Social Accounting Matrix Model and its Application
4.2 Conceptual introduction to simple modeling of social accounting matrix
An understanding of the I-O structure would give you an advantage for learning the SAM, which can be considered as an extension of I-O. In the I-O modeling, we basically disre- garded the final demand from the right column and the value added from the bottom row.
Interindustry transactions among industrial sectors remain endogenous and final demand and value added parts become exogenous.
In the SAM structure, we extend the structure to include all the transactions in the econ- omy, so that all the transactions of goods and services and corresponding monetary flows in the whole economy can be captured. SAM shows how the money flows in the economy/soci- ety that is analyzed. A highly simplified version of the SAM would still involve the under- standing of three important entities, and their existences can enable us to represent how our society functions among those, namely, production activities, factors, and institutions.
4.2.1 Key concepts of institutions, production activities, and factors of production Figure 4-1 shows a simplified visual depiction of concepts of the SAM, which shows how the money flows in the society.
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We will consider each component individually.
● Institutions – This word sounds unfriendly. If the word does not give you any image, con- sider this as a household, namely you, and your family, if any. That simplified concept will suffice for a while, until more detailed explanations are made.
● Production activities – The top circle in Figure 4-1 represents production activities, and this is indeed the I-O that we just learned. In the production activities, industrial sectors sell and purchase goods and services. As we learned in I-O, industrial sectors depend on inputs from others to produce outputs, which can be sold either as intermediate goods or as fin- ished products to satisfy final demands.
● Factors – This is referred to as factors of production in the table. It can be considered as an exchange market for factors of production, or just an exchange market for labor and capi- tal. Just like any other market, such as foreign exchange market, vegetable market, or real estate market, there should be sellers and buyers for a place to function as an exchange market. What the buyers and sellers put in this market are labor and capital. Note that the word capital has broader meaning here than that used in accounting and finance.
Now, we follow step-by-step how the goods, services, and money flow in the society, so that we determine who the buyers of labor are, why they buy labor, who owns the labor, and why labor is put on the market.
$$ for
consumption (2) Production
activities (I-O table)
Institutions (household, firms,
government) Factors
(of production:
labor, capital)
$$wage and rents (4)
Value Added:
Labor and capital (3)
$$labor income, profits (6) SAM Concept
(5)
Final demands:
goods
and services (1)
Figure 4-1 Structure of the social accounting matrix.
4.2.2 Trilateral interactions in the social accounting matrix table
In the SAM structure, each component interacts with two other components in a unique man- ner. Indeed monetary flows occur in one direction and counter-flows occur in the other direc- tion. It is important to understand the basic structure and flows among three components. We will consider each flow individually.
4.2.2.1 Step 1: Flow between institutions and production activities
Institutions consist of household, firms, and governments, but let us simplify the idea by con- centrating on the largest component, household. As mentioned previously, if the household still sounds unfamiliar, you may put yourself here. As you live, you certainly have multiples of final demand for goods and services. You probably have to purchase your apples, orange juice, rice, bread, clothes, stationary, and gasoline in your daily life. Think where those goods came from or who produced those goods. As you travel on holiday, you may want to stay at a good hotel. You may enjoy the spa service at a Four Seasons Hotel or a Ritz Carlton. You did not purchase the tangible spa (unless its cash flows from operations are securitized for sales as a financial product), but you purchased an intangible service or wonderful experience. Now the question would be who provided you with a wonderful spa treatment, and who created such a wonderful intangible product as spa treatment?
You, as institutions, purchase goods and services to fulfill your final demands from the industrial sectors as shown by arrow (1) in Figure 4-1. And concurrent with your purchase of goods and services, you must have paid money for the goods and services that you consumed.
The monetary flow occurred from you (i.e. institutions) to the industrial sectors, which may be the agriculture sector for your apple, manufacturing sector for your clothes, stationery, and gasoline, or services sector for the spa treatment services. The flow of money for consumption of goods and services are shown by arrow (2) in Figure 4-1. This is how the industrial sectors receive inflow of money from institutions for their consumption. In exchange for providing goods and services, production activities receive money from you (i.e. institutions).
4.2.2.2 Step 2: Flow between production activities and factors
Once the production activities (i.e. industrial sectors) respond to your request for the output as final demands, such as apples, clothes, rice, bread, computers, orange juice, and plasma televisions, or for services such as spa treatment and a clean hotel room, they have to produce more of such products. Recall in the I-O structure, in order for an industrial sector to produce outputs, many intermediate goods and services are required from other industrial sectors, which end up stimulating the output of other sectors. A factory that produced orange juice will produce bottled orange juice when they are given all the necessary inputs for their pro- duction, such as oranges from agriculture sector and plastic bottles from manufacturing sec- tor. But in reality, without one important input that we took for granted in the I-O structure, the factory will not be able to produce orange juice. What is missing?
