclude
some portions of the official GNP because they are "regrettables," goods
and services that do not contribute directly to well-being: among these are
spending on defense goods, protection against crime, and commuting.
Conversely, some activities that contribute to well-being that are not
presently part of GNP are proposed for addition to the welfare-oriented
output concept: for example, parents' use of time in caring for Clear
children and other types of services produced in the home. Whatever the
merits of such welfare-oriented approaches to the measurement of total
economic well-being, it would be inadvisable to incorporate most of the
proposed changes in aggregate productivity measures because of the
difficulty of meeting the required standard of consistency in the matching
of output and input.2
The point of departure for the measurement of aggregate productivity is
a labor input concept that includes total hours sold on the market or
worked to produce market goods and excludes time spent at home or time
spent in voluntary leisure and charitable activities. By hours sold on the
market, we mean the hours of wage and salary workers. By hours worked
to produce market goods we mean the hours of proprietors, partners, and
unpaid family workers engaged in producing goods and services for sale to
others. The two together are referred to here as market-oriented labor.
Without a measure of inputs used in non-market-oriented activity, the
output of such activity cannot be included in the aggregate productivity
measure. At the same time, the exclusion of the output of regrettables
would be impracticable in many cases because market-oriented labor input
simultaneously produces regrettable (often intermediate) goods and
desirable output. For instance, how is the labor engaged in producing
automobiles for commuting (a regrettable activity) to be separated from
that engaged in producing automobiles for pleasure driving when the same
automobiles are often used for both purposes?
To limit output to goods and services produced by market-oriented
OCR for page 90
90
REPORT OF THE PANEL
labor may seem to give undue priority to the measurement of market-
oriented labor input in principle, we could recommend tailoring input
concepts to the desired output universe, rather than vice versa but in
fact, most types of non-market-oriented labor, such as parents' time in
caring for children, produce non-marketed goods and services. Without a
direct measure of the output of these hours, any attempt to measure their
productivity will yield a meaningless result. The limitation of output to
goods and services produced by market-oriented labor has another
advantage. The numerator of the productivity ratio, real output, then
applies to the same universe as the numerator of the ratio compensation
per hour. The ratio of compensation per hour to output per hour is unit
labor cost, a variable of interest in itself for the analysis of the proximate
determinants of the rate of inflation.
The requirement that output be produced by market-oriented labor is a
necessary but not sufficient condition for its inclusion in the numerator of
the productivity ratio. A second criterion is that output and inputs be
independently measured in a given industry or activity. When output is
measured by hours of labor input, as in some categories of government
production, not-for-profit activities, and private services, the productivity
ratio by definition is constant. Since the use of labor input as an output
measure usually reflects practical or philosophical difficulties of measuring
output, rather than a "true" absence of productivity change, these
activities are best excluded from aggregate productivity measures. Other-
wise, the rate of change of aggregate productivity will be biased toward
zero, and the level of aggregate productivity will be biased toward
constancy. In addition, the growth of aggregate productivity will appear
erroneously to slow down whenever there is a shift in the mix of
expenditures toward the industries or activities in which output is
measured by labor input.
Even when the numerator and denominator of a productivity ratio
apply to exactly the same universe, there may be shifts in productivity that
do not result from changes in efficiency. A cyclical increase in the demand
for the products of a high-productivity industry, such as the automobile
industry, relative to a low-productivity industry, such as the textile
industry, raises average economy-wide productivity when that average is
calculated as the ratio of aggregate output to aggregate input. An
alternative procedure would be useful for some special purposes, namely,
to calculate the change in aggregate productivity as the weighted average,
using fixed weights, of the rates of change of productivity in the individual
industries, but there may not be enough reliable industry measures for
such a procedure.3
OCR for page 91
The Measurement of Output
GUIDELINES FOR INCLUSION OR EXCLUSION
91
Table 5-1 summarizes the current treatment of separate components of the
GNP in the broadest official measure of productivity. The first line includes
the core activities of the economy in which output is produced by market-
oriented labor input and the output measure is independent of the measure
of labor input. Ideally, an aggregate productivity measure would be limited
to those activities; in fact, the broadest official measure of productivity also
includes the activities in the second line, in which output is measured by
labor input. This is not a serious problem, however, since 95 percent of the
measure consists of activities in which the measurement of output meets
our criteria and only the remaining 5 percent consists of activities in which
the measurement of output is based on labor input.
