Supply and demand biases in linear interindustry models

a r t i c l e i n f o We explore the sectoral and aggregate implications of some endogeneization rules (i.e. on value-added and final demand) which have been common in the extended demand-driven Leontief model and have been recently proposed in the supply-driven Ghosh model. Extended linear models are refinements that aim at endowing the linear models with additional general equilibrium feedbacks. We detect that these rules may give rise in these models to some allegedly pathological and biased behavior. We find that in these models sectoral or aggregate output may not follow the logical and economically expected direct relationship with some underlying endogenous variables — namely, output and value-added in the supply-driven model and output and consumption in the demand-driven model. Because of their shared mathematical structure, whatever is or seems to be pathological in the Ghosh model also has a symmetric counterpart in the Leontief model. These would not be good news for the inner consistency of these linear models and raise doubts regarding the validity of their empirical applications. To avoid such possible inconsistencies, we propose new and simple endogeneization rules that have a sound economic interpretation. Both the classical Leontief (1936) and Ghosh (1958) models have been subjected to criticism because of the way they handle the role of some key variables. In Ghosh, for instance, output depends on value-added and a change in a given sector's value-added will rise output everywhere with no need for additional value-added in the rest of sectors. There is more output overall but value-added is, in general, insensitive to this fact. In Leontief, in turn, output depends on final demand (say, consumption for simplicity). Any change in final consumption will raise output everywhere but this will not get reflected in any additional demand for consumption, even though overall there is more output and income around. We may conclude that consumption is insensitive to income, a fact that also runs against standard economic logic. These observations suggest that these features of Ghosh and Leontief traditional models are not quite realistic features of any production and consumption processes. Enter therefore the extended versions of these models to overcome these unwanted properties. In the Leontief model, we can establish a relationship between output x and final consumption d (or a part of it) by way of introducing the missing connection d = ϕ L (v) between consumption d and value-added …