Do Unit Value Export, Import, and Terms of Trade Indices Represent or Misrepresent Price Indices?

1. Do Unit Value Export, Import, and Terms of Trade Indices Represent or Misrepresent Price Indices? Mick Silver Paper presented at the 10th Meeting of the Ottawa Group, Ottawa, Canada October 10-12, 2007

2. Motivation • Draft Export and Import Price Index manual: strong reservations about unit value indices as proxies for price indices. • The draft manual favoured price collection from establishment surveys: prices of carefully specified like compared with like over time. • Comments received that unit value indices were standard practice and that the reservations were unwarranted not being evidenced based.

3. Purpose of paper • The main purpose of this paper is to consider whether export and import unit value indices derived from customs data, and commonly used as surrogates for export and import price indices, represent or misrepresent such price changes. • Suggest ways forward given their bias and widespread use

4. Unit value indices • Derived from administrative customs documentation: resource efficient • Information on value by source/destination country classified at detailed HS product classification • Limited information on quantity metric: number, weight – can segment by batch size • Usually good coverage • Detailed information from individual shipments allows for outlier detection

5. Unit value indices from customs data: the cause for concern • Bias arises from compositional changes in quantities and quality mix of what is exported and imported. • Quantity metric often unreliable or unavailable. • For unique and complex goods, model pricing can be used in establishment-based surveys but not unit value indices. • Methods for appropriately dealing with quality change, temporarily missing values, and seasonal goods can used with establishment-based surveys to an extent not possible with unit value indices. • With customs unions countries may have limited intra-area trade data. • An increasing proportion of trade is in services and by e-trade and not subject to customs documentation. • Unit value indices rely on outlier detection and deletion. Given the stickiness of many price changes, such deletions may miss the large price catch-ups. Alterman (1991) estimated that the U.S. UVIs produced in 1985 were calculated for only 56 percent of the value of imports and 46 percent of the value of exports.

6. More particularly • The test approach (Balk and Diewert) • The unit value index fails the Proportionality Test: that is, if all prices are multiplied by the positive number , then the new price index is . • The unit value index fails the Invariance to Changes in the Units of Measurement (commensurability) Test: that is, the price index does not change if the units of measurement for each product are changed. • Economic theoretic approach • Bradley (2005) takes a cost-of-living index defined in economic theory and compares the bias that results from using unit values as “plug-ins” for prices. Only in the uninteresting case of no price dispersion in either the current or reference period will the unit value (plug-in) index not be biased against the theoretical index.

7. Numerical relationship Balk (1998) compared a unit value index with a Fisher index (see also Parniczky (1974): the unit value bias will be equal to zero if one or more of the following conditions are met: • all base period prices are equal to each other and all current period 1 prices are equal to each other; • all quantity relatives are equal to each other; and • there is no correlation between the base period price and quantity relative, and also no correlation between the current period price and quantity relative.

8. Evidence • Alterman (1991) compared price changes between March 1985 and June 1989 for the United States (U.S.) For imports, over this period, the PI increased by 20.8 percent and the UVI increased by 13.7 percent. • Kravis and Lipsey (1971) found that the prices of manufactured goods exported by developed countries to developing countries had risen over about twenty years by 75 per cent, as compared to the l4 per cent shown UVIs. Kravis and Lipsey (1985) found a decrease in the terms of trade of manufactures relative to all primary products between 1953 and 1976 of over 36 per cent, using price indices, almost a quarter greater than that suggested by the UVIs (28 per cent). • Angermann (1980) Germany

10. This study... ...compares UVIs and PIs for both Germany and Japan for exports and imports using monthly data for1996:7 to 2006:9. • the magnitude and sign of the discrepancies between UVIs and PIs for measures of export and import price changes as: short-run indicators (month-on-month and month-on-12 month comparisons); • long-run relationship and cointegration; • predictive ability – Granger causality. • terms of trade • short-run indicators (month-on-month and month-on-12 month comparisons); • long-run cointegration; and • predictive ability (leading indicators). • the terms of trade effect and • as a long-run deflator. • Also.... for Germany: are some disaggregated UVIs satisfactory proxies for corresponding PIs?

11. Findings: export and import UVIs and PIs • The mean discrepancy for imports to Germany was 1.1 percent - this implies that if the month-on-month change in the PI was unity, no change, the UVI would be 1.1 percent change on average. The discrepancy for individual months can be much larger than this mean given a standard deviation of 1.0 percent and maximum of 7.3 percentage points. • About 25 percent of month-on-month comparisons different signs; i.e. in one quarter of comparisons UVIs were rising (falling) when PIs were falling (rising). • The UVIs and PIs were generally not I(1) and thus it was not possible to establish cointegrating relationships. • For most cases UVIs have some predictive power in relation to PIs. However, when they have, it is of little substance. No evidence of Granger-causality. The above evidence is that UVIs are misleading proxies for PIs: they mislead in the sense that the relative and absolute errors can be substantial and that in many cases the signs of changes are wrong. There is no evidence of long-run (cointegrating) relationships and UVIs are of little further help for predicting PIs.