The activities for which output is measured by labor input are those for
which no valid price index is available for the deflation of current-dollar
spending and for which an hourly earnings index is used instead. If prices
tend on average to rise by an amount equal to the increase in hourly
earnings minus the average rate of growth of labor productivity, then the
use of hourly earnings as a proxy for a missing price index has the effect of
assuming that the change in labor productivity is zero and thus of
measuring output by labor input. Among the activities in which hourly
earnings play a role are shoe repair, household services, health insurance,
the expense of handling life insurance, bank services to individuals,
spectator sports, clubs, and the services of proprietary hospitals and
schools; these activities all fall within the general area of consumer
services. The other major area for which output is partially measured by
labor input is construction (see "structures" in Table 5-1~. Although
expenditures on single-family houses and public roads are deflated by
relatively good price indexes, some of the remaining portions of the
construction industry are still deflated by input-cost price indexes, which
are a weighted average of wage rates and materials costs that make no
allowance for productivity change in construction activity.4
As indicated in the first and second rows of Table 5-2, aggregate
productivity growth appears to have slowed down substantially less
between 1947-1967 and 1967-1972 for the private business sector,
excluding the construction industry than for the total private business
sector. The major contribution of construction to the apparent slowdown
in the growth of productivity is shown directly in the bottom half of Table
5-2. The contribution of the construction industry is so large relative to its
overall share of economic activity because the absolute level of measured
productivity in construction actually declined during this period.5
OCR for page 92
92
REPORT OF THE PANEL
TABLE 5-1 Components of Gross National Product and the Measurement
of Aggregate Productivity (billions of current dollars, 1976)
Component
Amount (billions
of dollars)
1,700.1
TOTAL: Gross national producta
Total included in productivity measure
Included in the Bureau of Labor Statistics' productivity measure
for the private business sector, output not measured by labor
input
Included in productivity measure, output measured by labor
inputb
Personal consumption expenditures
Producers' durable equipment
Structures
Total excluded from productivity measure
Private business sector, excluded from productivity measure C
(owner-occupied housing)
Other sectors excluded from productivity measured
Government
Rest of the world
Households and institutions
Statistical discrepancy
,336.1
,274.2
61.9
43.6
2.1
16.2
364.0
96.4
267.6
92.5
14.4
56.5
4.2
aTable 1 .7 in Survey of Curren t Business July 1 9 7 8.
bEstimate provided by the Bureau of Economic Analysis. The figures shown equal 4 per-
cent of personal consumption expenditures, 2 percent of producers' durable equipment,
and 10 percent of structures.
CTable 8.3, line 63 in Survey of Current Business July 1978.
dTable 1.7 in Survey of Curren t Business July 1978.
SOURCE: Data are from the tables in the U.S. Department of Commerce, Surrey of Cur-
rentBusiness, July 1978 and from unpublished data of the Bureau of Economic Analy
sis. The components of the line items are detailed in the footnotes.
When we examine the slowdown for the next period, 1972-1977, it
appears that the sectors in which labor input plays some role in measuring
output cannot explain more than a small fraction of the deceleration. Even
when construction, financing, insurance, and real estate (FIRE), and
services are excluded, the measured productivity growth rate for 1972-
1977 was almost two percentage points less than the 1947-1967 average.
In this more recent period, the contribution of construction to the
slowdown was much less important than in 1967-1972. Overall, only a
small portion of output in the private business sector is measured by labor
input, and most of the apparent productivity slowdown between 1947-
1967 and 1972-1977 occurred in the goods-producing sector of the
OCR for page 93
The Measurement of Output
TABLE 5-2 Productivity Growth Rates in the Private Business Sector and
Subsectors, 1947-1977 and Subpenods (output per labor-hour in percentage
points)
93
Growth Rate 1947-1957 1957-1967 1967-1972 1972-1977 1947-1977
Annual average pro
ductivity growth rates
Private business
sector (PBS) 3.23 3.25 2.08 1.26 2.71
PBS less construc
tion 3.20 3.27 2.48 1.41 2.80
PBS less FIREa 3.33 3.42 2.15 1.27 2.82
PBS less services 3.41 3.29 2.33 1.47 2.87
PBS less construc
tion, FIRE, and
services
Total apparent slow
down from 1947-1967
to subperiod indicated
Contribution of con
struction
Contribution of FIRE
Contribution of ser
vice industries
Contribution of
remaining sectors
3.51
3.53
2.99
1.72
1.16b 1.98b
0.41
-0.07
0.14
0.53
3.13
0.15
-0.13
0.10
1.80
aFIRE = finance, insurance, and real estate.
bThe sum of the four percentages below does not equal this percentage because of
interaction effects.
SOURCE: Unpublished data of the Bureau of Labor Statistics' Office of Productivity
and Technology.
economy, in which labor input measures play virtually no role in
measuring output.
It is easier to state the platitude that the government agencies should
improve their measures of real output for activities in which labor input
currently serves as a proxy than to suggest specific ways to improve the
treatment of individual industries. For instance, it can be argued that the
output of proprietary schools should be measured by student-hours or
number of graduates rather than by the input of teacher-hours and
secretary-hours. A shift to number of graduates as a measure of output
would show a productivity improvement when class sizes increase. This
might be a valid approach when new types of audio-visual aids are
introduced, but it would elicit protests from teachers who believe that
students receive more educational output per student from small classes
OCR for page 94
94
REPORT OF THE PANEL
than from large ones.6 Similar questions arise in the measurement of
productivity in proprietary hospitals.7
At the least, each "problem" industry should be treated separately.
Consumer expenditures for the output of some government enterprises,
including the postal service, are already measured in the national income
accounts on an output basis (e.g., pieces of mail weighted by postage rates
in each category), rather than on a labor input basis. Even though a perfect
measure of output is unattainable and some questions about the definition
of output may be unanswerable, we should not too easily accept the option
of using labor input as a proxy for output. A transition to an output basis
for measurement for some activities may be possible when research reaches
a reasonable consensus on the proper criteria for the measurement of
output.8
Productivity measurement would benefit from research on how to
replace labor input measures used as output proxies in some sectors of the
economy. Until such research yields results, productivity measures might
benefit from the exclusion of those activities in which such proxies are
used. Nevertheless, current criteria for the exclusion of sectors from
aggregate productivity measures are generally sound. Imputed rent on
owner-occupied housing is properly excluded from the GNP before
productivity ratios are calculated, because there is no associated market-
oriented labor input (see Table 5-1~. Measurement of the "true" output of
police, firemen, and soldiers raises insuperable problems and justifies the
exclusion of the government activities in which they are engaged.
