Input-Output Model and its Relevance
The article delves into the significance, usage, and criticisms of the input-output model in economics, state planning, and the environment.
Shereein Saraf
November 2, 2020 / 8:00 AM IST
The article delves into the significance, usage, and criticisms of the input-output model in economics, state planning, and the environment.
What if a matrix could depict something as complex as a national economy. It was in the 1930s that such an idea came into limelight when Wassily Leontief, a Russian-American economist, published ‘Quantitative Input-Output Relations in the Economic System of the United States‘ in the Review of Economics and Statistics (1936), stirring quite a conversation. However, it was subdued by John Maynard Keynes’ General Theory of Employment, Interest, and Money (1936) that attracted worldwide attention in the light of the Great Depression and rising unemployment.
Leontief, later, won the Prize in Economic Sciences in 1973 for outlining the input-output model and developing its applications in solving economic problems.
In its initial years of reform, the Soviet Union State Planning looked like such a matrix – with countless rows and columns – adding up to total production in the economy. Gosplan, the State Planning Commission, established in 1921, was the central coordinator of national planning that used the method of material balancing to prepare input materials and target production. By 1964, most of the large countries in the Soviet bloc – Poland, Hungary, East Germany, Bulgaria, Czechoslovakia, Yugoslavia, and Romania – planned their economy using the input-output table. A central tool in the national and regional economic analysis, it finds its use in preparing budgets, targeting, and predicting future needs.
Theoretically, the input-output model is a macroeconomic concept, explaining the interdependence in the production systems as a network of exchanges within sectors of the economy. The transaction table, which is the same as the input-output table, shows the final demands of products for consumption, investment, and exports. It also shows the production and purchase of intermediate goods from different industries.
To understand this better, below is a hypothetical input-output table. When it comes to actuality, there are n industries and n products represented by the input-output model, n being a relatively large number.
This analysis benefits in finding out the amount of production to be changed – increased or reduced – per sector of the economy to achieve a planned change in final demand for the key drivers of the economy – consumption, investment, and exports. As production increases in one sector, the planners need to account for not only changes in final demand but also the ones derived from intermediate transactions. It is the system of double-entry bookkeeping – the sale of a product corresponds to its purchase by another industry.
In practice, one can conceptualize the input-output table either in terms of outputs or prices. As is customary in the United States and several other countries, states use producers’ prices to value transactions in the input-output tables. A balanced regional input-output model is constructed by disaggregating the national input-output table into regions. But the lack of data at local levels and using the identical pattern of input flow as the national level might pose limitations in calculations.
Disaggregation of the economy into a detailed breakdown of all industries and sectors is advantageous for prediction, though. Forecasting – in the short or the long run – employs a detailed industrial classification revealing the bottlenecks that might occur during the expansion of production.
A widely used technique, the input-output analysis has found its application in diverse and complex economic systems of decentralized market economies with private enterprise to centrally-planned economies controlled by public ownership. Even in the case of sudden or large-scale expenditures on military or an economic transformation, this method has proved beneficial.
Environmentally Extended Input-Output Analysis (EEIOA) is one of the recent developments wherein the baseline model finds an extension to include externalities like environmental pollution often neglected by the conventional economic systems.
However, the construction of such a table is often a matter of debate when one considers underdeveloped economies. Critically examined by many scholars, some reject the whole idea without any reservation. One of the underlying arguments here is a lack of data, even the basic ones. In such an instance, it becomes difficult to formulate an input-output table, let alone analyze one. (Eleish, 1963)
Another argument is the lack of interdependence among economic sectors in an underdeveloped economy. Lastly, the stability of technical coefficients that determine the quantities of intermediate products for every sector or industry is under question. (Eleish, 1963)
There have been methods to construct an input-output model in the case of underdeveloped countries, which provide a fair analysis of the bottlenecks to improve upon development policies and ensure better planning – rounding to what the model aimed.