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    National Income

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    nitin

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    ey National income—income of the nation during « period of time—provides « compre- hensive measure of the economic activities of a nation. Its anaual magnitude divided by the nation’s population, called the per capita income, is used as a measure of the standard of living of the people in the nation, and the distipction between rich, middle income and poor countries is based on the magnitude of the per capita income. According to the World Bank Atlas method, countries having per capita income up to US $755 are referred to as low income countries, those having be- tween $756 and $2995 as lower middle income. between $2996 and $9265 as upper middle income and those whose income exceeds $9265 as high income countries. ‘The growth rate of an economy is also measured by the rate at which its real national income is growing. Knowledge of the national income and its movements cover time is of significance to a business organisation also, as this provides measure of the nation’s ability to buy goods and services, and, thus, business sales ‘are dependent on its magnitude. The success/failure of policy makers is very often judged by the rate at which the real national income grows during their regime. 2.1 INCOME CONCEPTS ‘There are several versions of national income, though, strictly speaking, only one of them is referred to as the national income. These include: © Gross National Product (GNP) ‘© Net National Product (NNP) Gross Domestic Product (GDP) z [ Besides, some of these measures are defined both at the market price as well as at the factor cost. Thus, we have the GNP at market price (GNP\,), NNP at the ‘market price (NP), NNP at the factor cost (NNP,) and so on. Also, there is the nominal and real income, and the measured income and PPP income. Thus, income is classified on several grounds, viz. income at market price versus at factor cost, national versus domestic income, gross versus net income, national versus private and personal incomes, nominal versus real income, and measured versus PPP in- come. All these are defined and distinguished in what follows. At this point it may be noted that it is the NNP at factor cost (NNP,), which is globally referred to as the | between the parties and so are non-producti - _ National income 23 national income (NI). Of the various measures, GNP, is the broadest and accord- ingly we start with this measure. Gross National Product | The GNP at market price stands for the monetary } value ofall goods and services thet are ge (a) Currently produced =, ()) Sold through the official market Pe {e) Not resold oF used in further production during the measurement period . (a) Produced by nationally owned resources (factors of production) (e) Valued at market prices f ‘A brief rationale and explanation of these factors follows. _ GNP is expressed in terms of money (rupees in India) because the goods and servines are non additive in physical quantities due 10 differences in the units of measurements (tonnes of wheat, metres of cloth, number of cars, number of haircuts tte.) and the per unit values (one car is not equal to one haircut or even Oe scooter) Itis said that “you can not add apples and oranges’. By using the prices, the GNP is constructed. Quantities of various goods are multiplied by their respee tive prices, and then the various money magnitudes are added to give GNP. Tcome is a flow concept and so the GNP includes only those items that ore produced during the peried of time for which the GNP stands. Thus, the GNP in Mg91 includes the production of all goods and services between January 1, 199) through December 31, 1991 only. The changes in inventories during the period are treated as positive or negative purchases by the producer for the purpose of recon ciling the production measure with the end-use expenditure measure Thus, if the Jnventory level goes up, the increase in inventory is added up to the end-use x penditure to give the current production data, and vice-versa, fn other words, in verse in inventories is tantamount to positive production and decrease in invenio- fies to negative production. The price (valuation) of the inventory is usually im- puted on the basis of the cost of production. Incidentally, note that if some inven- fory is lost during the current period due to theft, fire, earthquake or such other reasons, itis considered as a loss, which reluces the current profit by the loss evunt and thereby compensates for the cost of production of that lost inventory Such produced but lost inventory is not a part of the output. Transactions in old goods and the secondary capital market, barring commis- sions, if any, are excluded from the GNP. Even transactions in the PAmarY capital market are ignored until they lead to purchase of goods and services. Thus, trade in old cars/houses/other items and in equities/bonds are,not part of the GNP, barring the commission, if any, by intermediaries. This is because the ‘commissions alone constitute the current production. The second hand sales either do not reflect current production (sale of an old car by one person 10 another) or they involve double punting (purchase of a new Maruti car by a household from Marat Udyog and sale fo another household). Similarly, purely financial transactions are mere exchanges . Capital gains/osses are also ignored in the GNP as they are eamed over a period of time and not usually during the current year. Thus, if an art collector sels his painting ‘and makes a capital gain, the sales proceed does not enter the GNP as the painting was produced several decades ago. The year the painting was produced, it was @ pat of the national income but | 24 Macroeconomics SINCE it Was not marketed then, it remained outside even the national income. Thi is is for the reason explained below ‘The GNP accounts only for goods that are traded through the oficial market ‘This is a limitation of the measure but it is resorted to internationally owing to the difficulties in measuring non-marketed or not officially marketed production, Thus, it ignores the ‘do it yourself” activities (which are not paid for) as well as the un/ ander reported productions. For example, the household work, including babysitting, whitewashing of own house, and tutoring of own children and other do it yourself activities are excluded, while payments to maid-servants, washermen, paid babysitters, private tuitions