Expenditures by consumers that are regrettable intermediate inputs to the
achievement of ultimate well-being are properly not excluded (for
example, air conditioning, heating, commuting, uniforms, burglar alarm
systems, and locks) in part because they are produced by market-oriented
labor input, and it would be difficult in practice to exclude from aggregate
labor input the workers engaged in producing them.
There is growing recognition that the interpretation of productivity
measures could be enhanced if more attention were given to quality-of-life
issues. Quantitative data from federally funded research by BEA'S
Environmental and Nonmarket Division, studies of social indicators, and
work on goals accounting are intended to broaden our understanding of
many critical aspects of productivity change not fully covered in the
existing framework of economic measures. This broadening of understand-
ing does not require that data on the quality of life be incorporated into the
measures of output and productivity now in use.
Recommendation 6. The Panel concludes that many useful analyses
of economic and social welfare issues can be undertaken within the
OCR for page 95
The Measurement of Output
framework of output and input used in the current official measures.
However, the Panel does agree that for the study of many important
social problems for example, improvement of the health status of
the population-definitions of output and input that go well beyond
those currently used to measure productivity are required. The Panel
believes that for each of these special problems, partial and special
measures of output and input should be developed when possible.
However, the Panel concludes that it is not now possible to add or
subtract such special measures from the conventional measures of
output and productivity to construct a meaningful single index of
overall welfare for the nation.
NET VERSUS GROSS OUTPUT
95
At present the output numerator of the BES productivity ratio is defined as
gross rather than net of depreciation. If net output and depreciation grow
at the same rate in real terms, the choice between a gross and a net output
concept makes no difference in the growth rate of the resulting
productivity ratio. But if net output and depreciation grow at different
rates, there will be a difference in the growth rates of gross and net
productivity ratios. There are arguments in favor of both approaches, and
it is often useful to present estimates on both bases.
Proponents of the net-of-depreciation approach argue that depreciation
represents the "using up" of previously produced capital goods. Denison
(1967, pp. 1~15) points out:
Net product measures the amount a nation consumes plus the addition it makes to
its capital stock. Stated in another way, it is the amount of its output that a nation
could consume without changing its stock of capital. Insofar as a large output is a
proper goal of society and objective of policy, it is net product that measures the
degree of success in achieving this goal. Gross product is larger by the value of
capital consumption. There is no more reason to wish to maximize capital
consumption the quantity of capital goods used up in production than there is
to maximize the quantity of any other intermediate product used up in production,
such as, say, the metal used in making television sets. It is the television sets, not
the metal or machine tools used up in production, that is the objective of the
production process.;
Proponents of the gross-of-depreciation approach, on the other hand, do
not believe that productivity measures should be based solely on a welfare
criterion. A portion of the labor input included in the denominator of the
productivity ratio is engaged in the manufacture of capital goods to replace
those goods that are wearing out or becoming obsolete. There is no more
OCR for page 96
96
REPORT OF THE PANEL
reason to exclude capital consumption from the output numerator of the
productivity ratio than there is to exclude regrettable goods and services
that do not contribute directly to well-being. According to this view,
spending on defense goods, crime protection, commuting, antipollution
devices, and on capital goods to replace those used up in production is all
similar: they are part of the output of marketed labor input whether or not
they are desired for their own sake.
Although the Panel does not choose between these two approaches, it
notes that gross and net productivity measures show similar secular rates
of growth. In analyses of the sources of economic growth, however, use of
the gross-of-depreciation approach will show a larger contribution from
capital and a smaller contribution from other sources than use of a net-of-
depreciation approach. Over short periods, gross-of-depreciation measures
of productivity fluctuate less than net-of-depreciation measures in response
to output movements because measured capital consumption exhibits little
cyclical variation.
CAPITALIZATION OF INTANGIBLE INVESTMENT
Some researchers have recommended the inclusion in output of some items
now treated as consumption or intermediate goods, which would then be
capitalized, that is, treated as investment. A prime candidate for addition
to a welfare-oriented GNP measure is investment in research and
development (see Griliches 1973~. Why should a society be treated as
having less real output when it diverts resources from investment in
machines to investment in research? Exclusion of research activity from
real output means that the change of an hour from conventional
production to research will decrease measured productivity in the short
run until the fruits of the research begin to raise conventional output. The
main problem involved in including research as a part of final output is
that no measure of research output is available other than labor input. It
would probably be more desirable to exclude research employees from
private labor input than to attempt to add research output to aggregate
private real output.
Education is another prime candidate for capitalization as an investment
good. At present, both the output and the labor input of most of the
education industry are excluded from productivity measures because all
activity in general government and not-for-profit institutions is excluded.
In principle, however, education and health should be treated similarly.
The main advantage of health over education for productivity measure
OCR for page 97
The Measurement of Output
97
ment is the existence of discrete "outcomes" or "products" (e.g., a
tonsillectomy) that can be included in the consumer price index (thus
allowing a genuine rather than a labor-based output measure). In contrast,
defining the product of education raises the problem of choosing between
units of educational input and the alternative of the number of students
"processed" or graduated. But Scott (in this volume) suggests that health
output is equally difficult to measure and that alternative concepts of
health outcomes and processes yield differing measures of productivity in
the health industry.
