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National income accounting

V. Prasanna Bhat

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, na mely, 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 oper ated 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. Th us, 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. Sin ce 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). Howev er, 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 allow ance 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 Indi an 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 renderin g 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 eco nomy 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 su btracted 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-t axes 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 summarised 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.

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 i ncomes 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:

A Identifying the producing enterprise and classifying them into industrial sectors according to their activities; and

A 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, insuranc e, 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 value-added or n et 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 owner-occupied 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 producti on 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 entreprene ur 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 calcula tion 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, un distributed 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 sh ould 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 exp enditure 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 expen diture 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 beca use 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 i nvestment 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.

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, i n 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.