and so on are included in the GNP. Also, activities like painting, drawing, photography ctc, which are carried out for self-consumption (or even for sale but not in the current yeas), are left out of the GNP. Similarly, unreported productions (though a part of market transactions but not a part of official transactions) triggered by the desire to avoid excise duties or for other reasons, are not included in the GNP. These give rise to what is called as the black (parallel) economy, which has two components: legal but un/under reported and illegal like gambling, drinking, prostitution and narcotics, which do not even war- rant reporting. These are by all means parts of income but there is a problem in their valuation and information. This introduces a downward bias in the measurement of GNP. Also, some other market transactions, which are very much official, like transfer payments (and capital gains/losses, as mentioned above) are not included in the GNP. This is because such transactions do not constitute current production. To appreciate this, consider the transfer payments, which are of two types: public and private. Public transfers are social security payments, relief payments and retire- ment and pension payments, which the government makes to houscholds. In these transactions, the recipients make no contribution to the current production in retum for these benefits (retirement and pension payments are for the past work, and not for current work). As such, they are excluded from the GNP. Private transfer payments, such as son paying father for his old age expenses, father's gift to son, ‘and a rich households'/countries gift to poor persons/countries do not entail produc tion but simply the transfer of funds from one household to another. Thus, not all the officially marketed transactions are included in the GNP. There are two excep- tions even with regard to the exclusion rule of non-market transactions: (a) Self-consumption of production by the producers is valued, and js included in the GNP. Thus, the farmers" consumption of their own food grains is a par of the GNP. . (0) Rent on owner-occupied houses is computed and included in the GNP. “These two refinements in the GNP measures exist internationally, for these pose no serious difficulties in information gathering and valuation, and they are quite @ large part of the GNP. The prices of these items are imputed on the basis of comparable market prices. Ths, the ule that only official transactions are consid- ered in GNP is more of a convention than logic. "Raw materials, and intermediate goods (i.e, goods resold or used for further production during the measurement period) are not included in the GNP, so as to ‘avoid double counting of production, Thus, wheat used in making bread, leather vced in making shoes and tyres used in cars are excluded because these are con- a sis tained in the values of bread, shoes and cars, respectively. Alternatively, on one can think of recording value added at each stage of production. Thus, if wheat used in the production ofa loaf of bread is valued at Rs 2, wheat flour produced by the miller is valued at Rs 2.25, bread sold by ‘and that purchased by the household costs paise, the baker 75 paise, and the vendor Rs 3.50 and not the sum total of the values ‘of wheat, flour and bread. If the valuc- ‘added concept is used, then the farmer produces Rs 2 worth of GNP, the miller 25 the baker to the vendor is valued at Rs 3 Rs 3.50, then GNP due to this production the value of the final goods (goods that are produced and sold for consumption of investment) are included in the GNP. Incidentally, note that business planis and equipments, though used for further production, ave final investment) goods and so apd in the GNP. Unlike raw materials and intermediate goods, plants and equipments are not consumedido not disap 60 paise worth of GNP. Therefore, only i pear in the production process, Of course, the depreciation on them does take place but the same is taken out when the net national product is calculated, Similarly, r call that additions to inventories, though used for further production, are part of the GNP. ‘The GNP belongs to the nation, and thus, it must be produced by its owned factors of production only, Since some factors of production like labour, entreprs neur, and capital are globally mobile and we do have multinationals operating in tnany countries, a part of this GNP is produced abroad and a part of foreign GNP is produced under a nation’s territory. Thus, four-month's Visiting Professorshi if an Indian resident professor takes up @ in a University in the United States, his income in there will be a part of India’s GNP and simitarly the profit that a foreign owned firm (say Citibank) makes in India is not a part of India's GNP. Thus, for GNP, the location of production is immaterial. GNP, (GNP at market price) is inclusive of the indirect taxes (T). net of subsi- dies (S)"ss it values the goods and services atthe prices paid by their end users. To get the GNP at factor cost (GNP,), one must deduet net indirect taxes from GNF GNP, = GNPy~ T, +S @ay Gross Domestic Product The GDP refers to the value of the goods and services produced within the nation’ ownership of the resources. Therefore, in is United States GDP while Citibank's income in Indi geographical territory, irrespective of the the above examples, the professor's salary India’s GDP. In view of this, while the GNP consists of income produced by the nation’s owned resource’, irrespective of the place of production, GDP refers to income produced within the nation’s territory, irrespective of the ownership of the resources thal produced it. The difference between the two concepts earned abroad (NIA). Thus, is accounted for by the net factor income GDP;= GNP, - NIA (2.2) From the point of the employment generation at home, GDP is more relevant than GNP, and hence, the former oftcn receives greater attention than the latter. Other Income Concepts Corres sponding to GNP and GDP, there are NNP and NDP. The difference between the gross and the net is the capital consumption, called depreciation (D). Thus, np, = GNP, -D (23) 26 Macroeconomics NDP, = GDP, - D (2.4) 1c is the NNP,, which is referred to as the national income. This is because depreciation is really the consumed part of the fixed capital in the production process and itis difficult to measure it accurately (what we have is the accounting ‘and not the economic depreciation). Also, changes in the indirect taxes and subsi- dies are caused by government actions, they constitute