Consumer expenditures on antipollution and safety devices, such as
those required by the federal government for automobiles, are currently
included in real GNP. This inclusion occurs because in constructing
deflators for automobiles and other products a change in value due to the
addition of a government-mandated device is counted as an increase in
quality rather than as an increase in price. Since the production of
pollution is not currently subtracted from the GNP, the current procedure
in effect measures the benefits of antipollution devices by their costs and
exaggerates their benefits if costs exceed benefits. Applying our previous
principles, this approach seems desirable for the purpose of productivity
measurement. We do not want the shift of a worker from an assembly line
building automobile transmissions to an assembly line building catalytic
converters to cause a sudden drop in measured productivity, as it would if
all labor input in the automobile and automobile parts industries was
included in the input denominator of the productivity ratio but production
of converters was excluded from the output.9
Business expenditures for antipollution and other required devices are at
present treated in exactly the same way because the price deflators used are
developed by the same methods. However, in the case of business, the shift
of one dollar of gross investment from normal "productive" types of
investment to "unproductive" government-mandated investment will
cause future measured output to be lower than otherwise. The measure-
ment problems created by business expenditures on pollution control and
worker health and safety can be treated in one of two ways. The first is to
leave the output definition unchanged and to analyze separately the
contribution of government-mandated expenditures to the change in
productivity.- The second is to estimate what the contribution of these
expenditures to output would have been and add it to output to produce a
measure of what output would have been without government-mandated
expenditures. We prefer the first way and note the recent efforts of
Denison (1978b) to analyze the contribution of environmental legislation
to productivity change.
OCR for page 98
98
REPORT OF THE PANEL
DIVIDING VALUE CHANGES BETWEEN CHANGES IN
PRICES AND CHANGES IN REAL OUTPUT
CURRENT PROCEDURES FOR MEASURING PRICE CHANGES
The GNP implicit price deflator is a weighted average of thousands of
individual price observations, most of which are collected by the BES for
the consumer price index (CPI) and the producer price index (PPI), which
was formerly called the wholesale price index (see Early 1978~. The BEA
publishes annual deflators for about 60 different categories of consumer
spending, with individual item indexes of the CPI averaged together with
fixed weights to form each of the group deflators. The implicit deflator for
total consumer spending is an average of the 60 separate group deflators
with the current level of real spending by category as weights.~° Similarly,
annual deflators for producers' durable equipment are published for 22
categories, based almost entirely on individual item indexes of the PP~.~: A
variety of sources, both government agencies and private firms, is used to
compile the 25 published deflators for purchases of residential and
nonresidential structures.
The main emphasis of this section is on the adequacy of allowance for
changes in quality in the current procedures of price measurement. If
changes in the value of products that are actually price changes are treated
instead as quantity or quality changes, the growth of productivity and
aggregate output are overstated. On the other hand, if value changes that
actually represent quantity or quality changes are treated as price changes,
the growth in productivity and aggregate output are understated.
The basic Bus method of price measurement in both the cat and PP~ is
the specification method. BES staff draw up definitions or specifications of
the commodities they want to include, as in this example from the apt:
"color television receiver, console model, 21", 23", or 25" picture tube,
veneer cabinet; manufacturer to dealer or distributor, f.o.b. factory or
warehouse, each." For the All, companies provide on monthly mail
questionnaires price quotations on one or more particular color TV models
that fall within the BES specification. For the UPS, field agents record the
retail prices of items that meet the specification.
The complications begin when, for example, the TV manufacturer
switches to a new model that includes a remote control feature as standard
equipment and costs $50 more than the old model. A manufacturer
altering a product in any significant manner is supposed to report the
change to BES, which then decides how much to adjust the reported price
to reflect the change in quality. In the simplest case, a BES official might
call the manufacturer and learn that the remote control feature had
OCR for page 111
The Measurement of Output
declining growth rate of aggregate productivity in that period. A careful
study of construction prices and the adequacy of the present deflators
should be part of a larger research project needed to identify the possible
role of measurement error as a source of the experience of the construction
industry.
Except for construction, most of the problems of measuring type 1
quality change, as reviewed in this section, are being solved by the
improved methods of selecting items and sales outlets incorporated into
the latest BES revision programs. The importance of this section relates
mainly to the effects of a shrinking measurement bias on historical trends
in productivity growth. This leaves the omission of quality change of types
2 and 3 as the main potential source of error in the current price indexes.23
PROBLEMS IN MEASURING TYPE 2 QUALITY CHANGES
The extension of quality adjustments to changes of types 2 and 3 does not
involve any revolution in existing techniques of measurement but rather
different criteria for the application of existing techniques. The basic
method of specification pricing used to adjust for resource-using quality
changes can be extended to "costless" quality changes. Instead of
regarding as equivalent a new and an old model having the same resource
cost, BES would regard as equivalent a new and an old model having the
same value to the user. If a new model or product replaces an old one but
performs the same services for the user (as in the case of the transition
from rotary electric calculators to electronic calculators or from piston to
jet aircraft), any price reduction involved in the transition would be
included in the BES index rather than ignored as at present. If the services
perfo~ed by the new model are improved, treating the new and the old
models as equivalent will understate the true price reduction. The
feasibility of placing a dollar value on the improvement in the service will
diner in each individual case.
The hedonic regression technique can be useful in measuring any type of
quality change except those involving the introduction of products with
genuinely new characteristics. It is already used by the Census Bureau to
adjust for type 1 quality changes in newly produced single-family houses.
