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NATIONAL INCOME ACCOUNTING

V. Prasanna Bhat http://www.thehindubusinessline.in/2000/01/17/stories/211701ba.htm www.thehindubusinessline.com/2000/01/24/stories/212401ba.htm PART 1: CONCEPTS IN NATIONAL INCOME ACCOUNTING NATIONAL income is the (money) value of all the final goods and services produced by a country in a year. As these are measured in different physical units, it is not possible to consolidate. Thus, there is the need to reduce them to a common measure, namely, money. This gives a single measure of the final goods and services produced by a country in a particular year, which is otherwise known as national income or national product. Gross domestic product (GDP): GDP is the money value of all final goods and services produced in the domestic territory of a country in an accounting year. Domestic territory includes the following: Territory lying within the political frontiers, including territorial waters of the country, ships and aircraft operated by the residents of the country between two or more countries, fishing vessels, oil and natural gas rigs, and floating platforms operated by the residents of the country in the international waters or engaged in extraction in areas in which the country has exclusive rights of exploitation, and embassies, consulates and military establishments of the country located abroad. GDP at constant and current prices: GDP can be estimated at current as well as constant prices. If the GDP is estimated on the basis of the prevailing prices it is called GDP at current prices. In 1995-96, India's GDP at current prices was Rs. 8,57,570 crores - that is, measured on the basis of the prices prevailing in 1995-96. If GDP is measured on the basis of some fixed prices - that is, prevailing at a point of time or in some base year - it is known as GDP at constant prices or real GDP. Thus, in 1995-96, the GDP was Rs. 2,36,738 crores at 1980-81 prices - that is, measured on the basis of the prices prevailing in 1980-81. GDP at factor cost and at market price: The contribution of each producing unit to the current flow of goods and services is known as the net value added. GDP at factor cost is estimated as the sum of net value added by the different producing units. Since the net value added gets distributed as income to the owners of factors of production, GDP can also be estimated as the sum of domestic factor incomes and consumption of fixed capital. Conceptually, the value of GDP, whether estimated at market price or factor cost, must be identical. This is because the final value of goods and services (that is, market price) must be equal to the cost involved in their production (factor cost). However, the market value of goods and services is not the same as the earnings of the factors of production. GDP at market price includes indirect taxes and excludes the subsidies given by the government. Therefore, in order to arrive at GDP at factor cost, indirect taxes must be subtracted from, and subsidies added to, GDP at market price.

Net domestic product (NDP): While calculating GDP, no provision is made for depreciation. However, capital goods such as machines, equipment, tools, buildings, tractors, and so on, get depreciated during the process of production. When depreciation allowance is subtracted from GDP, NDP is got. Gross national product (GNP): GDP includes the contribution made by non-resident producers who work in the domestic territory of other countries - by way of wages, rent, interest and profits. For example, the income of all people working in Indian banks abroad is the factor income earned abroad. Similarly, factor services are rendered by non-residents within the domestic territory of India. Net factor income from abroad is the difference between the income received from abroad for rendering factor services and the income paid for the factor services rendered by non-residents in the domestic territory of a country. GNP is, thus, the sum of GDP and net factor incomes from abroad. In brief, GNP = GDP + NFIA (net factor income from abroad). Net national product (NNP): It can be derived by subtracting depreciation allowance from GNP. It can also be found out by adding the NFIA to the NDP. If the NFIA is positive, that is, the inflow of factor income from abroad is more than the outflow, NNP will be more than NDP. Conversely, if NFIA is negative, NNP will be less than NDP and it would be equal to NDP in case the NFIA is zero. Symbolically, NNP = NDP + NFIA. NNP at factor cost or national income: NNP at factor cost is the volume of commodities and services produced during an accounting year, counted without duplication. It can also be defined as the net value added at factor cost (by the residents) in an economy during an accounting year. In terms of income earned by the factors of production, NNP at factor cost or national income is defined as the sum of domestic factor incomes and NFIA. If NNP figure is available at market prices indirect taxes must be subtracted and subsidies added to get NNP at factor cost or national income. Symbolically, NNPFC = national income = FID (factor income earned in domestic territory) + NFIA. Personal income and personal disposal income: Personal income is the sum of all incomes actually received by individuals during a given year. In order to estimate it, from national income the sum total of social security contributions, corporate income-taxes and undistributed corporate profits need be subtracted and personal payments (which are incomes received but not currently earned) to be added. After the deduction of personal taxes from personal income of the individuals, what is left is personal disposable income which is equal to consumption plus saving. Mathematically, the relationships can be summarized as follows: A GNP at market price - depreciation = NNP at market price. A GNP at market price - net income from abroad = GDP at market price.

