Measuring GDP in India – The New Way
Ever since, the govt. changed the GDP calculation methodology, a pandora’s box seems to have been opened with some of the experts even questioning its efficacy in depicting true picture of Indian Economy and labelling it as mere window dressing of numbers. Let us demystify the entire GDP issue.
What is GDP and why do we need to calculate it?
GDP or gross domestic product is a measure of economic activity in a country. It is the total value of a country’s annual output of goods and services.
Simply put, GDP is the total value of goods and services produced within the country during a year. You take all final finished goods and services produced domestically in volume terms and multiply this by their market prices to arrive at the value of output. Intermediate goods need to be excluded to avoid double-counting.
Thus, in simple terms, if we value the total amount of goods (from needle to aeroplane) produced in India and total value of services (banking, insurance, coaching etc.), the number which we will get will be India’s GDP. However, measuring the same is not as easy as it sounds. India is vast country with huge population, majority of which is working in unorganised sectors. So, arriving at the value is quite a big task in itself.
Importance of GDP:
- GDP gives an overall picture of the state of the economy.
- GDP enables policymakers and central banks to judge whether the economy is contracting or expanding, whether it needs a boost or restraint, and if a threat such as a recession or inflation looms on the horizon.
- The national income and product accounts, which form the basis for measuring GDP, allow policymakers, economists and business to analyze the impact of such variables as monetary and fiscal policy, economic shocks such as a spike in oil price , as well as tax and spending plans, on the overall economy and on specific components of it.
Policy makers, investors, economists, businesses, bankers, politicians, and even the media keep a close watch on GDP estimates. GDP provides one single number that represents the monetary value of all the finished goods and services produced within a country’s borders in a specific time period.
Different ways of measuring GDP
GDP can be estimated using three different methods:
- PRODUCTION APPROACH: The production estimate is based on the value of final output in the economy less the inputs used up in the production process. Final outputs include products such as cars, while intermediate goods are inputs used in the production of another good or service, such as car tyres, electricity and advertising. As the value of the final good (the car’s price) reflects both the value of its inputs (the tyres) and the engineering expertise of the manufacturer, adding the final output of the tyre manufacturer to final output of the car manufacturer together would overestimate GDP. To avoid this double counting, the value-added at each stage of production is calculated and aggregated. This is known as gross value added (GVA), which is further adjusted for taxes and subsidies on products to create a GDP estimate. Thus,Gross Value Added = Value of Final Product – Value of Intermediate Goods
- EXPENDITURE APPROACH: The expenditure estimate is based on the value of total expenditure on goods and services, excluding intermediate goods and services, produced in the domestic economy during a given period. Whereas the production approach captures the value of production, the expenditure approach reflects the value of spending by corporations, consumers, overseas purchasers and government on goods and services. The primary data for this measure come from expenditure surveys of households and businesses, as well as from data on government expenditure. Thus,
GDP = C + I + G + (X-M) where
- C: Household spending
- I: Capital Investment spending
- G: Government spending
- X: Exports of Goods and Services
- M: Imports of Goods and Services
- INCOME APPROACH: The income estimate measures the incomes earned by individuals (for example, wages) and corporations (for example, profits) directly from the production of outputs (goods and services).Here GDP is the sum of the incomes earned through the production of goods and services. This is:
- Income from people in jobs and in self-employment +
- Profits of private sector businesses +
- Rent income from the ownership of land =
- Gross Domestic product (by factor incomes)
How is GDP calculated in India?
The Central Statistics Office (CSO), under the Ministry of Statistics and Program is responsible for calculating national income and GDP in India.
How the process works?
CSO sources its data and calculates the economic growth rate.
There are eight sub-heads under which GDP data is presented.
- Agriculture (including forestry & fishing)
- Mining and quarrying
- Electricity, gas, water supply and other utility services
- Trade, hotels, transport, communication and services related to broadcasting
- Financial, insurance, real estate and professional services
- Public administration and defence and other services
The next step
GDP is measured through output approach and expenditure approach. The above sub-heads when added up amount to GDP calculation through the output method.
Under the expenditure approach of measuring GDP, the various components include private consumption expenditure, government consumption expenditure, investment, change in stocks, valuables and net exports.
Though GDP measured from either side should be equal, since reliable data is not available for private consumption expenditure, there is always a difference in the two ways of measuring GDP. The difference is usually put as “discrepancies” in the expenditure approach of measuring GDP.
However, experts contend that this does not impact the credibility of overall GDP data as India collects such data through the output approach and tries to fit it into the expenditure approach.
What are the changes in the new GDP methodology?
There have been two changes to the GDP calculations.
One was a change in the base year for the calculation which is done routinely every five years or so. The government changed the base year for estimating GDP from 2004-05 to 2011-12.
The other was to adopt a new method to measure output.
Starting now, Indian GDP will be measured by using gross value added (GVA) at market price, rather than factor cost.
In India, GDP did not include what that the Government received . Now, what it earns by way of indirect taxes such as sales tax and excise duty after deducting subsidy is also added into the GDP.
With indirect taxes added and subsidies deducted under the new GDP calculations, there is more incentive for the Government to raise indirect taxes and reduce subsidies. This may have an impact on sectors such as agriculture which receive a lot of subsidy.
To understand the difference, let us look at it from the producers’ point of view. For a producer, GDP at factor cost represents what he gets from the industrial activity. This can be broken down into various components — wages, profits, rents and capital — also commonly known factors of production. Aside from these costs, producers may also incur other expenses such as property tax, stamp duties and registration fees, among others.
Similarly, producers may also receive subsidies (production related) such as input subsidies to farmers and to small industries (not food or petrol subsidies that you get on the final product). It is important to note that only taxes and subsidies on intermediate inputs are adjusted.
For arriving at the new gross value added (GVA) at basic prices, production taxes, such as property tax, are added and subsidies are subtracted from GDP at factor cost. Put simply, GVA at basic price represents what accrues to the producer, before the product is sold.
Also, under the new series, the headline growth is based on GDP at constant market prices — involving more adjustments to the above calculated GVA at basic prices. The first level of adjustment is to convert to market prices.
The price paid by the consumer is not the same as the revenue received by the producer. This is because of the taxes that are paid to the government in the form of indirect taxes. Similarly, the consumer may receive subsidies on food or petrol.
GDP at market prices makes adjustment for any such subsidy or indirect tax — to arrive at GDP at market price, indirect taxes are added while subsidies are subtracted from GVA at basic price.
The new GDP incorporates more comprehensive data on corporate activity than the old one. Earlier, data from the Annual Survey of Industries (ASI), which comprises over two lakh factories, was used to gauge activity in the manufacturing sector. Now, annual accounts of companies filed with the Ministry of Corporate Affairs — MCA21 — has been used. This is said to include around five lakh companies, bringing in more companies from the unlisted and informal sectors.
Two, until now, the manufacturing data was compiled factory-wise. Now, activity at the enterprise-level is taken. This means selling and marketing expenses are also reckoned, instead of just production costs.