The value of expenditures
National income accounts (NIAs) are fundamental aggregate statistics in macroeconomic analysis. The ground-breaking development of national income and systems of NIAs was one of the most far-reaching innovations in applied economics in the early twentieth century. NIAs provide a quantitative basis for choosing and assessing economic policies as well as making possible quantitative macroeconomic modeling and analysis. NIAs cannot substitute for policymakers’ judgment or allow them to evade policy decisions, but they do provide a basis for the objective statement and assessment of economic policies.
Combined with population data, national income accounts can provide a measure of well-being through per capita income and its growth over time. Also, NIAs, combined with labor force data, can be used to assess the level and growth rate of productivity, although the utility of such calculations is limited by NIAs’ omission of home production, underground activity, and illegal production. Combined with financial and monetary data, NIAs provide a guide to inflation policy. NIAs provide the basis for evaluating government policy and can rationalize political challenges to incumbents by people who are dissatisfied with measurable aspects of the government’s policies. In emerging and transition economies, implementing a dependable and accurate system of NIAs is a crucial step in developing economic policy.
NIAs, to be most useful, require honest and timely publication. Long-delayed information is of no use either in making policy or in monitoring the efficacy of policies already implemented. Delay frequently implies that the government has something to hide. Indeed, once released, NIAs can enforce their own discipline. That is, obfuscation cannot be maintained by altering or exaggerating one aspect of NIAs, say investment or growth of total income, since each such number is related to others, and consistency is a check on the accuracy of the components. Because the data cannot easily be faked, autocrats are loathe to publish their countries’ NIAs and either proscribe or delay their release. Turkmenistan’s dictator, for example, does not report to the IMF, and the governments of Myanmar (1999) and Zimbabwe (2000) ceased reporting NIAs. Conversely, nation-states that are committed to democracy report their NIAs, warts and all—for example, Croatia or Nigeria and proto-states such as Montenegro or Kosovo—laying bare the economic policy issues that confront them.
Measuring National Income
National income is the total market value of production in a country’s economy during a year. It can be measured alternatively and equivalently in three ways:
The value of expenditures
The value of inputs used in production
The sum of value added at each level of production
That the first two measures are identical can be seen by considering that any good—say, a loaf of bread—can be equivalently valued as either the price that is paid for it in the market by the final consumer or as the distributed factor payments—to labor (wages) and to capital (rent, interest, and profit)—used in its production. Since national output is the sum of all production, the total value will be the same whether added up by final expenditure or by the value of inputs (including profit) used in their production. The equivalence of the last measure can be seen by noting that the value of every final good is simply the sum of the value added at each stage of production. Again, consider a loaf of bread: Its value is the sum of the value of labor at each successive stage of production and other ingredients added by the farmer (wheat production), the miller (grinding to flour), the baker (flour plus other ingredients), and the grocer (distribution services).1
The broadest and most widely used measure of national income is gross domestic product (GDP), the value of expenditures on final goods and services at market prices produced by domestic factors of production (labor, capital, materials) during the year. It is also the market value of these domestic-based factors (adjusted for indirect business taxes and subsidies) entering into production of final goods and services. “Gross” implies that no deduction for the reduction in the stock of plant and equipment due to wear and tear has been applied to the measurements and survey-based estimates. “Domestic” means that the GDP includes only production by factors located in the country—whether home or foreign owned. GDP includes the production and income of foreigners and foreign-owned property in the home country and excludes the production and incomes of the country’s own citizens or their property located abroad. “Product” refers to the measurement of output at final prices as observed in market transactions or of the market value of factors (inclusive of taxes less subsidies) used in their creation. Only newly produced goods—including those that increase inventories—are counted in GDP. Sales of used goods and sales from inventories of goods produced in prior years are excluded, but the services of dealers, agents, and brokers in implementing these transactions are included.
Measured by expenditures, GDP is the sum of goods and services produced during the period. Total output comprises four groups’ purchases of final goods and services: households purchase consumption goods; businesses purchase investment goods (and retain unsold production as inventory increases); governments purchase goods and services used in public administration and welfare transfers; and foreigners purchase (net) exports. There is substantial uniformity in the shares of consumption and investment (the sum of capital expenditures and inventories) across nations with quite disparate income levels. As Table 1 shows, household consumption accounts for the largest share of GDP, an average of 65 percent for the nine countries considered; when added to government consumption, the share approximates 80 percent. Investment (gross capital formation plus increases in inventories) typically accounts for around 20 percent, although rapidly developing countries such as Thailand have higher investment and lower consumption shares. With few exceptions—for example, oil-exporting countries such as Nigeria—net exports are typically within plus or minus 5 percent of GDP. Five of the countries shown had average trade deficits during the fourteen-year period.
Measured by inputs, GDP is the sum of payments to domestic factors of production—wages, salaries, rent, interest, and profit, where profit is gross of the depreciation of domestic fixed capital—plus indirect business taxes less net subsidies to business. Because the value of any good or service is the sum of its inputs plus profit, the sum of the labor services, capital services (gross profit including depreciation), and indirect taxes less net business subsidies must equal the value of output, GDP. The third method of measurement is the sum of value added at each stage of production of each of these final goods and services.
