Theoretical foundation of I-O and

SUT
Vu Quang Viet

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 Sources for this presentation
• Vu Quang Viet, Handbook of Input-Output
Table Compilation and Analysis, United
Nations 1999. http://unstats.un.org/unsd/EconStatKB/Attachment541.aspx

• Eurostat Manual of Supply, Use and Input-

Output Tables basic data required for SUT,
2008. http://ec.europa.eu/eurostat/ramon/statmanuals/files/KS-RA-07-013-EN.pdf

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 Content
1. Theoretical foundation of I-O
2. Theoretical foundation of SUT in the SNA
3. Conversion of SUT to I-O

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1. Theoretical foundation of I-O

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 Input-output coefficient matrix
• Professor Wassily Leontief assumes:
– That a commodity is produced by using other
commodities as inputs in a fixed linear relations
between inputs and output;
– These relations are technically determined and
therefore constant unless the technology in use are
replaced by a new technology;
– One industry produces one only one commodity .
• Given these assumptions, in any given
economy, products X are partly used as
intermediate consumption AX and the rest is
used for final demand:
(1) X= AX + Y
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 IO coefficients, reflecting a technique of
production, are assumed to be constant
Production of steel Intermediate IO coefficient in A
cost matrix
Iron ore 58,000 0.5000
Coal 4,000 0.0345
Gas 2,000 0.0172
Chemicals 2,000 0.0172
Electritciy 3,000 0.0259
Services 3,000 0.0259
Intermediate consumption 72,000 0.6207
Value added 44,000 0.3793
Ouput 116,000 1.0000

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 VA/ ouput coefficient stability in US economy
(1998-2007, in current prices)
140.0

120.0

100.0

80.0

60.0

40.0

20.0

0.0
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
VA for All industries (%) 55.0 54.8 54.0 55.0 55.7 55.5 54.8 53.8 53.5 53.5
VA for Manufacturing (%) 34.9 34.5 34.4 34.4 35.1 34.3 33.7 31.7 31.9 32.1
Real GDP index (2000=100) 96.5 97.9 100.0 102.4 104.2 106.4 109.5 113.0 116.7 119.8
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 Application in National accounts
• If value added coefficients are constant over
time, or at least for a period of time, for
instance 5 years.
• Then,
• These value added coefficients can be used to
estimate value added given output, either
quarterly or annually.
• This technique is a common method to
estimate quarterly GDP.
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 I-O applications
• From I-O equation,
(2) X = (I-A)-1Y
• For application: with v, l as value added coefficients
vector, it is possible to calculate total value added V,
total labor L and total capital K required.
• It is also possible to calculate imports required for
intermediate consumption imports are assumed to
have fixed linear relations with inputs.
• I-O is also widely applied in other fields like
environment accounting and productivity analysis, to
name only a few.

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 Instructions and examples to
convert SUT to I-O
• Goto Excel.
• Instructions on basic Excel-based matrix
operations.

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 Impact of an increase final
expenditure (using I-O)
• X: vector of product
• A: I-O technical coefficient matrix
• Y: final demand (final consumption, gross capital
formation, exports minus imports)
•
• (1) X = AX + Y is an accounting equation
• (2) A = Ad + Am
• (3) X = (I - Ad)-1Yd is an equation focusing on the impact of
demand for domestic goods that impact on domestic
production.
• Imports do not generate any domestic production, except
for the margins involved bringing imports to users.

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 Preparation data for analysis
• X = (I - Ad)-1Yd
• The equation above shows that Yd =
– [Final consumption + gross capital formation] of only domestic
goods and services
– Exports
• To calculate impact of a project, the value of the project
must be divided into three parts:
– Construction (GCF) that generates short-term effects
– Long-term effects due to operation and maintenance
– Financing impact for funding the project, either:
• Tax increase (reduce disposable income and consumption)
• Borrowing (spreading out payment from future income)
• Value added/employment can be calculated using X. Value
added = vX. V is vector of value added coefficients.
• Impact on imports = Am X
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 Basic requirements for impact
analysis
• Homogeneity requires that all values must be measured in
basic prices.
• Expenses for a project are normally at purchasers’ prices,
they must be converted to basic prices.
• I-O technical coefficient must be split into domestically
required coefficients (Ad) and imported coefficients (Am)
• X must be measured in basic prices
• Y must be measured in basic prices. Y normally at
purchasers’ prices must be reduced to basic values to be
used in equation (3). This procedure requires tables of
shares (%) so values at purchasers’ values can be broken
down into basic values, trade and transport margins and
taxes less subsidies on products.