The hedonic technique is particularly useful when a product has many
attributes and provides a mixture of services. The technique involves
applying a statistical regression to the differing available models of a given
type of product available in two or more years. The dependent variable in
the regression equation is the price of each model, and the independent
variables are its measured characteristics and a dummy variable for each
year. For automobiles, the product most often studied to date, differences
OCR for page 112
I12
REPORT OF THE PANEL
in prices among auto models available in two adjacent years are explained
by size and performance attributes (length, weight, horsepower) and the
model's year of production. If 1979 models are higher priced than 1978
models, holding constant their other characteristics, then the estimated
coefficient on the year of production will indicate the average increase in
quality-adjusted price between 1978 and 1979.24
If the independent variables in the regression equation are the
performance attributes of value to the user, then the hedonic technique
corrects for quality changes of types 1 and 2 simultaneously. For instance,
an improvement in the acceleration of an automobile might be achieved by
a resource-using increase in the size of the engine, or by a "costless"
replacement of a conventional ignition system by an electronic ignition
system made possible by technical innovation. It is important to recognize
that the hedonic technique only provides a method of estimating an
aggregate measure of performance for a product having many different
performance attributes. In principle, the hedonic technique accomplishes
nothing that could not be achieved by the conventional specification
pricing technique since the latter could compare the price in two years of
two models having identical performance attributes; in practice, the
hedonic technique is useful for measuring quality change of both types 1
and 2 in the cases of some complex products (autos, refrigerators) because
models available in two adjacent years are rarely completely identical.
It is sometimes argued that type 2 quality adjustments are not feasible
on the grounds that they are inherently subjective and that results may be
sensitive to the particular methodology used and the particular perfor-
mance characteristics chosen. Yet ambiguity in the form of a range of
results from alternative specifications is not a unique feature of attempts to
identify type 2 quality change. It also occurs for type 1 quality change. The
BEA has accepted the usefulness of the hedonic approach by adopting the
Census Bureau's index for the prices of single-family houses; this index is
no more or less subjective than the hedonic indexes for the prices of
computer services cited above.
Nor is the present BES specification method free from subjectivity. Just
as hedonic results can vary depending on the particular way in which
observations are combined and equations are specified, so are the results of
the specification method sensitive to the number of models included and
the degree of attention given to adjustments for quality change. In making
type 1 quality changes by estimating the cost of new product attributes,
manufacturers must make arbitrary judgments on the allocation of joint
costs common to several products or attributes. Many of the changes
urged here involve applying the common-sense view that electronic
calculators provide the same type of service as the older rotary electric
OCR for page 113
The Measurement of Output
~3
varieties or involve relatively routine applications of well-established
econometric methodology whose results may be less controversial and less
subject to debate than some decisions already made in the process of
measuring type 1 quality change.25
Difficult questions are raised in all areas of national income accounting,
e.g., the determination of a proxy for output in such hard-to-measure
sectors as health, education, finance, insurance, real estate, and services.
There is no reason why a particular class of problems involved in the
measurement of type 2 and type 3 quality change should be arbitrarily
excluded. A fundamental guideline of national income accounting since its
inception has been that products are aggregated using market prices in
order to reflect the assumption that the ratios of market prices of two
goods measure the ratios of their marginal value to users. In the same way,
the fact that users pay more for computers with faster computation speeds
or for pocket-size electronic calculators containing a memory should
indicate that these attributes are valuable to them. Any technological
advance that produces more of these attributes should be reflected as an
. .
lIlCreaSe ill GNP.
PROBLEMS IN MEASURING TYPE 3 QUALITY CHANGES
The contribution of durable goods to output should depend on their value
to users, which in turn depends on the net stream of benefits they provide:
that is, the gross flow of services adjusted for operating costs. A firm
should be willing to pay exactly the same extra amount for a new model of
a machine that provides $1,000 more per week in revenue than an old
machine and costs the same to operate or for one that provides the same
revenue per week as the old machine but costs $1,0~)0 less per week to
operate. Present BES procedures occasionally capture quality changes of
the latter type when a new model is introduced for which a manufacturer
can provide an estimate of the extra production cost of providing the buyer
with a saving in operating cost. But many improvements in operating
efficiency have been introduced on all models simultaneously and have
been ignored.
Although the improvements in fuel economy on new model automobiles
since 1974 have been widely publicized, it is less well known that
automobile fuel efficiency (adjusted for changes in the quality of
automobiles) improved by 30 percent between 1949 and 1969 and then
declined by about half that amount between 1969 and 1974 (see Wilcox
1978~. Consumers benefited during most of the postwar period from
substantial reductions in electricity consumption and repair expenses on
television sets, air-conditioners, and other home appliances. Similarly,
OCR for page 114
114
REPORT OF THE PANEL
technical improvements achieved a steady reduction in the fuel require-
ments of steam turbine generators during most of the postwar period (see
Gordon 1974, Chapter 6~. Users should be indifferent to a choice between
receiving a $100 price reduction on a durable good and receiving $100 in
the form of a reduction in the present value of future operating costs.
The basic information required for type 3 quality adjustments may be
easier for manufacturers to provide than the estimates of costs of model
changes currently required for type 1 adjustments. Changes in fuel and
energy requirements can be reported by firms or independent testing
organizations. The conversion of these changes in operating cost into a
present value (for comparison with the capital cost of the durable good)
requires information on average product service lives, future utilization
rates, and future prices of energy and other inputs, as well as an assumed
interest rate for the purposes of discounting future values. While some
arbitrariness is required to choose values for service lives, expected
utilization, expected energy prices, and interest rates, this is not different in
principle from the difficulty faced by any private business firm or
government agency that must calculate future rates of return on private
and public investment projects.
