Using dfvad for Value Added Decomposition

Shipei Zeng

2021-10-15

Introduction

The package dfvad works for value added and productivity decompositions. Value added growth has been instrumental in our understanding of a large gap of economy performance over long terms, so we want to specify explanatory factors of value added growth. Diewert and Fox (2018), abbreviated as DF decomposition, have decomposed value added into five explanatory factors by assuming constant returns to scale. They are:

This approach is highlighted because it uses a Free Disposal Hull approach – no convexity assumptions. And it rules out technical regress. This is a feature of this approach because other researchers may argue that technical regress is there, but since knowledge is there and cannot be diminished, there should be no technical regress but inefficiency. It also has the advantage that it does not involve any econometric estimation, and involves only observable data. Quite objective.

The decomposition is more than analysing value added growth; we can specify the components of productivity growth by focusing on technical progress, efficiency and input mix.

Methodology

Cost constrained value added function

Let’s get a closer look at how value added and productivity are decomposed. A cost constrained value added function is defined as the maximum value added subject to the constrains that a feasible input expenditure is equal to or less than the observed input expenditure: \[\begin{equation*} R^{t}(p,w,x)=\max_{y,z} \{p\cdot y:(y,z)\in S^{t};w\cdot z\leqslant w\cdot x\} \end{equation*}\] and a unit cost function is defined by minimizing the ratio of input values to output values: \[\begin{equation*} c^{t}(w,p)=\min_{s} \left\{\dfrac{w\cdot x^{s}}{p\cdot y^{s}}:s=1,\cdots,t\right\} \end{equation*}\]

Under the assumption of constant returns to scale, a sequential approach is adopted where past observations up to and including the current period are used to determine the technology set. This approach rules out technical regress with period by period accumulation: \[\begin{equation*} \begin{split} R^{t}(p,w,x)&=\max_{s}\left\{p\cdot y^{s}\dfrac{w\cdot x}{w \cdot x^{s}}: s=1, \cdots,t\right\}\\ &=\dfrac{w\cdot x}{c^{t}(w,p)} \end{split} \end{equation*}\]

Explanatory factors

\[\begin{equation*} \alpha (p^{t-1}, p^{t}, w, x, s)=\dfrac{R^{s}(p^{t}, w, x)}{R^{s}(p^{t-1}, w, x)} \end{equation*}\]

\[\begin{equation*} \beta (x^{t-1}, x^{t}, w)=\dfrac{w\cdot x^{t}}{w\cdot x^{t-1}} \end{equation*}\]

\[\begin{equation*} \gamma (w^{t-1}, w^{t}, p, x, s)=\dfrac{R^{s}(p, w^{t}, x)}{R^{s}(p, w^{t-1}, x)} \end{equation*}\]

\[\begin{equation*} \begin{split} \delta (x^{t-1}, x^{t}, p, w, s)&=\dfrac{R^{s}(p, w, x^{t})/R^{s}(p, w, x^{t-1})}{w\cdot x^{t}/w\cdot x^{t-1}}\\ &=1 \end{split} \end{equation*}\]

\[\begin{equation*} e^{t}=\dfrac{p^{t}\cdot y^{t}}{R^{t}(p^{t},w^{t},x^{t})}\leqslant 1 \end{equation*}\] \[\begin{equation*} \varepsilon ^{t}=\dfrac{e^{t}}{e^{t-1}} \end{equation*}\]

\[\begin{equation*} \tau (t-1, t, p, w, x)=\dfrac{R^{t}(p, w, x)}{R^{t-1}(p, w, x)} \end{equation*}\]

Decomposition

Straightforward algebra using the explanatory factors show that we have the following decomposition of the observed value added ratio: \[\begin{equation*} \dfrac{p^{t}\cdot y^{t}}{p^{t-1}\cdot y^{t-1}}=\alpha^{t}\cdot \beta^{t}\cdot \gamma^{t}\cdot \varepsilon^{t}\cdot \tau^{t} \end{equation*}\]

Productivity growth can be defined as an index of output growth divided by an index of input growth: \[\begin{equation*} \begin{split} TFPG^{t}&=\dfrac{p^{t}\cdot y^{t}/p^{t-1}\cdot y^{t-1}}{\alpha^{t}\cdot \beta^{t}}\\ &=\gamma^{t}\cdot \varepsilon^{t}\cdot \tau^{t} \end{split} \end{equation*}\]