A GNP at market price - net indirect taxes = GNP at factor cost. A NNP at market price - net income from abroad = NDP at market price. A NNP at market price - net indirect taxes = NNP at factor cost. A GDP at market price - net indirect taxes = GDP at factor cost. A GNP at factor cost - depreciation = NNP at factor cost. A NDP at market price - net indirect taxes = NDP at factor cost.

PART -2: METHODS OF MEASURING NATIONAL INCOME The circular flow of production, income and expenditure represents three related phases production, distribution and disposal. These phases enable one to view national income in three ways - as a flow of goods and services, as a flow of incomes or as a flow of expenditure on goods and services. Corresponding to these phases, there are three methods of measuring national income. They are: value-added method (alternatively known as the product method); income method; and expenditure method. Value-added method: Value-added method measures the contribution of each producing enterprise in the domestic territory of a country, and involves the following steps: y Identifying the producing enterprise and classifying them into industrial sectors according to their activities; and y Estimating the net value added by each producing enterprise and each industrial sector and adding up the net value added by all the sectors. Enterprises are classified into three main sectors: (i) primary sector, which includes agriculture and allied activities; (ii) secondary sector, which includes manufacturing units; and (iii) tertiary sector, which comprise services such as banking, insurance, transport and communications, trade and professions. These sectors are further divided into sub-sectors and each sub-sector into commodity/service groups. For calculating the net product for an individual unit, from the value of its gross output, the value of the raw material and intermediate goods and services used by it, and so on, are subtracted and, from this, the amount of depreciation is subtracted t o get the net product or value added by each unit. Adding the value-added by all the units in one sub-sector, the value-added by the sub-sector is got. Again, adding the value-added or net products of all the sub-sectors of a sector, the valueadded or net product of that sector is got. For the economy as a whole, net products contributed by each sector are added to get NDP. If the information regarding the final output and intermediate goods is available in terms of market prices, it can be easily converted in terms of factor costs by subtracting (or adding as the case may be) net indirect taxes to it. By adding or subtracting net income from abroad, NNP at factor cost (or national income) is got.

