Appendix D: From Gross Output To Value Added: Framework

Appendix D: from gross output to
value added
Framework
Here I present a more formal analysis of bias 4 and bias 5 within
a simplified model, and I examine their consequences for measuring
industry's contribution to GNP. After that, I put forward a methodology
for gauging the extent of divergence between trends in value added and
gross output at the sector level, which can be executed for three broad
industrial sectors (defence industry, basic industry, and light industry).
In chapter 4, the two biases were defined as distortions arising from
the application of incorrect weights to gross output series for purposes
of measuring sector GNP (value-added) contributions. Bias 4 is gener-
ated by gross output value weights, and bias 5 by value-added weights.
Below, a true value added index is shown in equation (7), bias 4 is illus-
trated in equation (12), and bias 5 in equation (14).
The symbols used are listed as follows. A subscript j refers to the yth
sector of industry. A subscript t refers to period t. A superscript asterisk
indicates a Laspeyres index number based on period t = 0.1
a material input per unit gross output
D price/cost disturbance
8 share of price/cost disturbance in nominal gross output
H* a 'hybrid' value-added index
L labour input, hours
X labour input per unit gross output
M material input, units
m material input per unit labour input
|i the share of sector 1 in total industry value added
n price per unit material input
p price per unit output
a share of value added in nominal gross output
V real value added at constant base-year prices
205
Downloaded from Cambridge Books Online by IP 200.32.101.226 on Fri Nov 19 14:55:57 GMT 2010.
http://dx.doi.org/10.1017/CBO9780511523625.016
Cambridge Books Online © Cambridge University Press, 2010
206 Appendices
v ratio of real value added index to gross output index

TV wage cost per unit labour input
X real gross output, units
The first part of the analysis proceeds under the assumption that
everything is measured at fixed prices, with no inflation, hidden or oth-
erwise. Define net output, V (for value added) as gross output, X, less
intermediate purchases of materials. Industry comprises; branches (for
present purposes,; = 1, 2). Of the two branches, sector 1 supplies only
materials, and sector 2 supplies only fabricated goods. Industry as a
whole buys nothing from outside, and sells only to itself or to final
users. Assume that within industry each branch is integrated, so that
there are no intra-branch transactions and no distinction between gross
and finished output. The gross output of materials (sector 1) is identi-
cally equal to sector 1 value added, while the gross output of fabricated
goods comprises the value added in both sectors:
(2)
For industry as a whole, gross output double-counts the value added

in sector 1:
j (4)
Define V*t as an index number of industry value added in year t,

expressed as a percentage of the base year (t = 0). The index of value
added, V*t, can be reached in two ways. One is by a base-year weighted
average of index numbers of value added in the two branches, with
weights \it and (1 - \it) set to equal the shares of sector 1 and 2 in industry
value added in the base year (t = 0), so that:
(5)
Therefore, from equations (4), (5), and (6):
Appendices 207
The other way is from final products, which consist here of the output
of fabricated goods. Sector 1 has a lot of value added (equation (1)), and
of gross output, but no final product. Sector 2 has a share in value added
(equation (4)), but supplies 100 per centof final output; its final output
embodies its own value added, plus the value added in sector 1. Going
along the final-product route, therefore, we find industry value added
will be adequately captured by X2t alone, so that:
v
t ^ it \o)
If all we have is index numbers of gross output of the two branches

