By Mary O’Mahony
Economic activity in developed countries is highly dependent on trends in services sectors, due to declines in the share of manufacturing over time and to the concentration of many innovations related to information and digital technologies in services. Accurately measuring the volume of output growth in services requires reliable measures of prices, which are comprehensive in their coverage and capture any quality changes in the provision of these services.
Our paper published in the International Productivity Monitor, based on an earlier ESCoE Technical Report, is an attempt to undertake a systematic comparison of Services Producer Price Indexes (SPPI) across a number of OECD countries. This focuses on data that are in the public domain via downloads from National Statistical Office websites.
The research had two main aims. The first was to investigate if there is any evidence that UK SPPI growth deviates from that in other developed countries. Given the UK’s large and increasing share of services in aggregate economic activity, deficiencies in the measurement of SPPIs arguably could be a factor explaining the UK’s well known relatively poor productivity performance in the past decade. The second aim was to examine the impact of measurement methods more generally on SPPIs across all countries to gauge if some methods are likely to lead to upward bias of price growth.
The analysis is based on data for 16 countries and 31 separate SPPIs. The choice of SPPIs was driven by those available for the UK and the choice of countries was dictated by the availability of readily downloadable SPPI series. These SPPIs refer to Business to Business transactions and do not include services sectors that mainly transact with consumers and government such as personal services, education or health. The services industries included in this paper combined account for about 60% of total services value added in the UK. The time series extend from the early 2000s to 2017 but the coverage varies by country and type of service, with more complete series available from 2010. The method used was to apply panel regression analysis on growth in SPPIs.
The first main finding is that there is no evidence that the UK SPPIs systematically overstate price growth. Indeed, we find that that UK services price growth was, on average, lower than in most other countries. This is the case in the raw data and if we measure relative to general inflation using changes in the GDP deflator or the consumer price index.
There are a number of methods used by statistical office to measure prices, including transactions or list prices for repeated services, contract pricing, percentage fees and unit values. Especially for professional and business support services, a common method is to base prices on time spent on providing the services – time based (TB) methods. These by their nature do not allow for any productivity improvements. An alternative to this is model pricing (MP), which is a method that attempts to price a standardised service and so can capture productivity change. Although conceptually superior to TB, MP methods are often difficult to implement in practice due to challenging problems in defining a standardised service.
Using panel regressions that control for country, industry and service type fixed effects, and regressions that also include controls for market structure and regulation, we find, on average, that there was about a 0.3 to 0.4 percentage points per annum lower price growth using MP relative to TB methods. The latter are most prevalent in industries M and N, which comprises professional and business support services. A back of the envelope calculation using data for the UK suggests that, for these two industries combined, addressing this bias might have led to an increase in total factor productivity from about 1.8% per annum to 2% per annum in the decade 2005 to 2015. The impact on UK aggregate economy wide productivity is likely to be much smaller given that industries M and N account for about 12% of GDP.
Finally for a small number of services where TB methods are currently used, we investigated a possible alternative method that employs opportunity costs to measure price change for professional services, where opportunity costs are estimated based on the provision of these services internally in firms. This yielded results that were similar to those from the main regressions on average, signalling an upward bias in the use of TB methods, but with significant variation across types of professional services.
Mary O’Mahony is Professor of Applied Economics at King’s Business School, King’s College London, and an ESCoE Research Associate.
Lea Samek is a Young Professional at the OECD in the Science, Technology and Innovation Directorate, and an ESCoE Research Associate.
The opinions expressed and arguments employed herein are solely those of the authors and do not necessarily reflect the official views of the OECD or its member countries.
ESCoE blogs are published to further debate. Any views expressed are solely those of the author(s) and so cannot be taken to represent those of the ESCoE, its partner institutions or the Office for National Statistics.