The following items need be included carefully: (i) production of fixed assets by government, enterprises and households; (ii) production for self-consumption; and (iii) imputed rent of owneroccupied houses. The following should not be included: (i) sale of second-hand machines (because they were counted as a part of production in the year in which they were produced). (Brokerage and commission earned by the dealers of second-hand goods are a part of production and, hence, included while calculating the total value-added.) The product method gives information about the industrial origins of national income. Net income from abroad should be included or subtracted to get a true picture of national income. Income method: Factors of production pool their services for carrying out production activities. These factors of production are paid for their services in the form of factor incomes. Labor gets wages, land gets rent, capital gets interest and entrepreneur gets profits. Whatever is produced by a producing unit is distributed among the factors of production for their services and the aggregate of factor incomes of all the factors of production of all the producing units form the subject matter of calculation of national income by the income method. Transfer incomes are excluded from national income. Therefore, wages of labourers will be included, pensions of retired workers will be excluded from national income. Labour income includes, compensations in kind. Non-labour income includes dividends, undistributed profits of corporations before taxes, interest, rent, royalties, profits of non-incorporated enterprises and of government enterprises. It is difficult to separate labour income from capital income because in many instances people provide both labour and capital services as is the case with self-employed people such as lawyers, engineers, traders, proprietors, and so on. In sectors such as agriculture, trade, transport, and so on, of underdeveloped countries (including India), it is difficult to differentiate between the labour and capital elements of the people's incomes. For overcoming this difficulty, a new category of income, namely, mixed income, is introduced for incomes which are difficult to separate. Transfer incomes should not get included in the national income. Personal income, which is income of the household sector, should not be confused with national income. The former includes transfer payments, whereas the latter does not. Likewise, illegal incomes, windfall gains, death duties, gift tax and sale proceeds of second-hand goods are not included for calculating national income. Further, net income from abroad need not be added, as the incomes received include net foreign incomes too. However, if national income is calculated not from incomes received by the people but from data regarding incomes paid out by producers, then net income from abroad would have to be added separately. To work out national income, net income from abroad should be added to domestic income. Expenditure method: The various sectors - household, business and government - either spend their incomes on consumer goods and services or save a part of their incomes. Total expenditure in an economy consists of expenditure on financial assets, on goods produced in preceding periods,

on raw materials, intermediate goods and services, and on final goods and services produced in the current period. Expenditure on financial assets which are produced and owned within the country is excluded, but expenditure on financial assets of foreign countries is included in national expenditure. But only the net expenditure, that is, the difference between expenditure on foreign financial assets by residents and expenditure on the country's financial assets by non-residents or foreigners is incorporated. The difference is known as net foreign investment. Expenditure on raw materials and intermediate goods and services are excluded, as otherwise, there would be double counting of some of the items. Government expenditure on pensions, scholarships, unemployment allowance, and so on, should be excluded because these are transfer payments. Only expenditure on final goods and services produced in the period for which the national income is to be measured and net foreign investment are included in the expenditure method. Expenditure on final goods and services is broadly classified into expenditure on consumer goods and service. Consumption expenditure is classified into private consumption expenditure of the household sector and government consumption expenditure; and investment expenditure is classified into private investment expenditure by business sector and investment expenditure by government. To the total domestic investment, net foreign investment is added to arrive at national investment. Gross national expenditure = consumption expenditure + net domestic investment + net foreign investment + replacement expenditure (that is, expenditure on replacement investment). Net national expenditure = consumption expenditure + net domestic investment + net foreign investment. Net domestic expenditure = consumption expenditure + net domestic investment. These three methods should ideally lead to the same figure of national income and, therefore, national income of a country can be measured by these methods separately to get different views of the economy. Each method provides a check on the accuracy of the other. National income estimation in India In India, national income is not estimated wholly by one method. The contributions of different sectors to the total national income are estimated by different methods. Thus, in agricultural sector net value added is estimated by the production method, in the small-scale sector net value-added is estimated by the income method, and in the construction sector net value-added is estimated by the expenditure method. FOR estimating national income, India follows the methodology suggested by the United Nations. This, however, is more suitable for developed countries rather than for underdeveloped ones, which are largely characterized by non-monetized and unorganized sectors. The enterprises in underdeveloped economies produce at subsistence levels and are functionally undifferentiated. In addition to producing agricultural commodities, they take to other avocations (non-agricultural)