Weighted average approach

Two options are provided for multiple industries: aggregation prior to decomposition, or decomposition prior to aggregation. The weighted average approach focuses on the latter option. It uses weighted averages of the sectoral decompositions so that an approximate decomposition into explanatory components at the aggregate level can be available:

\[\begin{equation*} \ln \lambda^{t\bullet}=\sum_{k=1}^{K}\dfrac{1}{2}(s^{kt}+s^{k, t-1})\ln \lambda^{kt} \end{equation*}\]

\[\begin{equation*} \begin{split} \ln \left(\dfrac{v^{t}}{v^{t-1}}\right)&\approx \sum_{k=1}^{K}\dfrac{1}{2}\left(s^{kt}+s^{k, t-1}\right)\ln \left(\dfrac{v^{kt}}{v^{k, t-1}}\right)\\ &=\sum_{k=1}^{K}\dfrac{1}{2}\left(s^{kt}+s^{k, t-1}\right)\ln \left(\alpha^{kt}\beta^{kt}\gamma^{kt}\varepsilon^{kt}\tau^{kt}\right)\\ &=\ln\alpha^{t\bullet}+\ln\beta^{t\bullet}+\ln\gamma^{t\bullet}+\ln\varepsilon^{t\bullet}+\ln\tau^{t\bullet} \end{split} \end{equation*}\]

Growth values and level values

Growth values are period to period growth factors. Level values are cumulated explanatory variables defined as follows.

\[\begin{equation*} A^{1}=1,B^{1}=1,C^{1}=1, E^{1}=1, T^{1}=1 \end{equation*}\]

Using cumulated explanatory factors, we have the levels decomposition for TFP:

\[\begin{equation*} \begin{split} TFP^{t}&=\dfrac{p^{t}\cdot y^{t}}{p^{1}\cdot y^{1}\cdot A^{t}\cdot B^{t}}\\ &=C^{t}E^{t}T^{t} \end{split} \end{equation*}\]

Sample data

mining

A mining data set is enclosed as an example to run the function value_decom(). mining is constructed for the mining industry with data cubes from the Australia Bureau of Statistics (see Zeng et al., 2018). It consists of mining inputs and outputs adopted to demonstrate the decomposition of value added growth. Here is a glimpse of it:

year is the time period column, p2 is the output price, w2 is the labour price, u2 is the capital price, y2 is the output quantity, h2 is the labour quantity, and x2 is the capital quantity.

sector

A sector data set is enclosed as an example to run the function t_weight(). sector is constructed for 12 selected industries in Australia with explanatory factors produced by running value_decom() on each industry and binding them by row (see Zeng et al., 2018). It consists of explanatory factors of value added decomposition and is adopted to demonstrate the aggregation over industries. Here is a glimpse of it:

year is the time period column, p is the output price, y is the output quantity, alpha is the net output price index, beta is the input quantity index, gamma is the input mix index, epsilon is the value added efficiency index, tau is the technical progress index, and industry is the industry code column.

Examples

Decomposing value added growth into explanatory factors

value_decom() for decomposing nominal value added growth identifies the contributions from efficiency change, growth of primary inputs, changes in output and input prices, technical progress and returns to scale. Arguments required to decompose value added include x, w, y, p, t and data. x is a string indicating the quantity column, w is a string indicating the input price column, y is a string indicating the output quantity column, p is a string indicating the output price column, t is a string indicating the time period column, and data is a data frame containing the columns above. x, w, y and p can also be a vector of strings if there multiple inputs or outputs, and strings need to follow the same order. For example, in the mining data set where h2 is the quantity of labour and w2 is the price of labour, we need to put x as c("h2","x2") and w as c("w2","u2") so that h2 and w2 take the same position in the arguments.

value_decom() returns a list containing a growth-value table and a level-value table of explanatory factors for value added growth decomposition. It is sorted by the time period. The growth-value table can be extracted using the number index 1 or the sub-list name “growth”. The level-value table can be extracted using the number 2 or the sub-list name “level”.

Aggregation over sectors with a weighted average approach

t_weight() follows a “bottom up” approach that uses weighted averages of the sectoral decompositions to provide an approximate decomposition into explanatory components at the aggregate level. Specifically, the Tornqvist index is adopted in the aggregation. Arguments required to aggregate explanatory factors include y, p, id, t, alpha, beta, gamma, epsilon, tau and data. y is a string indicating the output quantity column, p is a string indicating the output price column, id is a string indicating the industry column, t is a string indicating the time period column, alpha–tau are explanatory factors of value added decomposition, and data is a data frame containing the columns above. y and p can also be a vector of strings.

t_weight returns a list containing a growth-value table and a level-value table of explanatory factors for value added growth decomposition. It is sorted by the time period. The growth-value table can be extracted using the number index 1 or the sub-list name “growth”. The level-value table can be extracted using the number 2 or the sub-list name “level”.

References

Diewert, W. E. and Fox, K. J. (2018). Decomposing value added growth into explanatory factors. In The Oxford Handbook of Productivity Analysis, chapter 19, page 625–662. Oxford University Press: New York.

Zeng, S., Parsons, S., Diewert, W. E. and Fox, K. J. (2018). Industry and state level value added and productivity decompositions. Presented in EMG Worshop 2018, Sydney.