How to understand the new GDP measurement in India?

The Central Statistical Office of India has upgraded the National Income Accounting standards by introducing some notable changes early this year. This has resulted in increased GDP for the country for many years and it became a notable issue globally.

1. Why the GDP accounting norms are changed?

Most tempting factor that compelled the CSO to introduce these changes is to make India’s national income accounting standards in conformity with global standards.

Globally, most accepted and followed national income accounting format is the System of National Accounting (SNA), prepared by the UN and ratified by the IMF, World Bank, OECD and EC.

The SNA describes a coherent, consistent and integrated set of measures in the context of internationally agreed concepts, definitions, classifications and accounting rules.

2. Globally accepted standard: the SNA

The SNA was launched in 1992 and upgraded in 2008. Because of these globally accepted norms and their refinement, GDP estimation methods have to be changed in India as well. Besides, the CSO has adopted a new base year of 2011-12, instead of the previous one – 2004-05. This change in base year is a normal exercise as Base year is changed in every ten years.

Now, the changes made by the CSO have resulted in notable increase in India’s GDP figures. We can say that three types of changes were made by the CSO in the GDP estimation procedure.

  • Methodological changes
  • Change in the base year
  • Giving comprehensive coverage to all sectors.

Of these changes, the most important is the methodological changes in the form of a shift to GDP in market prices from factor costs. Globally there is a consensus that GDP in Market Prices is more powerful and useful than GDP in factor cost. Eminent Macroeconomist, Gregory Mankiw defines GDP: “GDP is the market value of all final goods and services produced within a country in a given period of time.” (Mankiw, 1998)

3. Methodological Changes

Methodology is the science of doing something.

Specifically, there are two methodological changes adopted by the CSO in its new estimates and both are highly interrelated.

  • GDP of the country is to be estimated in terms of Market Price
  • Gross Value Added (GA) from different sectors will be calculated at basic prices.

Actually, estimation of GVA at basic prices is a step to measure the GDP at market prices. That is why both of these changes are interrelated. To understand the changes, we should learn some basic concepts; especially the following:

  • What is GVA (Gross Value Added)?
  • What is GVA at basic prices?
  • What is GDP at market prices?

What is Gross Value Added (GVA)?

As a national income estimation identity, Gross Value Added 9GVA) measures the contribution to of an economy, producer, sector or region. GVA provides the rupee value of the amount of goods and services that have been produced, less the cost of all inputs and raw materials while producing these goods and services. There can be GVA for a firm, industry, sector or the entire economy.

To estimate the GVA for the entire economy, we have to cumulate the GVA for all sectors.

Hence, first we should calculate the GVA of each sector in a prescribed format. Here, the SNA and the new methodology adopted in India calculate sectoral GVA at basic prices.

When using production or income approaches to estimate national income are adopted, the contribution to an economy of a particular industry or sector is measured using GVA.

Gross Value Added at basic prices (sectoral GVA)

Gross Value Added (GVA) for a sector is the sum of expenditure made in that sector.

As we have mentioned, the new methodology measures Gross value added at basic prices instead of at factor costs. The following identity reveals us what all expenditure items are considered when we calculate Gross Value Added in a particular sector at basic prices.

Gross value added at basic prices = CE + OS/MI + CFC + production taxes less production subsidies.

CE – Compensation of Employees

OS – Operating Surpluses

MI – Mixed Income

CFC – Consumption of fixed capital

Why tax has to be added and subsidies have to be reduced?

Taxes are out of the effort (production) of the producer. Actually, it is brought out of his income. On the other hand, subsidies are not his income, it is accrued from outside. Subsidies are not out the contribution of the concerned firm. So, taxes to be added and subsidies should be reduced to estimate the GVA of the concerned firm/sector.

Let us explain this in simple terms. The above identity says that GVA is the sum of payment made to labour, surplus of the business entity (profit), income of the self-employed people etc (Mixed Income) and the money we keeps to replace the existing machineries (CFC). These are the expenditure item for a firm, industry etc.

Now, what is unique about Basic price* is that it measures the GVA by adding production taxes and deducting production subsidies **. To understand the production taxes and subsidies, please look at the foot notes at the end.

In this way, the first step in calculating the GDP ie., obtaining sectoral GVA is completed. Now we have to cumulate these sectoral GVAs to get the GDP. The important thing is that GDP is measured now at Market Prices instead of at factor cost.

How GDP is calculated at Market Prices?

The new methodology measures GDP at Market Prices compared to the previous factor cost estimation. We have to understand that GDP at Market Prices has a standard format that it is measured by adding product taxes*** and deducting product subsidies***.

GDP at Market Prices is calculated as the total (or sigma ∑) of the GVAs.

The important thing is that from the cumulated or total GVAs, product taxes are added and product subsidies are deducted to get the GDP at Market Prices.

4. Change in the base year

The base year for national income estimation in the country has changed to 2011-12 from 2004-05. Usually a base year change is done periodically to accommodate the changes in the economy. Here, 2011-12 is considered to be a stable year among the available options.

5. More coverage

The coverage has been enhanced with greater representation of manufacturing and financial sectors and this became a notable change that caused an upward revision of GDP for few years. Comprehensive coverage of the financial sector including that of stock brokers, coverage of activities of local bodies etc marks a deviation that seems to have caused the increase in GDP figures.

Additional Explanations

*Basic price is the amount receivable by the producer from the purchaser for a unit of a good or service produced as output minus any tax payable, and plus any subsidy receivable, by the producer as a consequence of its production.

**Production tax and production subsidies- these taxes are paid by the producer independent of the quantity of production. Meaning is that the production tax is not per unit tax imposed on a commodity. Rather it is a general tax. Examples are land revenue and stamp duty.

The same is applicable for production subsidy. It is not the subsidy availed in terms of per unit of production.

*** Product taxes and Product subsidies – Product taxes or subsidies are paid or received on per unit of the product. Examples for product tax are excise duties, sales tax etc. Food, fertilizer and fuel subsidies which are provided per unit are product subsidies.