transfer payments and repre- sent no production. Moreover, this measure alone represents the income eared by domestically owned basic factors of production, namely, land, labour, capital and entrepreneurship. In every county, there are the government and the private sectors. The former consists of the Central, state and local governments, and the latter includes households, Firms are owned both by the government and the households. The national income belongs to both the government and the households. There are three measures of households’ income. They are, private income (Pvt. !) personal income (PI) and personal disposable income (PDI), and they refer to the income earned by, income received by and income available for disposable to the Households, respectively. The relationships between the national income and these households” income are described by the following identities: Pvt. | = NNP, ~ IAD - END + NDI + TAD + OTA (2.5) PI = Pvt. [-RE-CT (2.6) -HDT- MAD 2 (2.7) where Pvt I = private income 1AD income of government administration departments from entrepreneurship and property (eg. railways, post and telegraphs department) END = eamings of government non-department enterprises (public sector units) NDI = national debt interest on domestic debt TAD = current transfers from government administration departments OTA = other net current transfers from abroad RE = retained eamings of nation’s private corporate sector CT = corporate tax HDT = household direct tax MAD = miscellaneous receipts of government administration departments (court fee, etc.) ‘The new items in equations (2.5) through (2.7) are relatively small magnitudes and mostly self-explanatory. It would suffice to mention here that IAD and END are the goverment incomes and, thus, while a part of the national income, they are not components of private income, NDI is a peculiar public transfer payment. It is the payment for the use of public debt incurred in past wars and other government programmes and as such does not represent a purchase of a current good or service. It is considered a transfer payment and hence not a part of the national income, but surely a past of the private income. Also, NDI is subject to tampering through more or Jess borrowings by the government and, hence, like depreciation, must be ex- cluded from the national income. TAD (consisting of direct subsidies, social secu- rity payments, relief payments etc.) represents the transfer payments financed from taxation and as such are a means of redistributing income. They are, as stated _———— National income 27 above, not factor incomes and do not form a part of the national income, However, they are a component of private income. Similarly, OTA is a part of private income ut not of the national income. It would thus be clear that personal income or rather personal disposable income is one which the private sector has for using freely on Consumption and saving. This is basically the national income (or NNP at factor cost) after adjusting for government/public income, corporate savings in the form of retained earnings and the direct taxes in the form of personal income tax and corporate taxes. Though improvements in the national income and production accounts are con- sidered as a significant development in economics during the last century, it is obvious from the above description that the data are still far away from perfection, Nevertheless, they are good enough for a reasonable assessment, particularly for the purposes of comparison over time and across countries. To throw some ight on the relative significance of the various items in India’s national income accounting, and their movements over time, data on them is provided for 1980-81, 1990-91 and’ 2000-01 (the latest year for which data was available) in Table 2.1 Table 21 National Income and Related Aggregates (at Current Prices) (Rs crore) sgeVari a “ © 1980-81: 1990-91. 2000-9). 1. GNP at market prices 1,36,358 527,989 —-20,70,574 1.1 Indirect taxes: 16,746 76,329 2,47,528 1.2 Subsidies 3.160 18,609 95,383 2. GNP at factor cost (1 - 1.1 + 1.2) 1,22,72 470,269 18,78,429 2.1 Net factor income eamed abroad 345 -7545 17,414 3. GDP at factor cost (2 - 2.1) 1,22,427 477,814 18,95,843 3.1 Capital ‘consumption 12,087 52,195 1,986,447 4. NNP at factor cost (NI) (2 ~ 3.1) 1,410,685. 4,18,074 16,79,982 5. NDP at factor cost (3 - 3.1) 4.10340 425619 16,97.396 5.1 Income of govt. admn. depts. trom entrep. 554 4564. 19,887 and property 52 Saving of govt. non-dept. enterpri 820 2555 21,891 5.3 National debt interest 1824 20,233 1,09,222 5.4 Current transfers trom govt. admn, dept. 2835 15,641 61,300 55 Other net current transfers from abroad 2257 at 58,412 6. Private income (4 ~ 5.1 - 52 + 63+ 6445.8) 1,17,587 4,50,5620 18,67.438 6.1 Retained earnings of nation’s private sector 584 6198 90,531 62 Corporate tax 1378 5335 28,487 7. Personal income (6-6.1~6.2) 1,15,605 4,38,987 —18,08,420 7.1 Household direct tax 2197 7593 50,996 7.2 Miscellaneous receipt of govt. admn, dept, 303 2097 7317 8. Personal disposable income (7-7.1-7.2) 4,193,108 4,209,297 _17,80,107 ‘Source: National Accounts Statistics, CSO, various Issues. A careful study of the above data would reveal that the difference (positive) between the ‘« Incomes at each of the market price and factor cost stands’ at about nine per wane 28 Macroeconomics _ # domestic and national incomes is around one per cont gross and net incomes comes to around eleven per cent. © private and national incomes approximates a little over eleven per cent. ‘personal income and national income is little less than eight per cent. © personal disposable and national incomes is a little over four per cent ‘Thus, the shares of the various items in national income stand approximately at: nine percent for net indirect taxes, one percent for net factor income earned from abroad, eleven per cent for depreciation, eleven per cent for various items that distinguish private income from national income, three per cent for corporate taxes and retained earnings, and three per cent for household direct taxes and miscellane- ous receipts of the goverment administrative departments. 