during off-season and do not keep proper records of their secondary and primary inputs of production. Small capital assets, which may not be very important for a developed economy - and therefore excluded from fixed capital investment - are crucial for underdeveloped ones. In India, estimating the imputed value of rent of owner-occupied dwellings is a difficult task. The expenditure method cannot be used where markets are unorganized. The production method cannot also be used for unorganized sectors such as small-scale industries, trade and transport, and so on. Different methods are used to measure the income genera ted by various sectors of the economy. For calculating national income, the Indian economy is divided into 14 broad sectors, which are then grouped into three main categories - A, B and C. Agriculture, forestry and logging, fishing, mining and quarrying, registered manufacturing and construction are included in category A. The production method is applied to category A. The value added by this category is found by subtracting the value of raw materials and other inputs from the aggregate of commodity-wise output. Electricity, railways, air transport, water and organized transport, communications, banking and insurance, real estate, public administration and defense are included in category B. For category B, the income method is applied and, for this, all the types of factor incomes which are reported in the annual accounts of various organizations are aggregated. In category C, gas and water supply, unorganized roads and water transport, storage, trade, hotels and restaurants, ownership of dwelling and other services are included. For this category, sample surveys are done periodically to find out the average productivity of labour. Estimates of the workforce are interpolated or extrapolated and periodical computations of average productivity are carried forward or backward by using certain indicators. The year-to-year estimates of workers and their average productivity so derived are then multiplied to arrive at the estimates of value added. Consumption takes place with income generation. The problem, however, is that of deciding at which stage national income should be estimated. Another problem relates to the commodities and services that should be included in national income estimation. In fact, there are many goods and services which have no money payments. Services that are rendered out of love, courtesy or kindness have an economic value but no money value. Therefore, the problem of their inclusion and computation remains. In India, conditions not only differ among States but also within each State. Information based on samples taken from a few districts in a State may or may not be valid for the whole State. There is, therefore, the need for making the data on States more comprehensive. Also, the occupational distribution of working population in India is widely dispersed. Agricultural income that is consumed, small restaurants, tea-shops, and so on, along with barter exchanges, pose problems of computation. Most of the farmers cultivate only one crop a year and have the tendency to accept alternative work in the unorganized sector. Multiple sources of earnings make data collection difficult.

India's national income growth The real national income of India has increased at an annual average rate of 3.8 per cent in the 45 years of economic planning. In the last 14-15 years, the average annual rate of increase has been 4.2 per cent. Though this seems good, it pales when compared with those achieved by China and South Korea.

RIGHT OR WRONG? State with reasons whether the following statements are true or false: National income accountants follow uniform concepts. Incorrect. They often differ over the treatment of raw materials, intermediate goods and depreciation. For example, whether government services are final (as they add to the satisfaction level) or intermediate (as they are essential for economic activity). In India, these are treated as final services; in Russia, however, these are considered intermediate. Inadequate data is the main hurdle in national income accounting. Correct. Adequate data regarding output, raw materials, and so on, are often not available from many proprietorships, partnerships, non-profit institutions and governments. Lack of adequate and reliable data is a major hurdle to the measurement of nation al incomes of underdeveloped countries. In India, a large portion of the agricultural output does not enter the market and is retained either for barter or self-consumption. There is no means of estimating the volume and value of goods which do not enter the market for exchange or which are ex changed under barter. Income method of accounting is not suited for developing countries. Correct. The income method is more suitable for developed economies, as majority of the people file their income-tax returns. In developing countries, a large proportion of the national income is estimated by the expenditure method. The income method is not suitable owing to the prevalence of non-monetized transactions. There are no conceptual problems in income accounting. Incorrect. There are two types of difficulties in the estimation of national income. One is conceptual and the other, statistical. The conceptual problem relates to the definition of the various concepts and the terminology used - for instance, the definition of nation for computing national income, the method employed, the stage of economic activity at which national income is to be calculated and the type of commodities and services which are to be taken into account. National income does not necessarily refer to income produced within the borders of a country. The concept of national income extends beyond a nation's political boundaries. Income accounting has a bearing on exchange determination too. Correct. GDP and the obtaining currency, and so on, play a role in exchange-rate determination. Exchange rates vary depending on the domestic products and the currencies chasing the total of such products. Further, the demand and supply principles play a major role. However, the role of GDP in determining exchange rates - though small - cannot be ignored.