Fuel and energy are not the only costs of operating a durable good.
Design changes that alter maintenance requirements should also be taken
into account. The reduced frequency of maintenance and downtime for
motor vehicles, electricity generating equipment, color television sets, and
other products has been documented, although the information required to
adjust for such savings is inherently more difficult to obtain and interpret
than engineering data on fuel consumption. Improvements in scheduled
maintenance requirements must be evaluated against the claim that
assembly defects and recalls have become more common, at least for
motor vehicles.
Most of the discussion so far has referred to changes in operating costs
or durability made possible by manufacturing design changes, but some
changes should not be attributed to the industry that manufactures the
product. For instance, automobile tires have become more durable over
the years partly because of improvements in the quality of road surfaces.
The durability of some goods or the costs of repairing them may also be
improved by new techniques introduced by users or hired maintenance
workers. Careful measurement procedures under constant operating
conditions are required to avoid crediting a manufacturing industry with
productivity improvements for which it is not responsible.
Most new procedures for measuring quality change can be introduced
into the price series used to deflate output only after a period of research
and experimentation. Introducing changes in the deflators without an
OCR for page 115
The Measurement of Output
~5
adequate basis in research would not solve the problems we have been
. .
c Discussing.
On the other hand, the present policy of omitting all type 2 and type 3
adjustments represents a defect in official measures of output and
productivity growth. If the importance of type 2 change has grown
through the increased share in GNP of innovative electronic products and if
the importance of type 3 change has increased since the oil price increase
of 1974, then part of the slowdown in secular productivity growth
observed in the official data in the 1970s may be spurious. Some attempt
should be made to quantify those effects.
In seeking to measure type 2 and type 3 quality change, statistical
agencies may want to maintain alternative deflators for a period before
deciding to change (or not to change) those now in use. At times, they may
want to publish revised or alternative historical deflators for past periods
for use in studies of long-run growth.
The development of new or experimental real output measures could be
based on price adjustments suggested by outside researchers not only
academic researchers but also experts in the BES price research section and
in other parts of the federal government. Freed from the need to adhere
rigidly to the "type 1 only" criterion of quality adjustment, government
price analysts could range more widely than at present both in their
sources of data and their techniques of adjustment. Three examples of
adjustments that could be implemented quickly at relatively low cost are
improved linking, measures of improved performance, and present-value
calculations of energy savings.
Improved Linking As mentioned above, in the early 1970s the PP~ index
for calculating machines was shifted from rotary electric calculators,
which then cost about $1,000, to electronic calculators, which then cost
about $200, to perform identical operations more rapidly. The old index
for rotary electrics was linked to the new index for electronic calculators,
so that the PA reflected no price change rather than the 80-percent price
decrease that actually occurred. Using the criterion that the old and new
varieties should have been treated as the same product because they
provided the same services to the user, the 80-percent price reduction
could be retrospectively incorporated into an alternative historical price
index. Another example of the same phenomenon occurred for diesel
engines in the 1950s and 1960s, when technical improvements in high-
speed engines allowed many users to shift from low-speed to high-speed
engines having a much lower price per horsepower. The alternative
deflator could incorporate the effect of the reduction in price per
OCR for page 116
116
REPORT OF THE PANEL
horsepower instead of being based on the present fixed-weight combination
of the two types of engines.26
Measures of Improved Performance Given the growing importance of the
electronics industry, the most prominent electronics products should be
priced on a basis of price per weighted performance attribute. The studies
cited above demonstrate that the hedonic regression technique can be used
to establish a value for the major performance attributes of electronic
computers and turbine generators; the same methodology can be applied
to calculators, cash registers, and other products. Previous studies should
be used (or new ones commissioned) to provide information on the extent
of type 2 improvements for major products during the past three decades
of rapid technical progress, especially in electronics.
Present-Value Calculations of Energy Savings Probably the most impor-
tant adjustments required for productivity analysis are those that reflect
changes in energy consumption. A substantial portion of durable goods
have been subject to changes (both improvement and deterioration) in
energy use including electrical generating equipment, motor vehicles,
home appliances, and commercial aircraft. Studies of changes in energy
use could be commissioned as a collaborative effort of the BES price
research section and the government agencies responsible for estimating
future energy demand and the benefits and costs of environmental
regulation. It should be noted that many changes in fuel efficiency
occurred before the 1974 increase in oil prices.
The three kinds of adjustments discussed above involve objective
measurement and can be made on a scientific basis. They leave
unmeasured, however, quality changes in goods or services that have
yielded time savings to users. Such changes include the faster speed of jet
aircraft, the electronic calculator, the reduction of scheduled maintenance
requirements of motor vehicles, and the provision of free check-cashing
services by supermarkets. Given the wide range of estimates of the value of
household time that has emerged from recent studies of transportation
demand, adjustments of prices for time savings should perhaps be left, at
least temporarily, as a subject for further research outside government. It
should also be recognized that some other types of improvements can
probably never be valued, for instance, the convenience value provided by
a typewriter that allows a user quickly to switch typing elements for
esoteric symbols and a variety of type faces or the value of a calculator that
computes mathematical functions more accurately than a slide rule.
OCR for page 117
The Measurement of Output
IMPORTANCE OF QUALITY ADJUSTMENTS FOR PRODUCTIVITY
MEASUREMENT
117
The use of the example of the electronic computer in the discussion above
of type 2 quality change might tempt a skeptic to dismiss the importance
of the adjustment problem on the grounds that electronic computers
represent only a small portion of GNP. If we leave aside services and
structures as sectors that raise fundamental questions about the meaning
of output, we can attempt to provide a rough estimate of the fraction of
goods production for which unmeasured quality change may be important.
