Measurement – class 2

National Accounting - GDP

Practical information

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Statistics: 2 good textbooks

• For those who want to catch up: – Wonnacott and Wonnacott (Eng. or Fr.)– Full of examples, exercises– Empirical approach

• For those who want more math: – Tassi (Fr.)– Theoretical approach

Econometrics: 1 good textbook

• Empirical, excellent– Wooldridge: Introductory Econometrics, a

modern approach– Full of examples, exercises– Empirical approach

Measurement – class 2

National Accounting - GDP

What are National Accounts?

• A conceptual framework

• A number of people working in NSIs over the world

• Goal = to provide conceptual and measurement tools to describe the economy COHERENTLY

What are National Accounts?

• National accounting – a set of rules and definitions for describing and measuring economic activity (production, income…) in the aggregate economy – that is, in the economy as a whole.

Question

• Any idea how much is the GDP of the US? Of France? Of another country?

• (US $14,000,000,000,000 // FR 1.7 milliards €)

• Introduction: the Germany, dec. 2004 example

1.1. Defining GDP

1.1. Defining GDP

• OECD comments:• “Based on strong export growth, the German

economy is recovering from three years of stagnation. Weak domestic demand is still weighing on activity although there are signs that investment is strengthening. Private consumption declined as consumers’ confidence remained subdued and rising unemployment, tighter social security benefits, and accelerating consumer prices reduced disposable income growth.”

1.1. Definition• Gross Domestic Product (GDP) is the total

value of all the output (production) of an economy during a given period of time.

• Represents the amount of money one would need to purchase a year’s worth of the economy’s production of all final goods

• It is the single most-used economic measure

1.1. Defining GDP

1.1. Defining GDP

• Calculating GDP requires adding together million of goods and services.

• All goods and services produced by an economy must be weighted.

• Each good and service is multiplied by its price• Once quantities of a particular good or service

are multiplied by its price, we arrive at a value measure of the good or service

• All the units of value are added to arrive at GDP

1.1. Defining GDP

• Produced by whom?– Firms– Non-profit institutions– Government bodies– Households

• Produced where? – On a given territory: difference GDP / GNP

1.1. Defining GDP

• Example: Germany vs Luxembourg

1.1. Defining GDP

• GDP Is a Flow Concept– Only what is added to the economy between

Jan N and Dec. N– The store of wealth is a stock concept

► Wealth accounts – a balance sheet of an economy’s stocks of assets and liabilities

1.1. Defining GDP

• Introducing the OECD’s “pasta example”

1.1. Defining GDP

• GDP as an economically relevant aggregate

• Does not depend on the way the economy is organized

• Key concept: value added – VA = value of the output – value of

intermediate consumptions– Avoids double counting

1.1. Defining GDP

1.1. Definition

• GDP = value added

= outputs - intermediate cons°.

More accurately, GDP = gross value added + taxes - subsidies on products

1.1. Defining GDP

• Why “gross”?– It means the consumption of capital is not

counted– New wealth created during the period = NDP

= GDP – cost of using up capital (CFC)– A better measurement in theory– But measuring CFC is complex and different

across countries– Rankings and growth remain the same with

NDP or GDP

1.1. Defining GDP

• Demand = Investment + final consumption

– Investment = ‘Gross capital formation’ / ‘Gross Fixed Capital Formation’ (excludes stock-building = “changes in inventories”)

• “Gross” because CFC not deducted

– Consumption = ‘Household final consumption expenditure’. All purchases but dwellings, counted as Household GFCF

1.2. The expenditure approach

OUTPUT (SUPPLY) = DEMAND

• Pasta example (2)

1.2. The expenditure approach

• GDP = final demand aggregates

= HC + G + GCF + (X - M)

Can be rewritten as

SUPPLY = DEMAND

1.2. The expenditure approach• Example: Germany, 2004

1.3. The income approach

• Production generates income, shared between 3 “factors of production” : Labor, Capital, Intermediate consumption

• Value added is shared between K & L

OUTPUT = INCOME

V.A. = Wages + Profits

= compensations + operating surplus + ‘mixed income’

Conclusion of part 1 (1/2)

• 3 approaches to GDP

– OUTPUT: value added

– FINAL DEMAND : C + GCF + (X-I)– INCOME : compensations + profits

The Circular Flow

Goods

Rest of the WorldRest of the World

Financial marketsFinancial markets

GovernmentGovernmentFirms

(production)HouseholdTaxes

Factor services

SavingsImports

Government

Spending

Wages, rents, interest, profits

Exports

Investment

Personal consumption

© 2004 The McGraw-Hill Companies, Inc.