2.2 ECONOMIC UNITS AND CIRCULAR FLOW OF INCOME On the basis of the economic units, the nation could be stadied through five sectors: (a) households, (b) firms, (c) financial institutions (capital market), (d) the govern ment and (e) the rest of the world. These five sectors interact, produce and circulate the income. The process of sources and uses of income is depicted in Fig. 2.1 and explained briefly below. Al the factors of production are assumed to be owned by houscholds. Households supply these factors to firms (governmental, private and joint), who produce all the GNP. The firms pay factors’ rewards (rent, wage, interest and profit) to households, corporate tax to the government and for imports to the rest of the world, and maintain the balance as savings with financial institutions. The firms, in turn, receive payments for supplying consumption goods to households and to the government. ‘They also receive subsidies from the government for their exports to rest of the world, and raise funds for the investments from financial institutions. The government receives corporate tax from firms and personal tax from households and advances subsidies to firms and transfer payments to households, besides paying firms for their expenditure on goods and services. Its savings (lack of savings) go to (come from) financial institutions. Financial institutions receive savings from all the three sectors (households, firms and government) and pay for all the investment goods to firms. Households receive payments for all owned factors of production from firms and transfer payments from the government. It pays firms for consumption goods, personal tax to the government and puts its savings in financial institutions. This process continues period after period and this is how income is produced and Circulated among the various sectors of the economy. Incidentally, note that this process assumes that all the production takes place at firms, all the investments are made by firms and all the savings go to financial institutions. These are merely simplifying assumptions and their relaxation does not pose any conceptual problem, ‘The circular flow of income shows leakages (withdrawals) from the national ineome, which does not form a part of the expenditure on national product. These are savings (S), taxes (T) and imports (M). Also, it indicates injections (additions) into expenditure on national product, which do not come from national income. These are investment (I), government expenditure (G) and exports (X). These injections (A) investments savings | | (ve) q die) & ' eA S ® D “ Rents + wages + interest + proft] Fig. 2.1. Circular Flow of income and leakages are related. Saving partly or fully, as do taxes finance government expenditure. Also, some of the expenditure on imports provides foreigners with the means (0 purchase our exports. ‘Although the leakages may eventually finance the injections, they do not cause them. There is no reason for T =GandM =X, but the total planned leakages must equal the total planned injections for the equilibrium to hold: S+T+M=1+G+X (2.8) ‘The above equation indicates that in an open economy imbalances: finances investment, there can be three gaps! 30 Macroeconomics ¢ Investment-saving gap Fiscal deficivsurpluss © Current account (of balance of payments) deficivsurplus However, the sum of the three gaps must equal zero. In India, investments have always exceeded savings and governments have often experienced fiscal deficits, and the two have been financed by the deficits (imporis minus exports) in the current account. 2.3, INCOME MEASUREMENTS As was implicit in the previous section, national income could be measured in three different ways: ‘* Production or value added approach # Income approach * Expenditure approach . And if done correctly, the following equation must hold Production = Income = Expenditure 2.9) This is because the three approaches are circular in nature. It begins at produc- tion, through recruitments of factors of production, generating and going as incomes to factors of production, who expend it on production. A brief discussion of these approaches follows. Production Approach Under this approach, the GDP at the factor cost, is measured as the sum of the values of the flows of value added from various produc- tion centres or of the production of final goods and services. Thus, the GDP at the factor cost is given by GDP, = P,Q, + P,Q, +... + P,Q, (2.10) = LRG where P, = price of final good i Q, = output of final good i n= number of goods and services produced in the economy Incidentally, note that equation (2.10) assumes that all productions can be valued in money terms. The production sectors are conveniently classified into (a) primary, (b) second- ary and (c) tertiary. The primary sector includes agriculture, forestry and fishing, and mining and quarrying. The secondary sector consists of manufacturing, electric ity, gas and water supply, and construction, The tertiary sector consists of all items under services. The contribution of cach of these sectors and their sub-sectors to the GDP at the factor cost (at current prices) during 1950-51, 1980-81, 1990-91 and 2000-01 is reported in Table 2.2, A distinction is also made between the agriculture, industry and services sectors. ‘The first sector includes items | and 2 of the table, the second, items 3, 4, 5 and 6 and items 7 through 12 go in the third sector, - oe a _National Income 31. Table 2.2 Gross Domestic Product at Factor Cost by Economic Activity (at Current Prices) | Sevtor Wins) Wanaytowo7_2mn-or | 3B nme, ee es | 1, Agriculture 347 263 227 | 2. Foresty and tishiog 36 00OC8A TD 3. Mining end quarrying o7 15 25 24 \ Secondary 14.5 24.4 26.9 248 4. Manufacturing 5 ot77sto7 158 | 5. Electrty, gas and water supply 02 172226 8. Constwuction oe CO OO Tertiary (Services) 29.0 36.0 39.7 48.2 7. Trade, hotels and restaurants 65 12.0 13.0 13.8 8. Transport, storage and communication 35 47 7A 7a 9. Banking and insurance 0.8 28 44 62 10. Real estate, dwellings and business 92 6.0 a7 6.3 services 11. Public administration and defence 3.0 47 S7 66 12) Other services go 88 BBO GDP at factor cost (Rs crore) 8979 -1,22,427«4,77,814 18,95,843 ‘Source: National Accounts Statistics, CSO, various issues. A careful examination of the data in Table 2.2 would reveal that in the last 50 years, the share of both the secondary and tertiary sectors in GDP has increased substantially at the cost of that of the primary sector. Further, the role of the tertiary sector has grown at the fastest rate. This is a sign of prosperity, provided. of course. the requirements for wage-goods are met reasonably well! This will be obvious if, ‘one examines similar data for high and middle-income countries. In 2001, the share of agriculture, industry and services in GDP stood at about 2, 25 and 73 per cent in United States, and approximately at 9, 49 and 42 per cent, respectively in Malaysia In the same year, the world average for the