Unmeasured quality change has probably been limited to a subset of
durable goods: motor vehicles and household appliances and other
equipment. Among the types of consumer durables that have probably not
been subject to unmeasured quality change are jewelry, furniture, kitchen
utensils, and books. Many categories of nondurable goods are generally
agreed to be relatively free of unmeasured quality change, including most
types of food, beverages, shoes, toilet articles, publications, flowers, and
petroleum products. Quality changes in the form of new and more durable
fabrics have been common in the clothing and semidurable household
furnishing categories (with a 1976 value of $74.7 billion), and quality
improvements have also occurred in the drug ($10.7 billion) and tobacco
($16.2 billion) categories.27
In the producers' durable equipment (PDE) category, unmeasured
quality change is likely to have been relatively more important than in the
consumer goods category. Quality adjustments are probably now relatively
accurate in the "other" category, which includes furniture, fabricated
metal products, agricultural machinery, construction machinery, and
. . .
mmlug mac emery.
Our conclusion, reached by applying 1976 expenditure data to the
categories of goods discussed above, is that roughly two fifths of the total
production of goods may be susceptible to improved techniques of quality
measurement. If unmeasured quality change does turn out to be
quantitatively significant for a number of these categories, then aggregate
measures of output and productivity change would be altered substantially
by the proposed adjustments. Some of the categories are amenable to
relatively objective and straightforward adjustments, for example, for the
improved performance of electronic computers and energy consumption of
vehicles and appliances. But other major categories, particularly consumer
nondurables, would require difficult and speculative adjustments to correct
for changes for such characteristics as fabric durability and maintenance
requirements.
OCR for page 118
118
SUMMARY AND RECOMMENDATION
REPORT OF THE PANEL
This chapter has reviewed two sets of issues that bear on the accuracy of
output measurement for productivity analysis. First, which components of
the aggregate output of goods and services should be included in the
numerator or the aggregate productivity ratio? Second, are changes in
product quality treated adequately in the national accounts, and what
steps should be taken to improve their treatment? The basic answer to the
first question is that the present measure of aggregate productivity in the
private economy is based on an output concept that is somewhat too
inclusive; it contains a relatively small component of activities for which
an estimate of productivity change is not meaningful. An analysis of the
second question leads to a recommendation that government statistical
agencies expand their efforts to deal more adequately with the problem of
quality change.
Output included in the numerator of the productivity ratio must be
produced by the inputs included in the denominator. The basic measure of
labor in the denominator is market-oriented labor input. As in the present
national accounts, activities produced by non-market-oriented labor input
should be excluded from the output universe. Because they are produced
by market-oriented labor input, the production of national defense and
public safety, along with commuting and other regrettables, should not be
excluded from the output universe.
The requirement that output be produced by market-oriented labor
input is a necessary but not sufficient condition for inclusion in the
numerator of the productivity ratio. A second criterion is that output and
input be independently measured in a given industry or activity. On this
criterion, the present official measure of productivity uses somewhat too
inclusive an output concept: its universe includes a number of activities in
which output is directly or partly measured by labor input (much of
finance, insurance, and a portion of services). About 5 percent of the
present output universe is questionable on these grounds. A particular
candidate for separate examination is the construction industry, for which
the deflation of output has always posed difficult problems and which
bears a disproportionate share of the responsibility for the measured
deceleration in aggregate productivity in the early part of the past decade.
Real output is now measured by deflating the current value of output by
price deflators that do not adequately measure all types of quality change.
The deflators are quite successful in capturing quality changes that result
from new product features produced at additional cost, but they do not
attempt to capture quality changes produced by innovations that do not
OCR for page 119
The Measurement of Output
~9
raise costs or quality changes associated with the lower operating costs or
longer useful life of durable goods.
Recommendation 4. The Panel recommends that the Bureau of
Economic Analysis (BEA) and the Bureau of Labor Statistics (BES)
seek to improve their existing price indexes and to develop auxiliary
measures of price change. These new auxiliary measures should take
into account more adequately the types of quality change that are not
now measured. They should be a collaborative effort of BEA and the
productivity and price research divisions of BES.
Among the adjustments that could be incorporated in the new
measures are adjustments (through better linking procedures) for the
changes in value to users resulting from the introduction of improved
products; estimates of the value to users of improvements in
performance that are achieved without increases in real cost; and
estimates of the present value of future savings in operating efficiency
made possible by design changes and improvements.
Since many of the proposed adjustments would require background
studies and additional research, they could not all be incorporated
simultaneously into a single new output measure to be used for
productivity analysis. Instead, the output measure could be revised
periodically, perhaps every 5 years, as new research evidence becomes
available on the importance of unmeasured quality change both in the
current and in previous periods.
NOTES
1. The productivity ratio for any input can also change when changes in the
relative prices of inputs cause substitutions among them.
2. For further discussion on welfare-oriented output measures, see Moss (in
this volume).
3. Such an index would capture the cyclical change in productivity within the
automobile industry but would omit the compositional effect of the shift in demand
toward the auto industry.
4. The data for "structures" in Table 5-1 reflect a rough estimate by the
Bureau of Economic Analysis that 10 percent of construction expenditures are
deflated by input-cost price indexes. This estimate may be low, depending on
exactly how several of the nonresidential construction deflators are classified.
