Esther Peres
ECON 442 History of Economic Thought
Due: April 16th, 2008
Input-Output Analysis
In order to explore the development, mechanics, and application of input-output analysis we must
first look at the lives of the great economic thinkers who are responsible for its inception. The famous minds
associated with input-output analysis are Francois Quesnay and Wassily Leontief.
Francois Quesnay had a decisive influence on the discipline of economics. This assertion is all the
more surprising in light of his profession as a medical doctor, not an economist, under Louis XV in Versailles.
As a prominent member of the Physiocrats, commonly thought to be the first school of economic thinkers,
Quesnay and his colleagues are credited for coining the term “laissez-faire, laissez-passer.” They championed
a policy of deregulation and reduced taxes for agriculture (contended by the Physiocrats to be the sector
powering the economy) in an attempt to emulate the relatively hands-off policy of the wealthy British.
The Tableaux Economique illustrates the brilliance of the French doctor's formal conception of the
economy as a reproductive system. In Tableaux, Quesnay created a circular flow diagram of the economy that
showed what each sector of the economy produced and spent detailed by his famous zigzag diagram. One of
the primary purposes of the Tableaux was to study the conditions for economic growth and decline. This table
was used by Quesnay as a method of understanding and explaining the causes of growth. Three classes are
defined in Quesnay’s model: landowners, farmers, and others, referred to as "sterile" classes. The “sterile”
classes create no surplus for the next period because they consume what they produce.
Keeping in line with Physiocratic philosophy (whose name itself derives from the Greek words
power and nature) Quesnay thought the agricultural sector alone could produce a surplus that could then be
used for the following years production and, thereby, aid growth. Quesnay believed both industry and
manufacturing were sterile. In order to support his belief, Quesnay constructed the table to fit his conclusion
rather than consulting his table for affirmation. This creates inconsistencies in the Tableaux in order for him
to support his assumption that industry provides no surplus. Nonetheless, Quesnay’s formulation of a table
detailing sector production and expenditure relationships as a tool to measure and understand economic
growth was a pivotal foundation to input-output and modern multiplier analysis.
The formulation of modern input-output analysis as we know it today is accredited to Russian born
Wassily Leontief. (1906-1999) As a young man growing up in St. Petersburg, Leontief committed his studies
to input-output analysis. By the time he left Russia at nineteen and began his Ph.D. studies at the University of
Berlin he had already shown how to quantify Leon Walras’s abstract equilibrium theory. Unarguably brilliant,
it was not until 1941 as a professor at Harvard that he designed an input-output table for the American
economy. His hard work and ingenuity paid off; in 1973 Leontief earned the Nobel Prize for his work and
modifications of input-output analysis.
Input-output tables detail the process and impacts by which the inputs in one industry produce
inputs for another industry or produce outputs for consumption. The input-output matrix designed by
Leontief can be used to show the effects of change in production or output of a final good has on the demand
for its inputs. A simple example of this would be the car industry. With a 25% reduction in car output, using
the table, one could estimate the reduction in demand for steel, tires, labor, and other inputs that will
experience decreased demand as a result of decreased car production. Other practical applications of the
input output table is through multiplier analysis that allows the estimation of the economic impact an
industry can have on a region.
Leontief’s initial work with input-output analysis was an impressive demonstration of his
determination. The construction of input-output tables requires intense matrix algebra, which Leontief
computed using hand-held calculators. In the early implementation of input-output analysis, it was used to
understand the flow of trade between countries and to estimate the impact nationwide of converting from
war production to civilian production after World War II. As a result of these applications, Leontief showed in
a 1954 article using input-output analysis that US exports were relatively more labor intensive than US
imports. This finding, termed the Leontief paradox, was counterintuitive to the beliefs held by economists of
the time given the high amount of capital per worker and level of US wages. The paradox was later resolved,
with economic findings that showed, “in a country that produces more than two goods, the abundance of
capital relative to labor does not imply that the capital intensity of its exports should exceed that of its
imports” (http://www.econlib.org/library/Enc/bios/Leontief.html). Today, due to processing power and
ease of computer use, input-output analysis (also known as “interindustry analysis”) is used by the World
Bank, the United Nations, and the U.S. Department of Commerce. Another popular use today is with Regional
Impact Models derived from the federal input-output table and used by local governments and regions to
estimate impacts of industries on their local economy.
Economists are cautious using the input-output table and must be aware of its assumptions and
shortcomings. Input-output analysis assumes that technology constant (based on the year data is collected),
consumption patterns are the same across regions (Tulsa consumption of salsa is the same as Michigan), and
input proportions are fixed and the same as the time period used to estimate the model. The last assumption
causes a problem specifically when the cost of one input rises, the model doesn’t allow for substitution, which
is bound to happen in the real world. When input-output tables are used regionally to estimate impacts of a
project, for example the Hoover Dam, the impact is often overestimated due to the lack of differentiation
between short-term impacts (construction) versus long-term changes to the economy (operations). Another
overestimation happens when it is assumed that all impacts from a stimulus as estimated by the table are
new demand to the economy and not displacement from another sector of the economy. For example, with
the introduction of a sports stadium the estimated dollar impact on the local economy brought in by the
stadium is assumed to be all new money that would not have otherwise been spent at the movie theater if the
sports stadium was not there, a faulty assumption. Input-output analysis is a great estimator to make
predictions, but in light of its issues and inflexibility, it should not be used literally in forecasts because it will
necessarily give inaccurate answers.
Resources
http://www.rri.wvu.edu/regscweb.htm
http://www.econlib.org/library/Enc/bios/Quesnay.html
http://www.econlib.org/library/Enc/bios/Leontief.html