Barbara M. Fraumeni Muskie School of Public Service, University of Southern Maine & the National Bureau of Economic

1. Effects of Terms of Trade & Tariff Changes on the Measurement of U.S. Productivity Growth by Robert C. Feenstra, Univ. of California-Davis & NBER, Marshall B. Reinsdorf, Bureau of Economic Analysis, Mathew J. Slaughter, Tuck School of Business, Dartmouth College & NBER, and Michael Harper, Bureau of Labor Statistics, all USA Barbara M. Fraumeni Muskie School of Public Service, University of Southern Maine & the National Bureau of Economic Research (NBER), USA IARIW, Session 3 Joensuu, Finland August 22, 2006

2. Muskie School of Public Service Ph.D. Program in Public Policy • MISMEASUREMENT OF • Import & export prices • The impact of tariff reductions & currency devaluations • The import effect on input and output prices LEADS TO INCORRECT ESTIMATES OF PRODUCTIVITY CHANGE

3. Muskie School of Public Service Ph.D. Program in Public Policy • Second Half of the 90’s • New economy • Globalization of IT industry in the US • Key IT industries: Computers, peripherals, semiconductors & telecommunications equipment, are running trade deficits • Import & export share about 15% of the import & export totals for the U.S. • Tariff reductions (to zero) on a wide range of IT products • Currency depreciation after Asian crisis

4. Muskie School of Public Service Ph.D. Program in Public Policy • Import & Export Prices Indexes • BLS constructs Laspeyres indexes • This paper’s Tornqvist index lies below Laspeyres • Expected for net of tariff import index • For exports, due to substitution along foreign demand curves • For IT industries, differences between these two indexes show up in the 2nd half of the 90’s

5. Muskie School of Public Service Ph.D. Program in Public Policy • Import Price Regressions • Independent variables in fixed effect equation • Indicator of tariff reduction (ITA) stages • Tornqvist index of real exchange rates with lags • Export or domestic price index • 3 variations in industry coverage depending upon % covered by ITA • 100% • 50-99% • 1-49% • 2 control group regressions • For manufacturing industries only • For agricultural industries only when domestic price is included

6. Muskie School of Public Service Ph.D. Program in Public Policy • Regression Results • In the version with domestic prices (particularly with 100% ITA coverage), the pass-through coefficient indicates a highly magnified impact on lowering import prices • Exchange rate and export or domestic price coefficients also significant in all versions • Simulated prices, with no tariff or exchange rate reductions, show that the ITA effect is about = to the Laspeyres vs.Tornqvist formula bias

7. Muskie School of Public Service Ph.D. Program in Public Policy • Turning to Productivity Measurement • Define a revenue function with intermediate inputs gross of tariffs, but industry gross output net of tariffs • Authors show that eliminating tariffs with INCORRECT/CURRENT measurement • Increases US GDP rate of growth • Increases MFP rate of growth • See Figure 7

8. Muskie School of Public Service Ph.D. Program in Public Policy • Figure 7 • Initially at y0 (tangency A0 and PPF, including tariff on good 1) • Nominal GDP at B0 at y0 excluding tariffswithinitial welfare at Q0 • After tariff elimination producers line A1 has same slope as B0 (tangency at y1), thus welfare increases to Q1 • But there is no shift on PPF, therefore no change in MFP • GDP measures the slope of the indifference curve, which should not be used to estimate productivity change

9. Muskie School of Public Service Ph.D. Program in Public Policy • MFP Is Conflating True Productivity Changes with International Trade Changes • Figure 7 result • Also existing international trade measures are biased • BLS use of Laspeyres export & import price measures • Upward bias on MFP growth 1996-9 • .1 to .12 depending upon variant (BLS) • Very small effect with NIPA price indexes because upper level substitution bias is avoided

10. Muskie School of Public Service Ph.D. Program in Public Policy • Effect of Measuring Imports Gross of Tariffs • Import share too large • Falling tariffs reduce import prices • On net, from tariff effect, MFP overestimated by the same as the international trade effect without tariffs: .12

11. Muskie School of Public Service Ph.D. Program in Public Policy • Capital Input Effects • A corrected capital stock estimated with Tornqvist capital good import prices would have a higher growth rate than one with a Laspeyres index • Accordingly, MFP is too high by .038% per year for 1995-2002 • Shortcut method of treating investment as an intermediate input would bias MFP upwards by .07% per year

12. Muskie School of Public Service Ph.D. Program in Public Policy • Conclusions • Don’t ignore international trade effects • Both terms of trade (prices) and tariffs are important • Biases come from both the output and input side • Use of Laspeyre indexes creates biases in estimates

13. Muskie School of Public Service Ph.D. Program in Public Policy • Comments • Paper is chock full of useful and thought-provoking results • Difficult to find much to criticize • Only very minor issues – a better summary & • Argument for domestic price in import price regressions seem stronger than for an export price • Globalization: Is 2000 a poor ending year to use? • Not true for a K stock aggregate that the K stock rates of growth and the CSF growth rates will be the same as weights will differ