(equations (1), (2)), and we try to combine them using gross output
weights, we risk serious distortion (bias 4). The source of the problem is
the double-counting of intermediate transactions; the Xlt sold by sector
1 to sector 2 are credited first in the gross output of the originating
sector, then a second time in the gross output of the receiving sector.
Industrywide gross output can be rewritten (from equations (3) and (6))
as:
so that the index of gross output becomes:
x* -iilHiA.y* (10)
' (1 + M '
This shows that the gross output index will mirror the path of an index
of value added only when the relative weights of the different branches
in value added remain constant over time. If the weight of the sector
producing less highly fabricated goods (here, [it) declines, for example,
X*t will understate the trend of industry value added. Here is bias 4.
A condition for the relative weights of the different branches in value
added to remain constant over time is for their output to follow a
common path. When values added in different sectors follow divergent
trends, the effect of a gross output index is to give excessive weight to
the sectors producing less highly fabricated goods. Equation (9) can be
rewritten (from equation (3)) as:
j (11)
Therefore,
X* = 2 ^° V* I ^ " ^ o ) y* (12)
208 Appendices
which shows, in comparison with equation (7), that the weight of sector
2 is too small for X*t to track V*t accurately.
Bias 5 can be considered against this background. Consider the
hybrid measure, Ht, resulting from a procedure which weights sector
gross outputs by base-year value added:
H*,=no-X*u+(l-no)-X»2t (13)
For sector 1 (equation (1)), gross output and value added coincide; for
sector 2 (equation (2)) gross output is the same as total industry value
added. So this equation can be rewritten in terms of index numbers of
sector value added, from equation (7), as:
= lio-(2-[io)-V*u+(l-iioy.V*2t (14)
Compare the weights of V*2t in equations (14), (12), and (7). Since
(1 - JLX0)2 < (1 - |no)/(l + n0) < 1 - JLL0, it follows that, when the structure of
industry is changing, the result of weighting gross outputs by value
added (equation (14)) is even more distorting than gross outputs com-
bined using gross weights (equation (12)). The undervaluation of the
trend in sector 2, which produces more highly fabricated goods (such as
weapons), is increased, and bias 5 exceeds bias 4.
Application
The extent to which trends in value added diverged empirically
from gross output trends in different sectors of Soviet industry can be
gauged very roughly from trends in sector prices, costs, and sources of
disturbance in price/cost ratios. To begin with, consider a branch of
industry which produces a gross output X, using labour L and materials
M:
X=f(L,M) (15)
Output and materials are measured in physical units, and labour is
measured in total hours. Unit input requirements are given by at (for
materials) and Xt (for labour):
M,= <vX, (16)
Lt = \Xt (17)
Prices are formed on the basis of direct costs (wt, the hourly wage, and
Appendices 209
nt, the price of materials), plus an aggregate disturbance factor Dt, which
is measured in rubles; in this case total revenue is given by:
pt-Xt = wt-Lt+nt-Mt+Dt (18)
Dt = 8tPtXt (19)
Roughly speaking, we can think of Dt as a term which picks up the dis-
turbing influence of turnover taxation and budget subsidies, as well as
general noise in the price/cost relationship, while 8t is the proportion of
the price made up by these influences.
From the four equations (16)-(19) we find the price of output deter-
mined as follows:
(20)
Real value added in prices of the base year (t = 0) is reached as a result

of double deflation, i.e. the deflation of outputs and inputs separately:
= X([p0-(l-50)-tt0oc(] (21)
where <x( is given from equation (20) as:
L
<*,=— % -L (20a)
Substituting this expression back into equation (21) gives:
Vt=Xt[po(l-5o)--±r(pt{l-dt)-wt\t)] (22)
n
t
In the base year (£=0), however, this expression is reduced to:

V0 = w0\-X0 (22a)
Therefore, V*t is given by dividing equation (22a) into (22):
(23)
At this point it simplifies matters to introduce two further symbols. The

ratio of an index of value added to an index of gross output, vt, is the
correction factor to be applied to index numbers of gross output to
210 Appendices
calculate the corresponding index of value added, and is given by:

vt=V*t/X*t (24)
Equation (23) can now be rewritten to show this correction factor:
[po-(l-«o)—7"[p.-U-*.}-«>.-*J
v = n (25)
> -t~x
I also introduce a symbol ot for the share of value added (proxied by
wage costs) in nominal gross output:
Basic and light industry

Substituting equation (26) into equation (25) gives the general
expression used for estimating sector value added of both basic and
light industry:
' a0 a0 n\ n\
In the case of basic industry, since the prices of outputs and inputs are
treated as essentially the same, pt = nt, and equation (27) can be simpli-
fied to:
Equations 27 (light industry) and (27a) (basic industry) are esti-

mated in table D.I, the derivation of 8t for each sector being shown in
table D.2. For each sector the 1941-plan input/output table is used to
derive the 1940 share of value added in gross output.2 For wartime
trends in product prices I use various deflators already described; for
material inputs I refer to an index of prices of basic industrial goods and
assume that the transfer prices of farm products used in industry, and
transport and other commercial costs, followed the same pattern.3 In esti-
mating the trend of hourly labour costs, I follow a procedure outlined
below; hours worked in basic and light industry are obtained separately.4
Appendices 211
Table D.I. From gross output to value added: basic and light industry, 1940
and 1942-4
Symbol 1940 1942 1943 1944
(A) Basic industry