A very important input that is definitely required is the labor, which was not a product of other industrial sectors. Indeed in the I-O structure, we ignored the labor component as we
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disregarded the value added. Another major component that would be required for produc- tion activities is the capital.
When production activities need labor or capital, they seek for the factors, which you may consider as an exchange market for labor and capital. Note that the meaning of capital in SAM context is broader than that in finance and accounting. It may include land, office space, physical production facilities such as tractors or machinery, or hotel building as a real estate in addition to money as a capital. Production activities look for qualified labor and when they find it, they will use the labor for the production of output as shown by arrow (3) of Figure 4-1.
People say there is no such thing as a free lunch, and that is the case for the production activ- ities’ input of labor. Labor from factors has to be compensated with the monetary compensation, which is called wage as shown by arrow (4) of Figure 4-1. It is interesting to note that wage is paid for the labor that you provide, and not for your mere physical existence as a person. When production activities utilized land or tractors, which are included in the broad definition of the capital, production activities have to pay the rent, which also has broader meaning than what we usually refer as a monthly payment for an apartment. Rent payment is also captured by arrow (4) of Figure 4-1, which is a consideration or penalty for using somebody else’s capital.
4.2.2.3 Step 3: Flow between factors and institutions
Now that factors receive monetary flows in the name of wages and rents as shown by arrow (4) of Figure 4-1, let us see what happens next. We have to go back to a basic question of who Figure 4-2 Hotel industry ’s labor utilization of institution (household) ’s labor from factors. Note: A person put their labor in the factor ’s market (exchange market for labor and capital) and the hotel industry found her (his) quality of labor appropriate to do the job.
Source: Photograph taken by the author in Managua, Nicaragua, September 2007. (Plate 2)
owns the labor and capital. It is you (i.e. institutions, roughly equal to households) who own these. Even though the quality and quantity may vary, you own those important endowments.
So, the next question is whether all of you will receive some sort of money due to the owner- ship of labor and capital. In an ideal world, everybody owns the labor and capital and there- fore everybody receives some monetary rewards. In reality, not everybody will automatically receive some monetary rewards for ownership of labor and capital. After all, it is the capitalism that survived the Cold War and now it is the rule of the game that we have to be fully aware.
Let us first consider labor. You have to leave your house (unless you work entirely online from your home office) and make yourself available to the exchange market where produc- tion activities advertise for workers as shown by arrow (5) of Figure 4-1. Quality of labor may be perceived as a decisive factor for production activities to hire certain people out of a larger choice of candidates, and different perceptions on the productivity of such labor result in dif- ferent salaries. If you are employed as a housekeeper making beds, your wage may not be as high as someone who has specialized in yield management and obtained a hotel manage- ment degree and works in the same department of the same hotel. If you are unable to work satisfactorily (e.g. cannot make consistently tidy beds in the expected time), your labor may no longer be required and you may be dismissed and become unemployed (you are available to the labor market but there are no production activities that require your labor) as shown by arrow (5) of Figure 4-1. Generally, many of you will find some opportunity in which pro- duction activities would be interested in utilizing your labor as necessary input for their pro- duction. The manager of the spa at the luxury hotel may hire you if your qualifications and experience are likely to provide him/her with the required level of productivity at their facil- ity. In that case, your labor is exchanged with wages as shown in the arrow (4) of Figure 4-1 and the money continues to move to the owner of the labor, you (i.e. institutions), in the name of labor income, as shown by arrow (6) of Figure 4-1.
As for the capital, the similar picture applies in that even if you own capital (money, physical assets, commercial real estate, etc.), unless you put them on the exchange market as shown by arrow (5) of Figure 4-1, there would be no chance for your capital to receive rents from production activities as shown by arrow (4) of Figure 4-1. And even if you put your cap- ital in the exchange market, depending on the business environment, your capital may not be utilized by production activities. Once you put your capital on the market and production activities wants to utilize your capital, you will have a cash inflow of rents (i.e. return on your capital from your viewpoint) as shown by arrow (4) of Figure 4-1 and to be transferred to you as the owner of capital in the name of profits as shown by arrow (6) of Figure 4-1.
4.2.2.4 Step 4: Back to the institutions
The monetary rewards for letting others use your labor and capital brought a fresh cash inflow to you (i.e. institutions) via factors of production. If it was your labor that brought the labor income to you, you may want to reward yourself, for example, with a spa treatment, by buying new set of wheels and tires for your car, or by purchasing a new display for your desktop computer. Those final demands by you again stimulate the production activities, and money flows from you to the production activities. This returns to step 1, and the money
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starts a new cycle. Since the SAM tables are shown as a two-dimensional table, a conceptual understanding on how the money flows among them should help you understand the struc- ture of the SAM tables in the following section.