Intermediate inputs and economic productivity

Abstract

Many models of economic growth exclude materials, energy and other intermediate inputs from the production function. Growing environmental pressures and resource prices suggest that this may be increasingly inappropriate. This paper explores the relationship between intermediate input intensity, productivity and national accounts using a panel dataset of manufacturing subsectors in the USA over 47 years. The first contribution is to identify sectoral production functions that incorporate intermediate inputs, while allowing for heterogeneity in both technology and productivity. The second contribution is that the paper finds a negative correlation between intermediate input intensity and total factor productivity (TFP)—sectors that are less intensive in their use of intermediate inputs have higher productivity. This finding is replicated at the firm level. We propose tentative hypotheses to explain this association, but testing and further disaggregation of intermediate inputs is left for further work. Further work could also explore more directly the relationship between material inputs and economic growth—given the high proportion of materials in intermediate inputs, the results in this paper are suggestive of further work on material efficiency. Depending upon the nature of the mechanism linking a reduction in intermediate input intensity to an increase in TFP, the implications could be significant. A third contribution is to suggest that an empirical bias in productivity, as measured in national accounts, may arise due to the exclusion of intermediate inputs. Current conventions of measuring productivity in national accounts may overstate the productivity of resource-intensive sectors relative to other sectors.