5. It is not known why an input-cost price index erroneously might yield a
productivity decline over the past decade. One conjecture is that there has been a
shift in the composition of construction output toward non-union sectors and low-
wage regions, which would tend to reduce nominal income originating in the
construction industry. If this income series is deflated by an input-cost index based
OCR for page 120
120
REPORT OF THE PANEL
on an index of a fixed mix of wage rates (a Laspeyres index), the deflated real
output series would show a spurious decline in real output and productivity. This
conjecture can explain only part of the productivity decline, since input-cost
measures are used to deflate only part of construction activity.
6. As an example of the current controversy on the productivity aspects of
class size, see New York Times (1978~.
7. Scott (in this volume) discusses the measurement of the output of hospitals.
8. Scott (in this volume) poses the question of whether an outcome or process
measure for the output of hospitals should be used. Process and outcome measures
are not necessarily substitutes (although the former can be useful in analyzing the
latter).
9. While the current treatment of government-mandated devices makes sense
for productivity measurement, it has the unfortunate consequence of excluding
from the price indexes important changes in specifications for which consumers are
not generally willing to pay and which they perceive as increasing price rather than
quality. There may be a need for an auxiliary price deflator that treats the
introduction of government-mandated devices as representing price rather than
quality changes for use when that approach is appropriate. The present concept
should be retained for the measurement of real GNP and productivity.
10. The annual subgroup deflators for consumption expenditures are published
in the July 1978 issue of Survey of Current Business (hereafter referred to as Survey
1978) for the four most recent years (Table 7.12~; historical data back to 1929 can
be found in Survey (1976~.
11. The annual subgroup deflators for producers' durable equipment are also
published in Survey (1978, Table 7.14) for the four most recent years; historical
data back to 1929 can be found in Survey (1976~.
12. Detailed sources are provided in Survey (1974~.
13. The hedonic regression technique has been used by econometricians as a
systematic method for measuring the value of added size or other features
previously available on at least some models. But, as Jaszi (1962) perceptively
points out, the hedonic regression method is not a fundamental break from the
traditional method. Rather it is a way of identifying the determinants of price
differences across models and of averaging out the contribution to price of added
length, weight, and other such attributes.
14. Some commentators have been skeptical of adjustments for type 3 quality
changes because of the danger, for example, that shifts in fuel use in response to
changes in energy prices might erroneously be treated as attributable to equipment
manufacturers. The main measurement task is to identify shifts in the transforma-
tion function linking energy efficiency to the performance characteristics of goods.
Changes in relative prices simply cause movements along a given function and are
not treated as quality change, whereas shifts in the function are legitimately treated
as a quality change. For a detailed presentation of this position see Gordon (1979~.
15. An early argument for measuring type 2 quality change is in Griliches
(1964~. Defenses of the current practice of limiting measurement to type 1 quality
change include those of Jaszi (1962) and Denison (1957~.
16. For an important survey of theoretical and empirical issues in the
measurement of prices, see Triplett (1976~. Correspondence with Jack E. Triplett
has been helpful in the drafting of this section.
OCR for page 121
The Measurement of Output
121
17. For the purpose of growth accounting, especially for large aggregates like
the private business sector, one may want to keep measures of type 2 and type 3
quality change separate from the capital input measure. This is because these
changes are intimately related to advances in knowledge, and it is important to be
able to distinguish the effects of these advances from those that flow from savings
and investment behavior given the stock of knowledge (see Chapters 3 and 7~.
18. GNP consists of consumption, investment, government purchases of goods
and services, and net exports. The statements in the text about consumption and
investment apply equally to government purchases. If a manufacturer can improve
a machine gun by an innovation that raises the accuracy of its sight without an
increase in cost, there has been an increase in the value of that machine gun to its
ultimate user the taxpayer who is purchasing defense services. Whether the value
of that improvement can actually be measured is another question (see discussion
below).
19. See Chow (1967) and Archibald and Reece (1978~. The Archibald-Reece
result must be regarded as tentative; its implied 93.2-percent price decline over only
5 years needs to be confirmed by additional research.
20. These figures are the unweighted averages of the difference between the
growth rates of the catalog and PP~ indexes for 62 individual product classes (see
Gordon 1974~.
21. Deflators for the producers' durable equipment category of GNP are based
entirely on the PPi, yet many small businesses purchase equipment from retailers
and wholesalers.
22. See Gordon (1974, Chapter 6~. The prices are those paid by Consumers
Union shoppers for refrigerators, washing machines, and room air-conditioners.
23. In principle, the price indexes can contain an upward or downward bias
because of the measurement of quality change; Triplett (1976) presents examples
that go in both directions.
24. For a brief survey of the more important hedonic regression studies of
automobile prices, see Triplett (1976, pp. 3~41~. The Triplett paper also reviews
studies of quality change, both using the hedonic regression method and other
techniques, for a number of other products.
25. For example, the decision to treat safety and antipollution devices on
automobiles as a change in quality rather than price and the decision to ignore all
quality changes involved in the "downsizing" of automobiles in the period since
1976 are arguable.
26. This reduction in price per horsepower is shown in Census Bureau unit-
value data for diesel engines and has been confirmed by conversations with engine
manufacturers (see Gordon 1974, Chapter 5~.
27. The changes in tobacco refer to the reduction in average tar and nicotine
levels. Different users may evaluate these changes in different ways.
Representative terms from entire chapter:
quality changes