shares of these three sectors stood at about 4, 30 and 66 per cent, respectively. Thus, the production structure in India is still quite primitive. Incidentally, note that since the data in table 2.2 is on produc- tions from various sectors in the Indian territories, the sum total is domestic produc- tion; since they are gross of depreciation, it is gross domestic product; and since they are valued at the factor cost, itis the GDP at factor cost. Income Approach Under the cost or income approach, the national income equals the sum of the costs of production of goods and services, which equals the earnings that households receive for their factors of production. These include the wages and salaries received for the supply of labour (W); rents for land, buildings, equipments, and the like (R); interest for borrowed capital (I); and profit for entre: preneurship (P). Thus, the NDP at the factor cost is given by NDP, = W+R+1+P (2.11) Transfer payments/receipts, such as unemployment benefits and pensions are not included in income. Since there are self-employed people in all countries, and they rarely classify their incomes into the above four components, the functionally slsuelmited national income data contains a mixed income category, Further, a sig- haticant proportion of the Indian peopte are self-employed and accordingly, the mixed income category is a dominant component here. ‘The Indian data on income by factors’ share (functional distribution of income) for the selected few years are given in Table 2.3. Some columns in this table are blank as comparable data is not available, The data reveals that labour commands the maximum share in NDP (above 40 per cent) and that its share has increased over time, The labour share is ‘over whelming in all countries, For ‘example, in the United States in 1997, the share of employee compensation in national income stood at 72 per cent; the share of other factors were at 12, 6, 2 and 8 per cent for corporate profits, net interest, rental income and proprietor's income, respectively. Table 2.3 NDP at Factor Cost by Factor Incomes (at Current Prices) (9 shave) Facror income 1960-61 19RA-RS 1980-8) 1Y90-9F 199-94 7, Compensation of employees, wae 368° 98.4 ‘374 2. Operating surplus 7 15 12.9 2.1 Rent 52 3S 2.2 Interest 32 86 2.3 Profit and dividend 67 60 3, Mixed income S12 397 555 50.1 497 4. NOP at factor cost (Rs crore) 1,10,940 4,25,619 6.51.92 5. Property incomes (Rs crore) 9920 49,673 78,179 5.1 Rent 24.0 24 22.0 5.2 Interest 76.0 786 78.0 Note: Rant paid by an Industry for land, structures, machinery, equipment etc. is treated as 2 factor payment, Except for residential builings, no imputation for rent for using own buildings, machinery and equipment is made. Source: National Accounts Statistics, CSO, various issues Expenditure Approach Under this method, national income is measured as the sum of all final expenditure, Final expenditure consists of expenditure on private consumption (C), gross investment—both private and public (1), expenditure on government (federal, state and local) consumption (G). foreigners’ expenditure on our exports of goods and services (X), net of our expenditure on impons of goods and services from abroad (M), Therefore, GDP at the market price could be measured as GDPy=C+1+G+X-M (2.12) It must be noted that what is not consumed is saving, Further, while saving equals investment in the world as a whole, the same is not necessarily true for a country. ‘This is so because some countries save more ‘and some less than they need to invest ‘The balance between the supply of savings and the demand for investments is met by financial-flows between economies, the net of which is given by the difference between imports and exports of goods and services. ‘Thus, saving = incom’ © private consumption ~ government consumption = investment + exports ~imports. This relationship as well as the one in equation (2.12) are similar to the leakages = injections equation (vide equation 2.8). To see this, let us work on equation 2.8. Note that private saving = NI + TP - HDT - CT — C, and total taxes (net of subsidies and transfer payments) = HDT + CT + Indirect taxes — Subsidies Recall equation 2.8: S+T+M=1+G+X \3 Substituting for S and T, and calling NI as Y, we get sy (¥ + TP - HDT — CT ~ C) + (HDT + CT + Indirect taxes - Subsidies ~ TP) + M_ | ee =14+G4X \8 On solving the equation and rearranging the terms, we get | é Y=C414G4X~M - (Indirect taxes ~ Subsidies) | 2 This is the GDP at factor cost version of equation (2.12) above. {2 Equation (2.12) is often referred to as the income identity. It also indicates that > the difference between the gross domestic product and the gross domestic expendi- ture equals net exports of goods and services. It may be clarified that C includes all households’ expenditure on non-durable goods and all durable goods, except land and buildings, which are included in gross investment. Government consumption, called government final consumption expenditure, includes government purchases of the services of its officials and non-durable goods/services from other suppliers to provide collective services (defence, justice, health, education etc.). The govern: ment renders these services free or at a token fee and they are not included in private consumption. I consists of expenditures on structures (residential and busi- ress), equipments and inventories. “The data on these components of expenditure on the final goods are provided in ‘Table 2.4. The data reveal that while the share of private consumption declined significantly until 1990-91, it went up marginally during the last decade. Quite the opposite has been the trend for the share of investment in total expenditure, There has been an upward trend in the shares of both the government expenditure, and foreign trade in, goods and services. Incidentally, note that the structure of expenditure for (C), (1) and (G) in India compares fairly well with the world average of around 58, 22 and 18 per cent, respectively. However, India's foreign trade in goods and services falls much shorter than that of the world average, which stands at 30 per cent for export and 28 per cent for import of goods and services. It is instructive to note that India's trade has expanded at a faster rate in last couple of years. In 2002, India’s exports were at 17 per cent and imports at 18 per cent of the GDP. Even so, in terms of foreign trade, India remains a relatively closed economy. It is known that the United States emphasises on consumption while China on investment. Thus, in 2001, the shares of consumption, investment and government consumption expenditure in the GDP stood at 69, 21 and 14 per cent in the United States and 46, 38 and 14 per cent in China, respectively. Even in trade of goods and services, China enjoys a much larger relative share than the United States. In 2002, while the proportion of exports of goods and services to the GDP and import of goods and services to the GDP stood at 11 and 15 per cent in the United States, the said numbers in China were at 26 and 23 per cent, respectively. It is instructive to note that the sum total of the items in the above table is GDP at market prices, as investment here is gross, the various expenditures are on the domestically produced goods and services, and these are valued at the market price as they happen to be payments made by the final buyers. Also, note that the sum of C, I and G does not add to 100 per cent, because of the net exports, which is the fourth component of domestic expenditure. 