Looking for the inverted pyramid: an application using input-output networks

Herman Daly, one of the founders of Ecological Economics, compared the economy to an “inverted pyramid”. At the bottom are the essential raw material and energy inputs. When those are processed, the “value added” is recorded in economic statistics. The same happens when the processed goods are combined to make finished goods, sent to the store, and sold to consumers. The lesson is that everything we measure as value-added depends ultimately on raw materials and energy. They are what the value is added to.

In this paper, the authors apply Daly’s insight to propose a complementary measure to value-added that clarifies the role of raw materials and energy. Drawing on development economics, the paper calculates the degree of “forward linkages” of different economic sectors for a selection of European economies. The hypothesis is that raw materials sectors should have high forward linkages.

The paper finds that mining and forestry do tend to have high forward linkages, consistent with the hypothesis. Interestingly, that is not true of agriculture, which receives substantial inputs from the petrochemical industry. The authors also found that business services sectors, such as financial services, have high forward linkages.

Using the forward-linkages measure, the paper goes on to classify different types of economy using cluster analysis. The authors then create a visual representation of the inverted pyramid for sectors with high forward linkages, which shows how output from those sectors cascades through the economy.