1 Nominal value-added share o 53% - - -
2 Product price index f 100% 103% 104% 106%
3 Hourly wage index w* 100% 82% 85% 91%
4 Input price index n* 100% 103% 104% 106%
5 Unit labour requirement index X* 100% 170% 154% 142%
6 Disturbance factor 8 3% 4% -4% -8%
7 Real value-added index ratio V 100% 137% 112% 101%
(B) Light industry
1 Nominal value-added share o 28%
2 Product price index p* 100% 130% 150% 177%
3 Hourly wage index w* 100% 97% 97% 100%
4 Input price index n* 100% 103% 104% 106%
5 Unit labour requirement index X* 100% 144% 173% 196%
6 Disturbance factor 8 43% 48% 48% 50%
7 Real value-added index ratio V 100% 103% 97% 87%
Sources: Row 1: calculated from table F.5. Rows 2,3,4: index numbers of
prices of basic industrial products and consumer products (p), and of the
hourly wage {w), are taken from table A.I. For both branches of industry, the
price index of basic industrial products is taken as a proxy for input prices (n).
Row 5: unit labour requirements are calculated as the reciprocal of index
numbers of gross output per hour worked by manual employees. Gross
output of basic and light industry at 1937 factor costs in 1940 is taken frpm
table F.8, col. 1; for years after 1940, figures are interpolated on index numbers
from table 4.8, with results as follows (billion rubles):
1940 1942 1943 1944
Basic industry 58.7 29.3 33.2 40.0

Light industry 99.2 40.1 36.6 39.0
Hours worked in basic and light industry are taken from table G.6, rows 2-3.
Row 6: the disturbance factor (5), the proportional deviation of transfer prices
from unit costs attributable to turnover taxes and budget subsidies is taken
from table D.2, row 4.1. Row 7: the ratio of an index of value added to an
index of gross output, when both are expressed as percentages of 1940, is
calculated from rows 1-6 as shown in equations (27) and (27a).
212 Appendices
Table D.2. From gross output to net value added: disturbance factors in basic
and light industry, 1940 and 1942-4 (billion rubles at current prices and
per cent)
1940 1942 1943 1944

(A) Basic industry
1 Nominal gross output,
1.1 gross of turnover taxes 73.2 37.9 43.4 53.2
1.2 net of turnover taxes 70.8 36.3 41.8 51.1
2 Turnover tax 2.4 1.5 1.6 2.2
3 Subsidy from budget 0.0 0.0 -3.4 -6.5
4 Total disturbance 2.4 1.5 -1.8 -4.3
4.1 disturbance factor (%) 3% 4% -4% -8%
(B) Light industry
1 Nominal gross output,
1.1 gross of turnover taxes 218.7 124.5 132.2 171.1
1.2 net of turnover taxes 124.1 65.1 68.7 86.3
2 Turnover tax 94.6 59.3 63.4 84.8
3 Subsidy from budget - - - -
4 Total disturbance 94.6 59.3 63.4 84.8
4.1 disturbance factor (%) 43% 48% 48% 50%
Sources: Row 1: nominal gross output (including depreciation) is calculated

at prevailing prices, gross of turnover taxes (row 1.1) as the same net of
turnover taxes (row 1.2) plus turnover taxes (row 2). Nominal gross output net
of turnover taxes (row 1.2) is calculated from the value of gross output at 1937
factor costs, multiplied by index numbers of product prices of basic and light
industry based on 1937, from table A.I. Figures of real gross output of basic
and light industry are given in the note to table D.I, row 5. Row 2: the total
of turnover taxes, given by TsSU (1959), 457, is allocated in the same
proportion as in table F.4, col. 3, as follows:
to basic industry 2.3%
to light industry 89.4%
Row 3: budget subsidies to industry, from Zverev (1958), 212, are allocated 100
per cent to basic industry. Row 4: the sum of rows 2,3. Row 4.1: the ratio of
row 4 to row 1.1.
Sources of disturbance in the price/cost relationship are estimated as

