Friday, 26 June 2009

More on this "small open" economy

It only took a couple of days following my opening missive on this topic,
but sure enough a politician, no less than the Minister of Finance, Brian Lenihan, proclaimed that Ireland was an "open" economy in which any increase in demand would quickly leak away into imports. Of course he knew that because imports are high relative to GDP in this country and because everyone says so.

He wasn't reading this blog to be sure.

So I thought I might revisit this with some pesky data. Now the place to go looking for evidence of high "import multipliers" (i.e. that increases in demand will provide more stimulus to output abroad than domestically, compared with low import multipliers) is not under the national accounts estimates for national expenditure (that is the Y=C+I+G+X-M familiar to most econ 101 students), but deep within the Input-Output and Supply and Use tables of the national accounts.

These tables are clever things that try to track the flows of demand and output between different pre-defined industries and into some final point of demand, like to exports, or consumption or capital expenditure. These allow us to attempt to see if:

  • A drop (increase) in world demand might dramatically reduce (increase) demand for output in Ireland, or instead simply reduce (increase) demand for imports.
  • An increase in household consumption of government expenditure might be met mostly by imports (output produced abroad) rather than domestic output.

And these tables can track not just the first round effects, but all the way back up the production lines in the course of a year. That way we will know that if someone bought a computer from Dell, it would be comprised of a very large proportion of imports (originally) even though the final item itself came out of a factory in Ireland.

So what do these data tell us? Well, I first went to the "Use" tables, where we can see where all the exported output of Ireland comes from. Of the 95 odd industry groups identified, 80% of exported items come out of 10 industries (you can probably guess which ones, but chemicals, computer equipment, financial services feature prominently).

Next we go to what is call the "Leontief inverse" tables. These take output from every industry and calculate how much they rely on output from other industries (including those located overseas). So for our Dell computer example, these tables trace the origin of the inputs used to produce it, be they other domestic industries, or imported. It also tracks the origin of the inputs into those as well as adds them all up. The results we get are interesting to say the least.

For the industries that account for 80% of Irish exports (which is very large proportion of total output in the country), the "import multiplier" is about 0.58. That is 58% of the value of the output is actually provided from overseas in the form of imports. If you increase exports (i.e. the output of this group of industries) by 10%, you would expect imports to rise by around 6%. That is what we call "import leakage". The domestic affect will only be 4%. So Ireland isn't really an export led economy.

Compare with what you might normally expect to see. If you look at the same import multiplier for the entire rest of Irish industry (those whose output tends to go to meet domestic demand) you find a value of around 0.32. And this is interesting, because 30% is a number found just about everywhere else. if domestic demand increases 10%, imports increase by about 3%. This is half the size of the import leakage that might be expected to come from export demand.

Now this isn't the ideal form of analysis. It could be done more completely and address some of the shortcomings I have glossed over. But this was easy to do and the magnitude of the different import multipliers (for domestic oriented industries it was half that of export industries) makes this compelling.

So next time someone throws you the old "but Ireland is a small open economy" or "Ireland is an export-led economy" myths, ask them what the Leontief inverse tables of the input-output accounts indicate.

It is likely to shut their gob.

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