Sharing my worries regarding the affects of offshoring on REMI regional impact estimates

1. Sharing my worries regarding the affects of offshoring on REMI regional impact estimates George Erickcek & Susan Houseman W.E. Upjohn Institute for Employment Research Presentation prepared the Annual REMI Users Conference Santa Fe, New Mexico October, 2008

2. Production and Employment in Manufacturing It ain’t necessarily so.

3. Areas of concerns • Recently revealed errors in BEA’s pricing of imports may result in the overestimation of output and productivity gains. • I worry that, if true, these errors could result in REMI’s forecast for manufacturing goods and some services to be too robust. • These problems are compounded by time lags in the data especially in the construction of the national input-output accounts.

4. Why is this a problem? • Global offshoring has become “standard” practice for many manufacturers and possibly a growing number of service functions. • The hollowing out of a region’s supply chain will have immediate impact on the size of the “multiplier impact” • Regional output flow are lessen • Income earnings are reduced • Resulting consumption expenditures are diminished.

5. Federal Reserve Board and BEA Studies Show Substantial Growth in Outsourced and Imported Intermediate Inputs • Domestic providers of outsourcing services – significant growth in share of GDP 1982-2006: 7% to 12% • Domestic outsourcing esp. strong durable manufacturing • Substantial substitution imported inputs for domestic inputs in production of goods & services 1997-2005 • Growth imported intermediates esp. strong manufacturing – accelerated 1997-2005 Yuskavage, Strassner, Medeiros (2008); Kurz & Lengermann (2008)

6. Imports as percent GDP grew from 10.8% in 1989 to 17.0% in 2007 Developing countries—growth non-oil imports: 56% 1989-2000 70% growth 2000-2007 Growth imports from China especially dramatic: 13% growth non-oil imports 1989-2000 39% growth 2000-2007 Imports and Exports as Percent of GDP, 1989-2007 Growing Importance of Imports from Developing Countries

7. Problem Outsourcing and Offshoring Pose for Price Measurement • Changes in sourcing of intermediate inputs generally motivated by lower prices • Price drops associated with changes in sourcing generally not captured in US price statistics • Surveys implicitly assume patterns of sourcing are stable or change slowly over time

8. Implications of not measuring input price drops with changes in sourcing • Price indexes used to compute real value added at industry and sector levels—GDP at aggregate levels; • These real output measures, in turn, used to compute many productivity statistics • When price index growth is overstated • Real value of offshored input understated • Real domestic output and/or sector value-added growth overstated, • Aggregate and/or sectoral productivity growth overstated • Output and productivity statistics unreliable, especially in industries that have experienced rapid changes in offshoring.

9. Example: Producer Switches from Domestic to Lower-Cost Foreign Supplier of Intermediate Input • Price indexes constructed as average of changes across periods, zero in this example • If producer switches from US supplier in period 1 to foreign supplier in period 2, input price drops by 50%, but no price drop measured in official statistics Producer Buys Intermediate Input Input A US supplier $2 Period 2 Input A foreign supplier $1 Period 2 % change = 0 % change = 0 Input A US supplier $2 Period 1 Input A foreign supplier $1 Period 1

10. A simple illustration of the problem: This is very similar to the “Walmart” effect on the CPI.

11. Timeliness of BEA benchmark I-O tables • Latest I-O table used to compute GDP by industry and sector productivity measures based is based on 2002 data. • Imports are accounted in the final demand. • This means that the interindustry transactions do not capture the share of the an industry’s demand that is met through imports. • So if imports grow and the inter-industry transaction estimates are not adjusted, then the tech. coefficients are too high and so are the multipliers. • Imports are valued at “foreign port value” plus freight and duties.

12. Standard input-output model Inter-industry Matrix Final Demand Industry 1 Industry 2 Where: a11 = X11/X1total, mi = M1/Xtotal Note: There are no estimates of industry 11’s demand for industry’s 21 product that is imported

14. How is the growing use of global supply chains captured in the REMI model? • Not immediately clear. Highly focused on the impact of inter-regional comparative costs: Market Share. • REMI captures the trend in offshoring in two separate ways: • The national inter-industry coefficients are adjusted for imports. But how? • The sector’s regional presence is based on employment – If offshoring is occurring then the supply industries’ employment base would be declining lowering the model’s RPC.

15. REMI modeling Output for industry i in region k. Qki= ski DDi + ski Xi DD = domestic demand for i based on the models inter-industry estimates (somehow adjusted for imports) Xi = International exports ski = f(rel. prod. cost, geog, industry mix, export share)

16. REMI modeling Domestic demand for industry i in region k. DDki= ( ∑aijQj + ∑ciCj + ∑kiIj + ∑giGj) ski ∑aij Qij = standard input-output inter-industry demand estimation – the amount of i purchased to generate a dollar of j in the region k. However, REMI adjusts this by factoring in its estimate of the intermediate input access.

17. REMI modeling Domestic demand for industry i in region k. DDki= ( ∑aijQj + ∑ciCj + ∑kiIj + ∑giGj) ski The amount of i purchased to meet the final demand of consumption, private investment and government. Ski = The domestic share of k’s demand for i. Ski = f(hist. import trends, rel. prod. costs)

18. Closing thoughts and concerns. • The possible errors in the nation’s output estimates may have significant impacts on the output growth rates in the REMI model. • Given business reports that offshoring is still alive and well even in the era of high transportation costs (Mexico’s advantage), the necessary 5 to 10 year lag in the construction of the national input-output model is worrisome. • It is unclear how imports (a final demand component) are allocated in the interindustry transactions. • In short, all of these concerns make me think that multipliers generated by REMI and all other regional models may be too high.