follows. In the case of light industry I assume that the only disturbance
arose from turnover taxation, which bore mainly on retail goods. In con-
trast, the basic industries bore little more than 2 per centof the turnover
tax burden. On the other hand subsidies to industry became significant
from 1943 onwards, and postwar evidence suggests that they were con-
Appendices 213
centrated on the basic industries. The aim was to hold down product
prices in lossmaking branches where unit costs had risen, stabilising
defence industry costs.5 As a result defence industry costs were held
down, but the cost to the budget of subsidising heavy industry grew
steadily through the closing years of the war and postwar reconversion,
eventually requiring a major price reform which was implemented on
1 January 1949.6
Results for both basic and light industry are shown in table D.I (row
7). In light industry labour costs rose, and the burden of turnover taxes
rose, but material input prices were stabilised, and product prices also
rose. In basic industry labour costs rose, while product prices were sta-
bilised, but material input prices were held down by the same token. On
the wartime evidence, value added in civilian branches may have been
somewhat variable in relation to gross output; between 1940 and 1942
the ratio of value added to gross output appears to have risen, slightly
in the case of light industry, substantially in basic industry, but in each
case the increase was followed by correction. These are rather jagged
fluctuations, not showing a clear trend in relation to 1940.
These findings do not show a persistent divergence of value added
from gross output trends in either basic or light industry. Temporary
divergence (e.g. in basic industry in 1942) may reflect movements in
fundamentals, errors in data (e.g. interpolated price and cost series), or
faults in methodology (e.g. the neglect of extra-budgetary finance).
Thus, caution is indicated.
Defence industry
In the case of defence industry life is simpler in one respect - the
price/cost relationship was constantly revised as costs changed, and
was not disturbed by factors other than administrative noise. For
present purposes this enables us to set Dt = 0.
But in another direction life is more complicated, because we do not
have figures for direct labour requirements. Instead, I determine
requirements by fixing the ratio between requirements for labour and
materials, m, so that the quantity of materials required per hour worked
is treated as a constant, for reasons developed below. So, in addition to
equations (16) and (17) we have:
at = mt-Xt (28)
This gives a new variant for equation (20), written as:
pt = wt'Xt+nt-tnt-Xt (20b)
214 Appendices
which can be rearranged to put the unknown Xt on the left hand side:
& ( 2 9 )
wt+nt'tnt
We can now rewrite equation (21) above in terms of mt • Xt, setting 8f=0,
then substituting equation (28), and next equation (29):
V
t=Xt'(Po-no'at)
(Pt'no'mt)
The index of defence industry value added can now be obtained by