Calculating GDP: Some Examples

• Selling your two-year-old car to a neighbor does not add to GDP.

• Selling your car to a used car dealer who then sells your car to someone else for a higher price, adds to GDP.

• The value of the dealer's services is added to GDP.

Conclusion of part 1 (2/2)• Ex: Germany, 2004

GDP Components of Measurement

GDP Components of Measurement

Consumption 69 %

GDP Components of Measurement

Consumption 69 %

Investment13%

GDP Components of Measurement

Government Spending

19%

Consumption 69 %

Investment13%

Consumption 69 %

GovernmentSpending

19%

Net Exports -1 %

Investment13%

2. What is production?

• Most of what is included in production is uncontroversial

• Everything that is sold = OK

• But what about government (army, education…?)

• Services by households: paying your neighbor to mown the lawn ? Doing it yourself?

2. What is production?

• Services of H to themselves: no – Cooking, cleaning, child care…– Main reason: would mean making very bold

estimates of market value• Cost of such a service?• Opportunity cost? Whose wage?

– Consequence 1 (Hicks): marrying your cook reduces GDP (anecdotal)

– Consequence 2: dvp of services to households while women go into the labor force increases GDP twice (serious)

Unpaid domestic work: 30 to 50% of GDP

Source: OECD report

2. What is production?

• Services of H to themselves: no– Exception: homeowners’ “housing service to

themselves”– Rationale : growth in ownership rate would

make GDP decline? + international comparisons

– No direct measurement possible imputation– Paid services by households are estimated

(babysitting…)

2. What is production?

• Goods produced by H for themselves: yes– Esp. food produced for own consumption– Not big in industrialized countries, but ++ in

developing countries– Tools, furniture… as well

• The GOODS produced by Households are included, the SERVICES are not (except housing)

2. What is production?

Source: Understanding National Accounts, OECD, 2006

Schéma ins and outs (0)

Market transactionsProduction

Schéma ins and outs (1)

A = Market transactions not in production: “past and future production”

C = home production of services (except housing)

D = illegal activities

B = production not on the market but estimated

Schéma ins and outs (2)

2. What is production?

• The illegal & the underground economy– Illegal = forbidden trades

• Not estimated, in practice, except some countries• Under 1% of GDP in OECD countries

– Underground = allowed but hidden to escape taxes

• Estimated by national accounts and included in GDP

2. What is production?

• The underground economy : how does INSEE (France) estimate its production ?

– Black labor: + 1% GDP• Estimated sector by sector on ‘expert knowledge’

(investigations + sociological research)

– Tax evasion: + 3% GDP• Inference from tax investigations + theoretical VAT

calculated on recorded transactions

2. What is production?

2. What is production?

• Market sectors whose output is difficult to measure (1)– Banks: how to value the lending of money?

• Difference between interests paid and interest received = “FISIM”

• Formula = (rl-rr).L + (rr-rd).D

L = loans /D = deposit– rr in Europe = average of inter-bank rate and longer-term

rates– rr in the US = rate on US treasury bonds

• Output = consumption => allocated between firms’ int. cons. and households’ final consumption

2. What is production?

• Market sectors whose output is difficult to measure (2)– Insurances : Premiums = indemnities + claim

expenses + profit• Output = claim expenses + profit• Calculated as premiums received – indemnities

paid out

– Income from invested premiums “theoretically” belong to the households

• Output = premiums received + investment income – indemnities paid out

2. What is production?

• General Government– Defense, education, health care, foreign

policy, economic policy…– Output is calculated as the sum of production

costs:• Intermediate consumption• Compensation of civil servants & other employees• Consumption of fixed capital• Taxes (in rare cases)

– Pb: no return to investment!• Ex: x-ray machine at a public hospital vs. at a clinic

3. Defining final uses

• The “expenditure approach”

• Final uses = final expenditure = demand

GDP = final demand aggregates

= HC + G + GCF + (X - M)

= domestic demand + external demand

3. Defining final uses

• The subcategories of GDP can be misinterpreted.– For example, the line between investment and

consumption is often fuzzy.