34 Macroeconomics Fable 4.4 CDP at Market Price hy Expenditure (at Current Prices) (% sharey? Heod of expenditure 99091" 2000-01 Private consumption 617 a2 Investment (gross) 252 229 Govemment expenditure 115 13.2 Exports 76 139 Imports (minus) 76 10.0 ot 167 GOP at market prices (Re crore) «9968 1,06,013,85,894 20,87,988 Note: Sum may not add to 100% due to siatistical discrepancies Source: National Accounts Statistics, CSO, vatious iasuee, The government budget constraint is given by G+TP=T+GBD (2.13) where TP = all transfer payments from governments - GBD = government budgetfiscal deficit 1 taxes Note that (G) (government expenditure) does not include transfer payments from the government, for they are not part of the GNP. Government income from depart- mental and public sector enterprises, and the proceeds from disinvestments are included in (T). GBD is financed through printing money (monetised deficit) and/or borrowing from citizens and/or abroad. This assumes that the government either makes no investments or itis included in (G). ‘The above three measures are used to generate income data. Since production must equal income, which must, in turn, equal expenditure, all the three approaches are expected to yield identical results, However, some statistical discrepancy might crop up due to the vast data and, thus, some allowance is often made for such errors. Depending upon the state of perfection in the data collection, different countries luse one or more approaches to arrive at the estimates of the national income. In India and most other countries, the production approach is used for incomes from the commodity producing sectors (primary and secondary, barring unregistered manu- facturing and electricity, gas and water supply) and the income approach is used for the rest. Since there is no unique measure of production in services, the income approach is used globally. Here it must be noted that since employees are not always paid equal to their contributions, the income remains an imperfect measure of output. For example, under the Fourth Pay Commission report, the Government of India granted @ big increase in the salaries of its staff while there was no corre- ‘sponding increase in production. Thus, this is yet another shortcoming in the meas- ‘urement of national income. The Central Statistical Organisation (CSO) is in charge f the national income accounts in India. The first official estimates were presented in 1956 and since then they have been presented on a yearly basis. It may be worthwhile here to indicate that while there are several versions of income and that they are really different, in the macroeconomic analysis of business cycles and growth only national income (and disposable income) is commonly discussed. Thus, indirect taxes, subsidies, depreciation and net factor income from abroad are ignored to avoid complications. Lr { { Notional Insorne 2.4 NOMINAL AND REAL INCOME Income is measured in the nominal as well as veal evtns, ‘The former is ohne | when outpuis are valued at thelr comresponding current prices and the Tatler ie Minained when outputs ara valued at their conreaponding Constant prices (prices prevailing in the choven base yen), hus, a Nominal income ® £ HOF (2.14) ira Real income » PP Qt (218) ih where Ps oc price of good / in the current year Of = output of good 4 in the current year P) = price of good (in the base year Hoth these concepts arc useful, While nominal income is the true measure of income, a change in it over timo is poor indicator of the change in the economi well-being of the carer, This is because, this could change due to # mere change i prices or a change in it could be composed of changes borh in the output as well a6 in the prices. As such, if an individual's income doubles and the prices of all the goods and nervices that he buys with all his income also double, there is no change in bis purchasing power or economic well being, Therefore, for judging the change in economic well being, we need to remove the price-effect from the changed income. The real income concept achieves this by valuing all the goods and vervices fat their corresponding prices in somne base year and, thus, a change in it indicates & ‘change in the purchasing power over the base year, ‘The ratio of the nominal 10 real income is called the Income deflator, Thus, in 2000-01 India’s nominal national income was Rs 16,79,982 crore and her real income (income at 1993-94 prices) ‘was Rs 10,57,982, and the income deflator stood at 1.5879. Computation of the real income creates problems duc to the emergence of new products and change in the quality of products over time, as those products have no price during, the bave year, when they did not exist. ‘Approximations are made (0 take care of such difficulties. Also, in real income calculations, the choice of bave year is significant, lest it gives distorted information. In this context, the controversy ‘around the late Professor Raj Krishna's ‘Hindu Rate of Growth’ is well known, In the mid-1980s, the policy makers had argued that India had entered jnto higher growth era, which the late Professor Raj Krishna denied on the grounds that they ‘were basing their calculations on the 1979-H0 base, which happened to be a nepa- tive growth year in the country, For this reasom, the bave year has 10 be a normal year, neither too good nor too bad, und ‘also not a year of significant events, 2.5 MEASURED AND PPP INCOME Gustav Cassel coined the concept of the purchasing power parity (PPP) income 1923, though its intelectual origin could be traced 10 the