dividing Vo into Vt, then simplifying the resulting expression by substi-
tuting equation (26) and rewriting it in terms of the ratio vt between
value added and gross output index numbers:
(30)
n\
The last difficulty is that we do not know at for t > 0. The latter can be
estimated, however, from trends in costs and technology), as:
ot=wt/(wt+nt-mt)
= G0'W*t (31)
<J0-w*t+ ( l - c r o ) - n Y m*t
Remembering that m*t = 1 by assumption, equation (30) can be deter-
mined by substituting (31) into it. Equations (29), (30), and (31) are esti-
mated in table D.3, row 6 revealing sustained divergence of trends in
gross output and value added.
On this basis, and the wartime final output of defence industry/ the
other most important wartime indicators of defence industry perfor-
mance (value added, productivity, and employment) can be obtained,
the results being reported in table D.4. In table D.5 the implications are
set out for year-by-year evolution of the inter-industry matrix of the
input/output table of appendix F.
The years of World War II saw a dramatic decline in Soviet weapon
prices. It is shown in appendix E that the unit variable cost of weapons
also fell, and it is argued that price/cost proportionality was roughly
Appendices 215
Table D.3. From finished output to value added: defence industry, 1940-5
1940 1941 1942 1943 1944 1945
1 Nominal value-added
share a 60.6% 57.8% 56.0% 55.5% 56.2% 60.6%
2 Product price index p* 100% 85% 66% 61% 59% 57%
3 Hourly wage index w* 100% 92% 88% 89% 95% 114%
4 Input price index n* 100% 103% 107% 111% 114% 114%
5 Input per hour worked
index m* 100% 100% 100% 100% 100% 100%
6 Real value-added index
ratio v 100% 108% 120% 125% 128% 132%
7 Unit labour requirement
index X* 100% 88% 69% 62% 58% 50%
Sources: Row 1: for 1940, see table F.5; this is the share of value added in
finished, not gross output (i.e. gross output, less intraindustry use). For other
years, extrapolated to other years from equation (31). Row 2: table A.I, row 1.
Row 3: table G.7, row 2.1a. Row 4: table A.I, row 2. Row 5: see text. Row
6: as equation (30). Row 7: as equation (29).
maintained. The reduction in the cost of a unit of output reflected a
mixture of a fall in the requirement of inputs per unit of output, and in
the cost of each unit of inputs. Since trends in w a g e costs and input
prices are k n o w n , at least approximately, the fall in input requirements
per unit of output can be calculated as a residual. Since w a g e costs fluc-
tuated uncertainly, and input prices rose somewhat, the main burden of
explaining the d o w n w a r d trend in w e a p o n prices must fall u p o n real
decline in input requirements.
What is not k n o w n is h o w the fall in input requirements w a s divided
b e t w e e n labour and nonlabour inputs. Here one m a y imagine t w o
extreme assumptions. First, assume that nonlabour requirements
remained unchanged. In that case, the share of value added in real gross
output in defence industry remained steady, but labour requirements
must have shrunk to the point of insignificance, implying a fantastic rise
in output per hour worked. Second, assume that labour requirements
remained unchanged. In this alternative case, nonlabour input require-
ments must have fallen virtually to vanishing point in order to explain
the extent of price reductions, while the share of value added in gross
output tended towards 100 per cent. In other words, both extreme cases
are implausible; reality must have fallen between them, with a sharp
(but not infinite) reduction in nonlabour input requirements, balanced
b y a similarly sharp increase in output per worker. The share of value
216 Appendices
Table D.4. Output and productivity in defence industry, 1940-5 (rubles at

1937factor cost and millions)
1940 1941 1942 1943 1944 1945
(A) Gross and finished

output (billion rubles)
1 Finished output 18.0 26.6 55.3 65.8 70.2 47.5
2 Intraindustry use 2.0 2.6 4.3 4.6 4.6 2.7
3 Gross output 20.1 29.2 59.6 70.4 74.8 50.2
3.1 rubles per worker 11460 15560 21729 24440 25918 24330
3.2 rubles per hour
worked 5.44 6.13 7.59 8.41 9.04 10.26
(B) Value added (billion rubles)
4 Finished output 18.0 26.6 55.3 65.8 70.2 47.5
5 Interindustry supply 7.1 9.2 15.1 16.1 15.9 9.4
6 Gross value added 10.9 17.4 40.2 49.6 54.3 38.1
7 Depreciation 0.4 0.6 1.5 1.8 2.0 1.4
8 Net value added 10.5 16.8 38.7 47.8 52.3 36.7
8.1 rubles per worker 6019 8939 14108 16616 18135 17788
8.2 rubles per hour
worked 2.86 3.52 4.93 5.71 6.32 7.50
(C) Employment
9 Employees, million 1.751 1.879 2.743 2.879 2.884 2.062
10 Hours worked,
million 3688 4770 7855 8371 8271 4891
Sources: Rows 1,4: table B.9, row 3. Row 2: for 1940, row 3, less row 1;
extrapolated to other years on row 5. Row 3: for 1940, table F.8, row 8, col. 1;
for other years, row 1, plus row 2. Row 3.1: row 3, divided by row 9. Row 3.2:
row 3, divided by row 10. Row 5: for 1940, row 4, less row 6; for other years,
extrapolated on the basis of row 1, multiplied by table D.3, row 5 times row 7.
Row 6: for 1940, row 1, multiplied by table D.3, row 1 (also, table F.8, col. 2, row
8); extrapolated to other years on the basis of row 1, multiplied by table D.3, row
6 (also, row 4, less row 5 in this table). Row 7: for 1940, table F.8, col. 3, row 8;
extrapolated to other years on row 6. Row 8: row 6, less row 7 (for 1940, also
table F.8, cols 4, 5, row 8). Row 8.1: row 8, divided by row 9. Row 8.2: row 8,
divided by row 10. Row 9: for 1940, public sector employment in MBMW
(3,519,000, from table G.I, row 1, col. 2) is multiplied by the defence industry
share in total MBMW value added (table 4.7, col. 1, rows 1.1 and 1.2).
Employment in subsequent years is taken from hours worked (row 8) divided
by hours worked per worker in MBMW, from table G.6, row 5. Row 10: for
1940, row 9, multiplied by hours worked per worker in MBMW, from table G.6,
row 5. Hours worked in subsequent years are interpolated on row 1, multiplied
by table D.3, row 7.
Appendices 217
Table D.5. Defence industry, 1940-5: sums of input/output coefficients
1940 1941 1942 1943 1944 1945