The Importance of NIA Data in Policy and Development Analysis
The development of NIA statistics provided the potential for converting economic policymaking from a rule-of-thumb-based guessing game to a quantitatively based science. Yet, policy remains, in part, a normative decision process, and rival politicians, as advocates of conflicting policy agendas, frequently assess the economy’s performance differently and argue for divergent policies, even when citing the same NIA data. People’s disagreements often are based on the distribution of income as opposed to its average level. Nevertheless, quantitative assessments of the economy and its growth bring discipline to the discussion.
The importance of accurate and accessible NIA is implicit in an observation made by a West African policymaker: “What cannot be measured cannot be managed.” Of course, implementing measurability does not imply that all economic processes are manageable; and, in the case of government expenditures, unlike the other components of GDP, there is no way to assess value from observing voluntary market transactions. Because government expenditures are neither voluntarily elicited nor priced in the market, they are valued at cost, which is primarily the cost of labor. The capital cost of the buildings and land used is not included.
Limitation of NIA as a Gauge of Welfare
Per capita GDP is frequently used as a measure of welfare, both for indicating the rate of improvement over time and for comparisons across nations. Yet per capita GDP is an imperfect indicator of welfare of the representative individual. GDP does not account for nonmarket production in the household—for example, meal preparation, cleaning, laundry, and child care. Therefore, when these activities are, because of greater labor force participation, shifted to the market—as restaurant meals and semiprepared foods in grocery stores, cleaning and laundry services, and day care—the change in the value of production is overstated due to the decline in nonmarket (household) production. Second, gray market and illegal activities—such as production and distribution of marijuana or gambling—can be significant sources of sustenance in economies but are not included. Third, in benign climates, clothing and heating are less costly, so comparing across countries (or across regions within large states) will distort the relative level of well-being. Fourth, government services, because not subject to a market test, will typically be worth less than they cost, even though cost is used as a measure of value. Fifth, per capita income—an average measure—can be a misleading image of the representative resident’s well-being if the distribution of income is very unequal. A better measure is the median income level and, for many analytic purposes, the income level by quintiles of the income distribution; however, such distributional measures cannot be directly obtained from GDP data and population and require separate surveys. Another limit on per capita income as a measure of well-being is that it flies in the face of the way people think about having children. Most young couples see themselves as being better off when they have their first baby, even though the immediate impact is a 33 percent drop in the family’s per capita income.
History of NIA
An indication of NIAs’ impacts on economics is that the third and fifteenth Nobel Prizes in economic science were awarded largely for contributions to the development of national income statistics—to simon kuznets in 1969 and to richard stone in 1984. Their citations also noted the men’s advocacy roles in persuading the United States and United Kingdom to devote adequate resources to produce and maintain timely and accurate NIA data.
Working for the U.S. Commerce Department in the 1930s, Kuznets had developed time series of national income in order to develop a quantitative basis for studying and measuring economic growth and the shifts in production from agriculture to industry to services. Interestingly, Kuznets parted with the department because it refused to include estimates of household production. paul samuelson once quipped that the size of the U.S. GDP could be dramatically increased if housewives would simply contract out with their neighbors (reciprocally) to provide cleaning and cooking services. In fact, this very omission of household production has overstated the rise in national output of the economy due to the increase in women’s labor force participation from around 25 percent in the late 1930s to about 60 percent in 2003. Kuznets also strenuously objected to counting all government spending on goods and services as part of GDP because he regarded most such expenditures to be intermediate, not final, products.
In contrast to Kuznets, Stone developed a double-entry accounting system, also in the 1930s and 1940s, partly driven by the British government’s war effort. His social accounting matrix implemented many cross-checks on the validity of components of national income and, in so doing, derived means of measuring them. He demonstrated, empirically as well as theoretically, that national income could be measured as either the market value of final product or the total of the gross factor incomes used in producing it. Stone’s structure became the foundation for the United Nations System of National Accounts (SNA), first published in 1953, providing a uniform basis for all countries to report national output. Virtually all nations now use his system of national accounts.
Kendrick, John W. “National Income and Product Accounts.” In International Encyclopedia of the Social Sciences. New York: Macmillan and Free Press, 1968. Vol. 6, pp. 19–34.
Mankiw, N. Gregory. Macroeconomics. New York: Worth Publishing, 2000.
Ott, Mack. “National Income Accounts, Economic Policy Analysis and the Initial Estimates of Kosovo’s GDP.” Contemporary Economic Policy (April 2003).
Rothbard, Murray. “The Falacy of the ‘Public Sector.’” New Individualist Review (Summer 1961): 3–7. Available online at: http://www.mises.org/rothbard/public.asp.
United Nations. System of National Accounts 1993. New York: United Nations, 1993.
United Nations. Use of the System of National Accounts in Economies in Transition. New York: United Nations, 1996.
National output includes only the value of net exports. In each of these three equivalent measures, the value of imports is deducted from the value of exports.
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"GDP Fetishism" by David R. Henderson. March 1, 2010. Economic welfare or wellbeing, defined, with examples of how GDP measurements often do not reflect economic wellbeing.
Diane Coyle on GDP. EconTalk podcast episode on measuring GDP.
Jerven on Measuring African Poverty and Progress. EconTalk podcast episode on measuring GDP in less developed countries.
Pettit on the Prison Population, Survey Data and African-American Progress. EconTalk podcast episode on measuring U.S. GDP.
"Welfare and Economic Welfare", by Arthur C. Pigou. Chapter I of The Economics of Welfare, discusses the experience of well-being and the limitations of what economists can measure.