• Ex: where would you classify the expenses of companies on software?

3. Defining final uses

• Households– By convention, all their purchases are final– Even cars, or wine they will keep for years– Except dwellings, counted as GFCF

3. Defining final uses

• Government– By convention, general government

consumes the goods it produces

3. Defining final uses

• Firms: “The GFCF borderline”– Most capital goods are straightforward:

machinery, warehouses, offices, factories…– In principle, the difference btw GFCF and int.

cons. is “used entirely within a year”.– How about software then? It is now included

in GFCF– Mineral exploration is now included in GFCF

3. Defining final uses

• Firms: “The GFCF borderline”– Intangible assets: trademarks, copyrights?

• Theoretically included in GFCF

– R &D expenditures?• Not yet included, but will be in 2012

• Shows that national accounting is a live process, ever adapting to changing economic realities…

3. Defining final uses

3. Defining final uses

• Imports and exports– “degree of openness” is important in

economics

3. Defining final uses

• Imports and exports– Here, the definition of the Economic territory is

very important– Ex: French overseas territories were

previously NOT included in France’s ntaional accounts

– Now, they are less import/export + output of overseas firms included in France’s production

– “resident units”: more difficult to define when borders blur (transnational workers, firms…)

4.1. Measuring GDP

• How do we obtain these figures? – These are STATISTICS : estimates,

approximation– Very different from corporate accounting!

4.1. Measuring GDP

• Firms: sources from taxation– Companies tax declarations (profit taxes)– France: 2 million firms– Problems with improvements in definition of

GFCF: software is not recorded as investment by firms (current expenditure) approximation from other sources

– Value of copyrights as GFCF : not properly estimated

4.1. Measuring GDP

• Government: – “public accounts directorate” merges together

accounts of central gvt, local authorities and other gvt institutions

4.1. Measuring GDP

• Households: more complicated – No accountants doing the bookkeeping!– Consumption: retail sales – the share

assumed to go to firms (rough estimate!)– Car registrations– Tax data for tobacco & alcohol sales– Gas and electricity: until now, state

companies– Little if no use of HBS (used products are not

to be counted in N.A. + value-added break up. Ex: organized travel)

4.1. Measuring GDP

• Households: more complicated – Compensations: from firms, gvt and non-profit

units– Dividends = by difference

• Dividends received by H = dvd paid by firms – dvd received by firm and gvt – net dvd from abroad

– Admittedly not entirely satisfactory• Concentrates measurement errors on H

4.1. Measuring GDP

• Imports and exports– OK for goods that go through customs: data

from customs service– But services escape measurement!– Have to rely on surveys of firms dealing with

the rest of the world– Another challenge for national accounting!

– Plus, European market no more compulsory declaration, but customs surveys

– Total EU-EU exports > total imports by 5% !

4.1. Measuring GDP

• Statistical but no way of measuring its accuracy

• No confidence interval

• Not “sample survey inference on population” framework, but mix of sources, adjustments…

4.2. Quarterly accounts

• Use monthly indicators to extrapolate value of N.A. variables

• Example 1: turnover estimated through VAT declarations, used to estimate growth of output (neglecting changes in stocks)

• Example 2: car registrations (new license plates) used to estimate car consumption

4.3. When is GDP “final”?

• Never… (new base years)

• April Year n + 3

Conclusion

• Measurement is necessary.

• GDP measurement categories have made it possible to think and talk about the aggregate economy.

“Lessons to be learnt” (1/2)

• Aggregation means comparison: making things equivalent under some respect (here: market value)

Always wonder what kind of aggregation made a figure possible

• Flow variables vs. stock variables

Always wonder what you have and what would be more relevant

“Lessons to be learnt” (2/2)

• Trade-off between getting information fast & reliability

statisticians vs. political demand (unemployment figures as case in point)