1 Technical coefficients 0.45 0.40 0.33 0.29 0.27 0.24
2 Leontief multipliers 2.00 1.88 1.70 1.62 1.58 1.51
Sources: Row 1: for 1940 table F.6, col. 1, row 8; for other years, table D.4, the
sum of rows 2, 5, divided by table D.4, row 3. Row 2: calculated by inversion
of the (I-A)-matrix appropriate to each year, as table F.6, col. 2.
added in gross output rose, but remained (of course) far below 100 per
cent.
For present purposes I assume that output per unit of labour and non-
labour inputs in defence industry rose in the same proportion (or, which
comes to the same thing) that nonlabour inputs per hour worked
remained constant. This approach is also supported by various indica-
tions reviewed in appendix E, where it is shown that results in terms of
the implied productivity and employment trends in Soviet defence
industry are consistent with other evidence in official documents, as
well as the evidence of comparative trends in the defence industry of
other countries involved in the war.
The defence industry trends suggested by table D.3 were quite dif-
ferent from those observed in civilian branches. On the assumptions
explained above, the large product price deflation, unaccompanied by
subsidies, must be explained either by huge increases in output per
hour worked, or by huge cuts in material input requirements, or more
plausibly by some combination of the two. It is implied (row 7) that
gross output per hour worked in defence industry nearly doubled, but
value added per hour grew more rapidly, peaking at 2.2 times the 1940
level in 1944.

Appendix D: From Gross Output To Value Added: Framework

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Appendix D: From Gross Output To Value Added: Framework

Uploaded by

Copyright:

Available Formats

Appendix D: from gross output to

v ratio of real value added index to gross output index

For industry as a whole, gross output double-counts the value added

Define V*t as an index number of industry value added in year t,

Therefore, from equations (4), (5), and (6):

If all we have is index numbers of gross output of the two branches

so that the index of gross output becomes:

Real value added in prices of the base year (t = 0) is reached as a result

where <x( is given from equation (20) as:

Substituting this expression back into equation (21) gives:

In the base year (£=0), however, this expression is reduced to:

At this point it simplifies matters to introduce two further symbols. The

calculate the corresponding index of value added, and is given by:

Basic and light industry

Equations 27 (light industry) and (27a) (basic industry) are esti-

Symbol 1940 1942 1943 1944

(A) Basic industry

1940 1942 1943 1944

Basic industry 58.7 29.3 33.2 40.0

1940 1942 1943 1944

Sources: Row 1: nominal gross output (including depreciation) is calculated

Sources of disturbance in the price/cost relationship are estimated as

The index of defence industry value added can now be obtained by

1940 1941 1942 1943 1944 1945

Table D.4. Output and productivity in defence industry, 1940-5 (rubles at

1940 1941 1942 1943 1944 1945

(A) Gross and finished

Table D.5. Defence industry, 1940-5: sums of input/output coefficients

1940 1941 1942 1943 1944 1945

You might also like