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 From impact of production to extended
impact due to change in household
income
• Increase in households’ income may increase their consumption and thus makes
additional rounds of impacts.
• To include this round of impacts, matrix has to be extended to include an
additional row of compensation of employees and an additional column of
household final consumption.
• The additional impacts are based on the assumption that households will increase
their consumption by the same percentages, both total consumption and
consumption items.
• Ad is a domestic I/O coefficient matrix
• coe: compensation of employees coefficient row vector. (derived by coe/output)
• hhc: household consumption coefficient column vector (derived by household
consumption/total coe)

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Example of a project investment on public water
supply – short-term/long-term impacts
 Investment cost: $100millions: increasing GDP
 Annual maintenance cost: $5 million : increasing GDP
 Impact of financing : reducing GDP

Short-term impact of Investment in terms of goods and services at

construction basic prices
1. Cost of machinery 90
2. Trade and transport margins 5
3. Taxes on products 5

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2. SUT and national accounting

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 National accounting: A move from
I-O to SUT
• The move from I-O to SUT is an attempt to describe the economy
more realistically. It shows an activity can produce more than one
product. This is the contribution of Richard Stone, the father of
SNA.
By-product, joint product
• In SUT, a commodity can be produced by many industries: these are
cases of by-products or joint products. For example, molasses are
from production of sugar, or new scraps from metal industries.
Hydrogen is joint product of petroleum refining.
Secondary product
• In SUT, secondary product is basically a product of lesser value
produced by the same enterprise
• In principle, each product is produced by different technology and
therefore can be separated easily if costs are known.
• Thus, if needed it is better done statistically, by collecting
appropriate data rather than by using mathematical method.
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 Supply and use tables (simplified)
Use table Intermediate consumption Final Product
demand output
Product 1 19 28 10 123 180
Product 2 29 18 8 34 89
Product 3 7 7 3 45 62
Value added 110 51 41
Industry output 165 104 62

Supply table Industry 1 Industry 2 Industry 3 Product

output
Product 1 156 24 0 180
Product 2 9 80 0 89
Product 3 0 0 62 62
Industry output 165 104 62 18
 Supply and use table

SUPPLY TABLE

Total supply
Product taxes of products
Domestic supply of products Imports
and trade in
by activities in basic prices c.i.f
margins purchasers’
prices

USE TABLE
Total uses
Final demand
Intermediate uses of products of products
Exports in
by activities in purchasers’ in
f.o.b purchasers’
prices purchaser’s
prices
prices

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 Purposes of SUT and I-O
• SUT: The main purpose is statistical. SUT is an accounting scheme
to assemble data with the purpose to reflect reality with the least
manipulation of data. Production, consumption, investment are in
terms of economic activity reflected through establishments,
enterprises or institutional sector units. SUT always takes the form
of industry by product.
• I-O table: The main purpose is analytical. The product-by-product
symmetric input-output tables is to describe technological
relations in an economy in a way that can be used for input-output
analysis. I-O should thus be as homogeneous as possible. In
addition, I-O coefficient matrix must be square in order to get its
Leontief inverse for analytical purpose. I-O table requires that SUT
be first converted from purchasers’ prices to basic prices.
• Conversion of SUT to I-O: SUT can be rectangular (more products
than activities), however I-O has to be squared to be inverted, thus
a need for conversion.

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3. Conversion of SUT to I-O

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Assumptions used for conversion SUT
to I-O (see Table 1)
Example of product/industry technology assumption

Slide of
inputs cut
and
transferred

Yellow product is principal

Yellow product is secondary in blue industry

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 Table 1. Conversion assumptions
Notes Industry by industry I-O table

Product by product I-O table

Model A
Each product is produced in its own
Product technology specific way, irrespective of the
industry where it is produced.
Technology
Operation: Slicing the input
column where the product
produced and adding it to the
column where it is the principal

Negative elements may occur product.