early 19th century 'n the 36 Macroeconomics writing of David Ricardo. The concept is used to convert the country wise measured (at the official exchange rate) income data into the comparable (purchasing power equivalent) income data across countries. The national income data of different countries is constructed on the basis of the corresponding country's data on prices of goods and services. Since prices vary across countries, countrywise national income data is not comparable. To overcome this difficulty, the World Bank has designed a scheme of converting all individual country's income data into the PPP income data, by computing the PPP of each country’s currency in terms of the US dollar. Thus, the PPP of Indian rupee = number of Indian rupees required to purchase a repre- sentative basket of goods and services in India that ‘one US dollar will buy in the United States. Accordingly, PPP income of India = (Measured Income of India) Official Rupee ~ Dollar Rate PPP of Indian Rupee Thus, referring Table 1.1 of Chapter 1 (also Table 2.5 on page 2.19), while the measured (nominal) per capita income of India in 2002 was US $480, its PPP counterpart was US $2570, giving a PPP correction of 5.35. This means the price in the United States is about 5.35 times the Indian price for a representative basket of goods and services. Tius, by the PPP theory, the Indian rupee is highly undervalued (by a factor of 5.35). On this same basis, it can be found through the data in Table 1.1 that the price in the United States was about 4.67 (4390/940) times China's price, while Japan's price was only about 78 per cent (26,070/33,550) of the United States price in 2002. For international comparison, the PPP income is certainly a better measure of purchasing power than the measured income. The PPP income data of various countries are given later in Table 2.5 and analysed subsequently. 2.6 INCOME AND HUMAN DEVELOPMENT INDEX Human Development Index (HDI) is yet another measure used for the measurement of the extent of development across countries. It is based on three parameters: ¢ Per capita GDP-PPP (income) @ Life expectancy at birth (health) Adult literacy, and primary, secondary and tertiary enrollment rate (skill) ‘These three ingredients are combined into an overall index called HDI by the United Nations Development Project (UNDP) and the UNDP publishes this data for various nations over time regularly. The above three variables are combined through a methodology into the HDI. This is not a place to go into its details but it may be noted that © Per capita GDP-PPP is adjusted to some normalised figures where relatively high values are reduced to smaller figures and the numbers below US $5500 are left unchanged, The adjusted income data are then transferred into the GDP index of 0 to 1. * Life expectancy is also converted into an index with a value of 1.00 if itis no less than 85 years and to 0.0 if it is no more than 25 years. = @ Literacy and enrollment data are combined into an education index betwee. and 1 by giving two-thirds weight to the former and one-third to the latter ‘The respective index takes a value of 1.0 if the rate is 100 per cent, and 0 if |" the rate is $ per cent or less. «The three indices are then combined into a simple arithmetic average to arrive at the HDI. ‘Thus, HDI is more comprehensive than income for assessing the health of 8 country. The international data on this index is provided and compared later in this chapter. It may not be out of place to nore that India's Human Resource Develop tment Minister, Murali Manohar Joshi, has challenged this measure as it ignores spirituality, morality, satisfaction and crime rate, which are integral parts of Human Resource Development. * 2.7 INCOME AND WELFARE Recall that national income is supposed to measure the material well being of the nation. However, due to several measurement errors, it remains a misleading meas- wae of material well being and itis even less effective ot ‘a measure of welfare. This is because welfare is an economic concept ‘and it is tantamount to happiness OF quality of life and, thus, it is. @ much broader concept than income or even human development. It includes not only raaterial well being but also other aspects of cconomic welfare, such as leisure, education, health, environment, mutual respects dignity, honour, respect for the family values, religion, culture, customs, traditions, habits, emotions and the like. The reason these factors are left out is that they have no price tags. Although our pet capita income is only 2 fraction of that of North ‘americans, many of the latter think that ‘Indians are happier than them. Even in India, "the same is true regarding the rich when compared to their counterparts 1 middle income and happy: families. Th is true that in the absence of a better measire, national income is taken as 2 surrogate measure of economic welfare. However, jt is obvious that the per capita income (national income divided by the population) is a better indicator of the standard of living than national income, For example, the national income of India is over five times that of Malaysia but the standard of living in the former jis much rower than that ofthe latter as the per capita income of the former is merely one- seventh of the latter. Thus, om the yardstick of per capita income, India emerges a5 one of the poorer countries in the world, ‘Also, per capita income is subject to the uneven income distribution problem ‘and it is said that “growth without social justice js inhuman and social justice without growth is impossible” ‘Thus, though it is undoubtedly true that ours js a relatively poor country, our poverty is perhaps exaggerated by the per capita income measure aS it suffers from the twin limitations, viz. those due (0 errors in the measurement of national income, and those due to income being an imperfect measure of economic welfare. TO * summarise. 