Social Accounting and I/O Theory

By Hank Robison, Chief Economist, EMSI

The latest version of Analyst (EMSI’s web-based labor market analysis tool) is built on an elaborate Social Accounting Matrix (SAM) platform. A SAM has its roots in input-output (I/O) theory. As a prelude to the release of Analyst 3.0, this blog post goes back to the general history of economic doctrines and takes a brief look at the historic roots of SAM and I/O-like theories.

SAM and I/O Theory in the History of Economic Thought

The roots of SAM and input/output (I/O) theory extend back as far as any major economic method. The accompanying graphic shows the timeline of economic doctrines from roughly 1600 onwards. Economic thought goes back further than this (e.g., the value theories of Aristotle and others) but our chart starts at 1600. As shown in the graphic, most of the techniques of modern applied economics (e.g., elasticity analysis, marginalism, cost-benefit, and others) date to roughly 1900, to Alfred Marshal and his immediate followers and predecessors, the founders of Neoclassical Economics. In contrast, SAM and I/O theory, and more particularly the General Theory of Economic Independence of which SAM and I/O theory are a part, can be dated to the writings of 17th century English economist William Petty. By the middle of the 18th century, French economist François Quesnay had extended Petty’s limited speculations into a fully articulated albeit still purely theoretical I/O-like model, the Tableau Economique. Purely theoretical contributions continued through the period of “Classical Economics,” roughly Adam Smith through Karl Marx.

For applied economics, the “great leap forward,” as William Baumol recently described it, came with the work in the 1920s of Russian born, American economist Wassily Leontief. The great difference with Leontief’s model was that it could actually be populated with real-world data. In 1973, Leontief was awarded the Nobel Prize in Economics “for the development of the input-output method and for its application to important economic problems”.

With Leontief’s earliest work, the gap between theory and application in the theory of economic interdependence had closed considerably, but it had hardly closed altogether.  Leontief’s first applied model (a model of the US economy in 1929) exhibited just 40 sectors of detail. By the 1950s, I/O modelers were able to boast of models with as many as 100 sectors. By the early 1970s, this figure had grown to models with roughly 500 sectors. Compare this to EMSI’s web-based tool with over 2,000 sectors in a model of a single region, and many more in multi-regional models. More sectors mean finer industry detail, and finer industry detail means greater power in addressing real-world economic issues – a closing of the theory-application gap.

What accounts for the rapid increase in SAM and I/O model sectoral detail is of course the advent of the modern electronic computer and its rapid advance, particularly through the 1990s and beyond. The so-called “Moore’s Law” (Wikipedia provides a useful description) explains the advance in computing power. The pair of stylized graphs below illustrates the related advance in SAM and I/O model size and applications power, and the coinciding advance in computing power.

Economic Impact Modeling in Analyst 3.0: A Broad Overview

The uses of SAM and I/O models generally fall under two headings “descriptive” and “predictive.”

Descriptive Analyses

Analyst allows the regional researcher to lift the economy’s hood and examine its internal workings – to examine its sources of strength and see where and how its residents obtain their incomes. The economy’s ultimate source of strength is found in its exports and these are normally examined through an application of “export base theory,” sometimes called “economic base theory.” Some might object that his/her region’s strength is in the beauty of its natural surroundings, or its location relative to transportation networks, or some other essentially environmental attribute. Ultimately, however, these seemingly non-economic factors are important inasmuch as they contribute to the community’s economic base (i.e., its ability to draw and maintain sources of outside income). Lose outside income and eventually the whole economy feels the negative effects.

Outside income circulates within the regional economy, through interindustry purchases, and through the spending of consumers’ incomes earned in the process. Tracking these associated “multiplier effects” is part and parcel of economic base theory. But where do the generated personal incomes go? With a large retailer (e.g., a Walmart or Costco), or with a major manufacturing plant (e.g., General Electric or Maytag), the bulk of the generated property income will leak out to absentee owners. Even with labor income, a more or less large portion of that which is generated in the region may leak out as a result of incommuters. However, and conversely, a more or less significant amount of residents’ income can come from sources outside the community. Offsetting the incommuters, the region may contain an even larger number of outcommuters, and there is always outside property income. A community with a large share of retired and/or well-to-do leisure residents will exhibit a large share of residents’ outside property income. Analyst helps the regional researcher account for the overall amount and sources of residents’ income, and thereby understand still another contour in the structure and operation of the regional economy.

Predictive Analyses

Predictive exercises using Analyst are as numerous as the what-if questions that face the regional analyst. A major regional employer has announced plans to cease operation.  What will be the effect on other regional industries? What occupations will be affected?  What might an effective retraining program look like?

Or how about this one: A large well-known company is looking to locate a new facility.  Promises are made as to on-site job and income creation, additional jobs and incomes through generous multiplier effects, an expanded local tax base, and other positive local effects. In return for these “good things,” the company expects some “investment” on the part of the community: tax forgiveness, infrastructure improvements, specialized training for workers, and so on. Are the company’s projections realistic? And are they worth the investments the community must make? Analyst can help address these various questions.

Examples of predictive analyses in the evaluation of economic development strategies are even more numerous. What industries or industry clusters work best with the region’s existing occupation and skills mix? Or, given a list of potential new industry, which ones will have the greatest multiplier effects? Which will have the greatest positive effect on local tax revenues? And there is typically this one: Given the economy’s existing mix of industries and their associated input needs, where are there holes in the local supply chain, and thereby opportunities for import substitution? These and other routine economic development questions are readily addressed with Analyst.

For more information on EMSI’s I/O model: Rob Sentz (rob@economicmodeling.com)

Follow EMSI @DesktopEcon.

Source note:  There are several fine treatments of Input-Output and related methods in the history of economic thought.  See in particular Miller, R.E. and P. Blair, 2009, Input-Output Analysis: Foundations and Extensions, Second Edition, Cambridge University Press: New York., Appendix C.  Also see Baumol, W., 2000, “Leontief’s Great Leap Forward,” Economic Systems Research, 12, 141-152, and Kurz, H.D., and N. Salvadori. 2000, “’Classical’ Roots of Input-Output Analysis: A Short Account of its Long Prehistory,” Economic Systems Research, 12, 153-179.