Dissecting computation of national income

The output of goods and services is a continuous process, so in trying to measure what is produced, we are dealing with a flow and not a stock. We calculate the flow of output over time and the period used for this purpose is invariably one year. The total national product includes services and goods because production is defined as any economic activity for which people are ready to pay and which satisfies a want.

Gross Domestic Product (GDP) is defined as the money value of all goods and services produced in a country, usually for one year. However, placing a monetary value at times is a bit confusing and misleading. While doing so, many other elements are at times left out in the computation process. So when we talk about Gross National Income, the word ‘National’ requires some explanation. Gross National Product (GNP) is not the value of the total output produced within Bangladesh. The total product of all resources located within Bangladesh is known as GDP. The difference between GNP and GDP is essentially a matter of ownership. Some of the Bangladesh’s output is produced by resources owned by foreigners. And this leads to a flow of income (interest and profits) out of the country.

On the other hand, Bangladesh-owned assets abroad lead to a corresponding flow of income from overseas into Bangladesh. The net difference between these flows is recorded as net property income from abroad. When this item is added to GDP, we arrive at GNP.

GNP, therefore, is the total output from resources owned by the residents of a country wherever these resources happened to be located. GDP is the total output from all resources located inside the country, wherever their owners live. The word ‘gross’ indicates that no deduction has been made for that part of the total output needed to maintain the nation’s stock of capital assets. The output value required to replace obsolete and worn-out capital is called ‘depreciation’ or ‘capital consumption.’ The total output of capital goods is Gross Investment, and the net addition to the stock of capital is known as Net Investment.

Net National Product consists of all the goods and services becoming available for consumption and the net addition to the nation’s stock of capital. This is the total which is generally known as ‘National Income’. However, National Income is a notional value, not an exact figure, as while calculating NI, a number of mistakes are either taken into account or left out of computation. Therefore, NI is never an accurate and authentic figure. Therefore, some items are not included while calculating NI or left out of calculation due to placement of their value. For example, services provided by housewives at home could not be measured in terms of money value. Therefore, they are left out of computation. This could have a major impact on the NI figure.

The first problem that arises is that of valuation. The total output consists of various goods and services whose quantities cannot be added together in physical units. For example, kilograms cannot be added to metres. The only possible unit of measurement is money. Suppose all commodities have money value/prices. In that case, the products of the quantities and the prices will give us total money values. Although money is the only measuring unit, it also raises difficulties. Since money value changes from year to year and time, it is difficult to compare the output value.

Difficulties are encountered when goods and services do not have market prices. They are primarily public goods and services such as defence, law and order, health services, etc. They are certainly part of the national output. The only solution adopted is to measure their value ‘at cost’.

A similar problem is encountered with the goods and services that people provide. For example, farmers consume some of their own output, or repair work done by one on a ‘do it yourself’ basis cannot have market value as these activities do not go through the market. Since there is no reliable market indicator, the assumed value must be an arbitrary estimate, or it may be decided to omit the item from the calculation of national output.

Adding up the total outputs of all enterprises in the economy will give us an aggregate many times greater than the actual value of the national product. The problem here is one of the ‘double counting’. It arises because the outputs of some firms are the inputs of other firms. So the easy way to deal with such a problem is to take the value of the final product.

The value of the national output is measured at factory cost, in terms of the payments made to the factors of production for services rendered in producing that output. Using market prices as a measure of the output value can be misleading when market prices do not accurately reflect the cost of production including profits. At times market prices contain some element of taxation, and a few of them include an element of subsidy.

So it would be very misleading to use the figures for National Income at market prices since it would mean that the value of national output could be increased by an increase in the rates of taxation.

Computing NI by output method or income method uses the output figures of all firms in the country. We know the problem of ‘Double Counting’, so we must either use the value-added method or take the total value of the final products. Exports are included because they are part of national output, but imports of materials and services must be excluded. If the value-added method is used, imports will be automatically excluded. This will give us GDP and to this total, the net property income from abroad must be added. Suppose the general level of prices has been changing during the course of the year. In that case, it is necessary to make an adjustment for the monetary changes in the value of stocks.

All personal incomes are not included in the NI to compute NI under Income Method. We take only those earned for services rendered and in respect of which there is some corresponding value of output. In advanced economies, a sizeable proportion of total personal income comprises ‘Transfer Payments’. These payments take the form of Social Security payments such as old-age pensions, unemployment pay, child benefits, and the like. All these are transfer payments not because they are paid out of taxes, but because they are not payments for services rendered ---there is no contribution to current real output by the recipients.

The official statistics record income for wages, rent, interest, and profits and self-employed in a separate income category. They are recorded as gross before taxes are paid. This is the measure of the factors’ contribution to output. However, all incomes generated in production do not find their way into personal incomes. Some proportion of profits will go to build reserves for the companies. In the case of profits of nationalized industries, a proportion may go to the government and not to persons. These undistributed surpluses must be added on to the totals of factor incomes received by persons. To reach the accurate income figure, we must include the item ‘net income from, abroad’ and adjust stock appreciation.

To estimate the value of NI by expenditure method, we must record the final expenditure. Expenditure on intermediate goods and services must be excluded. There are several adjustments to the total national expenditure to arrive at a figure of NI at factor cost. This method necessitates some adjustments to take into account international transactions. Total domestic expenditure includes spending on foreign goods and services (imports), which do not generate factor income at home. On the other hand, it does not include expenditure by foreigners on domestically produced goods and services (exports), which do generate income at home. So we add exports and deduct imports from total domestic spending.

Comparing National Income over time also poses problems. Prices tend to increase over time. So an increase over the period does not necessarily indicate that there has been an increase in the number of goods and services produced in the economy. If the rate of economic growth is greater than the rate of prices (inflation), it can only be said to increase output. Inaccuracy of the statistics poses another problem. NI statistics are inaccurate, and therefore, it is impossible to give a precise figure for change in income over time. Inflation affects changes in real income over time. The inevitable errors made in calculating inflation compound the problem of inaccuracy. The statistics provided by NI accounting can simplify the procedures and techniques used to measure the aggregate input and output of an economy. The data provided is used to frame the government’s economic policies. It helps recognize the systematic changes happening in the economy.

NI accounting provides information on the trend of economic activity level. Various social and economic phenomena can be explained through the data, which helps policymakers frame better economic policies. Bangladesh Bank can use the NI accounting statistics to fix the interest rate and revise the monetary policy. The data on GDP investment and expenditure helps the government to frame or modify policies regarding infrastructure spending and tax rates. The NI accounting data show the contribution of different sectors toward economic growth. NI is used to make comparisons over time and between countries. It is also used to make a judgment about economic welfare. Growth in NI is usually equated with a better standard of living. Therefore, it can be concluded that the computation of NI is a guide to having a notional idea about which way the country is heading.

The writer is former Director General, Export Promotion Bureau. He can be contacted at hassan.youngconsultants@gmail.com