12. Findings: terms of trade • The discrepancies are generally larger than the substantial discrepancies found for the export and import indices. • The month-on-month ToT indices had the wrong sign in over one-third of the month-on-month comparisons. • ToT indices measured by both UVIs and PIs do not have unit roots and thus are not cointegrated. • The ToT indices measured as lagged UVIs are shown to have some predictive information in relation to ToT PIs but it is very weak, as demonstrated by the standard errors of the regression in relation to the means of the TOT PIs. • PIs are found to have a similar predictive effect for UVIs so we cannot establish that ToT UVIs Granger-Cause ToT PIs.

13. Findings: terms of trade effect • Terms of trade effect, or trading gain (loss), is a measure of the effect on income of changes in the terms of trade of a country, the relative price change of imports against exports. • for example, in 2005 Japan’s trade balance of 6,956 billion Yen is eliminated by the adverse change in its terms of trade when using PIs, but only halved when using UVIs. • The SNA 1993 (Eurostat and other, 1993) outlines the method of calculation as:

14. Findings: long run changes • One way of considering this is in terms of the use of such indices as deflators. The volume of exports by Japan can be seen to have increased by 50 percent over this period when a UVI deflator is used, but the increase is halved when a PI is used. • A framework for testing whether there is a difference in long-run changes is provided by Diewert. This uses simple t-tests to test the null hypothesis whether the differences between the mean log inflation rates for UVIs and PIs are equal to zero. The null hypothesis could not be rejected for exports, imports, and ToT for Germany and Japan There is no evidence of long-run differences by this approach or any of the preceding analysis.

15. What is to be done? • Use unit value sub-indices for homogeneous product groups: • The PLANISTAT Report “Any list of CPA categories for which UVIs are a priori acceptable as proxies for SPIs [import price indices] would be very short, especially as regards monthly data. It would include almost only aggregates and raw materials, even if sizable discrepancies between UVIs and SPIs are deemed acceptable.” Renaud Decoster (2003). Finland, Netherlands and Sweden • The relative discrepancies between month-on-month changes in the UVIs and PIs were calculated for Germany for each of the 150 class series. The 15 classes in the lowest percentile were then identified. The best two product classes, the manufacture of motor vehicles and the manufacture of pulp, have mean m-o-m discrepancies of 2.00%; that is, if the PI showed no change the UVI would show a 2% change. These averages have standard deviations that at 6 and 7 percent for the best two classes. • Use a more detailed stratification of unit values • Limited stratification factors. • Scanner studies: Bradley (2006); Silver and Webb (2002); de Haan and Opperdoes (1999). • Use other country mirror data or global commodity price indices or establishment surveys.

16. The resource constraint • Where resources are not a problem, the preferable approach is a one-off switch to an index based on establishment-based price surveys. This may be prompted by a move to a customs/monetary union. • Exports and import price indices can be identified within the framework of a statistical authority’s working operation as an extension of output and input producer price indices (PPIs). If a PPI program is already established, there will be natural synergies between the export and import price indices and the PPI. • Where resources are limited hybrid indices are advocated with, over time, a staged progressive decreasing reliance on UVIs in favor of establishment-based price surveys. • Strategies of increased stratification, by country of origin/destination, size of shipment, and type of commodity, and improved detection and deletion (after follow up) of outliers will improve UVIs. However, the nature of customs documentation and natural volatility of sticky price changes and pass through rates constrain the benefits of this. • The initial aim is to identify important commodity groups whose current series are unreliable, imported or exported by a few establishments: the “low-hanging fruit.” However, change should be a limited number of staged steps with good metadata and backdated series so that changes in prices are not tainted by methodology.

17. Summary: unit value indices were found to have: • No well-defined relationship over time to the desired narrow specification price indexes; indeed there are substantial discrepancies in direction and magnitude. • No predictive power for narrow specification price indexes. • For terms of trade indices the discrepancies are much worse. • Measures of the terms of trade effect (for real national income) and deflated volume changes were vastly different when measured using unit value indices as opposed to price indices. The evidence goes beyond the fact that export and import UVIs are inadequate surrogates for their PI counterparts when used in economic analysis; the evidence was that they were seriously misleading.