38 Macroeconomics { National Income: (@), Ignores the non-market’ and unotficialrharker (paralleVblack)' economy. Thus, income underestimates the mate llsbeing: (b) Measures the output of the services! sectér erroneously. Thus, material wall being 1s’ poorly measured by {ricdriig: ae Le Baa SR (©) Ignores the quality of products, which may nol be ‘accurately meastirod by” their: prices. Hence, income: Is’ bus ‘Mneasivte ‘Of triaterial: vo -beingia! eR cee ot, aE 5 (@) .18:valued atsthe official exchange rate, tor, intemational comparison, and. is therby. often. over. or under. valued; Ft, example, ‘in uly 1991, India | devalued its currency, by t 9g) 3 ‘The relative size of these factors varies across countries and, hence, they do affect the relative welfare of people. Due to this, efforts are on to develop indices to evaluate the quality of life by measuring the status of economic welfare. Currently, we have the Corruption Index, ‘Competition Index’, and so on. However, efforts towards a comprehensive welfare measure are still far from perfection, and accord ingly, per capita income (PPP) and HDI are sil used as alternative measures of the standard of living over time and across countries. Recall that even these magnitudes | fo not include all the above variables and it is perhaps true that less developed | economies are not as poor as revealed by their per capita incomes OF HDI alone. ‘What then is the bottom Line for the measurement of economic well being? This is sil debatable, However, internationally, GDP per capita is considered as the one. ‘To be more fair, it should be GNP per capita, adjusted, in some way, for non- market and parallel economy, everage work hours (oF leisure), quality and length of life (education, pollution and life expectancy) ete. a8 they alone determine the current consumption level, and the saving-investment rate, which, a5 would be Sbvious later, determines future consumption levels. vor international comparison, related data on the economic well being and’progress for selected countries are provided in Table 2.5, (Saving-investment data are given Jater in Chapter 6). The data reveal the following: ‘e The United States happens to be the largest economy and this is true not only for countries included in the table but also for the world as @ whole, both in teams of the measured as well as the PPP level of GNP. Furthermore, United Stutes GNP is around one-third of the world’s GNP. This is so partly because the United States ranked 5" (PPP) or 6” (Measured) in per capi income and 3 in population in the world in 2002, and ‘countries ranking 1" and 2" in population (China and India, respectively) have rather low ranks in terms of per capita income. India takes the 4th position in terms of the PPP GNP and the 11" position in measured GNP in the world, The same for China stand at 2” and 6", respectively. The other high PPP GNP countries are Japan, Ger- many, France and the United Kingdom, in that order. “The other high measure GNP countries are Japan, Germany, the United Kingdom, France, Italy and Canada, in the descending order of their ranking. Switzerland enjoyed the third highest measured per capita income (US $37,930), the first two ranks being taken by Bermada and Luxembourg, while the United States had the third highest PPP per capita income (US $35,060), the first two ranks being taken by Luxembourg and Norway, in a ‘sample of 208 countries in 2002. India takes « rather low rank with 145th for PPP and 159th for measured per capita income, Countries with higher meas- ured per capita income include Norway, the United States, Japan, the United Kingdom, Germany, Canada, France and Singapore, in that order, while coun- tries with higher PPP per capita income include Switzerland, Denmark, Ice- land, Austria and Canada, in descending order. «© China has attained the maximum growth rate in per capita income during the 1990s, thereafter, ASEAN nations enjoy the next position, and India stands uch above the average rate of growth in the standard of living. ¢ Japan tops the list in terms of life expectancy at birth rate with an echieve- ° nent at 85 and 78 years for males and females, respectively. India’s success in this regard is quite low at 64 and 63 years, respectively. ‘© Adult illiteracy is close to zero in most developed countries but itis still quite high in India, standing at 31 and 54 for men and wornen, respectively. 002 *UeE POM ‘soIPO;PU! weudo}eneg PLOM 'e00 'dONN ‘vodey weuxdojeneg ueWnH ‘E002 Lodey jeUdoyeneG PUOM ‘seaunoS | zec'0 = = = = zt use ‘0805 zs6'97 —PAV'IE PLOM | ze L ° 9 oe se ozs orig, < cztt 806 voneieped ueissny | sro zp aB is ozs eo- oae 062 cot 6 Bu96in, ses'0 ° ° 2 @ Lz ose'9z On'6s 2S use eyensny | eco u s ok se osee ove eye) us | sero uw a i908 zt ov61 ou 192 ueisned 12Z0 tz 8 69 eh oe o6ey ove pun | eee € ‘ wo BL “yy car's: 066 Raioy jo ayandey | 06z'0 at 8 02 se osze ovse esheeW | ze9°0 a 8 v9 89 0662. ore B1S@UOPUl | 7880 u ° 92 og 060'ez 069'02 ssodebus ze6'0 ° ° “2 @ osz'se —oe'ze pusaZins | 260 ° ° 8 ouo'92 ©——oss'te vader oe60 ° ° sz 08 ous'sz —ose'st wop6um pawn 460 ° ° a ; ove'zz ‘epoueg 60 o ° re 8 seis pewn oss'0 vs te co 8 Bui g eopouey S7OW_ SaTouack FON Z 2 (1H) i 8 ese (s1026) 8) mawdopanap (ssa) 1007 To0z 4H14- 32: a 3) woumy Kosa ampy — Kounisadx2 2ffT fawn | sayqeven parejay pue awo>uj uo reg jeuonewsaiu| SZ 21901 a Norway tops the list in human development, with HDI of 0.944, India takes, the 127th position out of the 175 countries. Countries with high HDI include Iceland, Sweden, Australia, Netherlands, Belgium, the United States, Canada, Japan, Switzerland and the United Kingdom, in that order. This ranking is given by the Human Development Report, which has a sample of 175 coun- tries and the latest available data are for 2001. ‘According to this report, Thdia’s rank, in terms of the per capita income (PPP), is 115. This, together With India's HDI rank, implies that India's position is worse on the skills and health fronts than in per capita income alone. For more detailed data and their analysis, readers may 60 through the original sources, However, itis rather clear from the above data that there are wide varia~ tions in income and other related variables across nations and India has a long way to catch up, even if tis able to accelerate its relative growth rate.” yy pus vopSnPon iwed * References. 1. EPW Research Foundation. ‘National Accoun's Statistics of India-1 and -2', Eco: omic and Political Weelly (November 18, 1995): 2955-64 and (November 25. 1995): 3021-36. 2, Ghosh, Arun, “International Comparisons of National Income: A New Methi Economic and Political Weekly, (June 11, 1983). 3, Parker, R-H and G C Harcourt (ed). Readings in the Concepts and Measurement of Income, (Cambridge: Cambridge University Press, 1969). odology”. SS Review Questions 1. Which of the following activitiesitransactions are included: in the national income son (0) A maid servani’s work in her employer's house (c) A vegetable vendor's profit 3 (dA: worker's wage on her employment (@). Direct sale. of arrold car by:Mohan to Mahesh ‘Deprecinton of inachines die to wear, tear and obsolesence \ excise duty

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