Model B Model A: The slicing is based on
Each industry has its own specific the input coefficients of the
way of production, irrespective of its principal product.
Industry technology
product mix. Model B: the slicing is based on
No negative elements the input coefficients of the
industry where it is produced.
Operation: Slicing the sale/use Model C
row of the industry where the Each industry has its own
Fixed industry sales
product is produced and adding it specific sales structures,
structure
to the row where it is consumed. irrespective of its product mix.
Sales structure

Model C: The slicing is based on Negative elements may occur

the sales structure of the principal
industry where it is produced.
Model D: the slicing is based on
Fixed product sales
the sales structure of the principal
structure
product of the industry where it is
produced.
Model D
Each product has its own
specific sales structure,
irrespective of the industry
where it is produced.
No negative elements

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 What is the most appropriate
approach?
• In terms of economic theory, the most appropriate I-O
matrix is a product by product matrix, and the most
appropriate assumption is the product technology.

• Model A is preferred but it may produce negative inputs

which do not make sense. This is the reason for some
countries to use industry technology assumptions to derive
product by product matrix (Model B) to avoid negative
cells.

• A product by product I-O model can generate impacts on

industries by distributing output and value added
generated by products to industries assuming same market
shares as in the supply table.
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 SUT and conversion to I-O
• It is important that statistical office focuses its work on
SUT rather than on I-O.
• The conversion may be left to economists.
• For statisticians, splitting of secondary production from
main production should be done only if data are
available. Not only that data that link the economic
activity to the establishment and also to the enterprise
that owns the establishments should be kept for the
purpose of setting up institutional sector accounts.
• The conversion of SUT to I-O can be produced
mechanically by mathematical methods, but this
should generally be avoided.

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 Few steps for conversion in more
appropriate way
 The conversion should not be done
automatically in one stroke using mathematical
formula. It can be done selectively, one industry
at a time. In this case one can select industry
technology when the product is subsidiary (i.e.
the secondary product produced in more or less
the same inputs as the main product). This is
called mixed technology.
 In applying the product technology, some cells
may be negative. If these values are small, they
can be treated as statistical errors and brought
to zeros. RAS method can be applied to balance
the use table.
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 Instructions and examples to
convert SUT to I-O
• Goto Excel.
• Basic Excel-based matrix operations.

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 Example in balancing using RAS method
1. Original SUT

use 1 2 FD Total Supply 1 2

1 0 80 50 130 1 130 0

2 60 30 130 220 2 20 200

COE 60 20 Input of
product 2
produced by
OS 30 70
industry 1 to
be transferred
Total 150 200 is 0.4x20=8

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2. SUT after slicing and transferring by product technology
assumption
Problem: negative cell (1,1): -8

Extraction Product by product matrix

of inputs (Model A)
for 20 from
industry 1
UseN
is based on SuplyN
(─) (+)
inputs of
industry 2
1 2 FD Total 1 2 Total
8 -8 88 50 130 1 130 130
3 57 33 130 220 2 220 220
2 58 22
7 23 77
20 130 220 130 220
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3. Unbalanced use table after setting negative values to zeros:

Set cell (1.1) =0, apply RAS to balance the use table.
1 2 FD Total

1 0 82.898 47.101 130

2 57 33 130 220
COE 58 22
OS 23 77
Total 138 214.898

1 2 FD Total
1 0 84.866 47.101 131.967
2 53.695 33.783 130 217.479
COE 54.637 22.522
OS 21.666 78.827
Total 130 220 30
 RAS method
• RAS method is an iterative method;
Row balancing
• First, it calculates the row sums of the initial matrix;
• Second, calculate these initial row sums and known row sums
• Third, distribute the differences to elements in the rows to make initial
row sums to known row sums.
Column balancing
• Apply the same procedure as above to column sums to make the initial
column sums to known column sums.
Iterative process
• Repeat the same procedure to row balancing, then ro column balancing
until the percentage differeces are less than a given value, for example
0.1%.
Modified RAS method
• Keep some elements as given since they are values of known certainty.
The best way is to remove them from the balancing exercise by giving
them zero values and deduct them from known row and column sums.
Zero values will always be zeros in balancing. After balancing, the
elements will be replaced by known values. 31