Economic and Financial Terminology Part 1
Growth and Development– Measurement of growth: National Income and per capita income – I
1. SECTORS OF AN ECONOMY
Economic activities are broadly classified into 3 broad categories
(i) Primary Sector includes all those economic activities where there is the direct use of natural resources as agriculture, forestry, fishing, fuels, metals, minerals, etc. In India mining activities are considered a part of secondary sector.
(ii) Secondary Sector- manufacturing or industrial sector – which uses the produce of the primary sector as its raw materials.
(iii) Tertiary Sector – includes all services such as education, banking, insurance, transportation, tourism, etc. This sector is also known as the service sector.
2. Measures of National Income:
Measures of NI are GDP, GNP,NNP, NNP at factor cost, Personal Income and Disposable Personal Income
3. NATIONAL INCOME
– Income level is the most commonly used tool to determine the well-being and happiness of the nations and their citizens.
– The four ways to calculate the income of a nation are the concepts of GDP,
NDP, GNP and NNP.
4. GDP – Gross Domestic Product (GDP) is the value of the all final goods and services produced within the boundary of a nation during one year. For India, this calendar year is from 1st April to 31st March. Final means the stage of a product after which there is no known chance of value addition in it.
– uses GDP
(i) Annual percentage change in it is the ‘growth rate’ of an economy.
(ii) Size indicates the ‘internal’ strength of the economy. But it does not say anything about the ‘qualitative’ aspects of the produced goods and services by the economy.
(iii) It is used by the IMF/WB in the comparative analyses of its member nations.
5. NDP– Net Domestic Product (NDP) is the GDP minus depreciation (wear and tear or reduction in value of assets used in production of goods and services). In India by the Ministry of Commerce and Industry) and a list is published, which is used by the different sections of the economy to determine the real levels of depreciations in different assets.
6. Depreciation is used as a percentage reduction in value of assets in economics and in another way If the value of the domestic currency falls following market mechanism in front of a foreign currency. Capital consumption is the other term for ‘depreciation’. In the process of their uses fixed assets depreciate (go for wear and tear) at the rate decided by the government of the economy – the rates for the same assets may vary across economies. In the new system of national income accounting it in written as CPC (Consumption of fixed Capital) – in use since 2015-16 after the advice of the IMF.
7. Thus, NDP = GDP – Depreciation. This way, NDP of an economy has to be always lower than its GDP for the same year, since there is no way to cut the depreciation to zero.
8. Uses of NDP are :
(a) For domestic use only – to understand the historical situation of the loss due to depreciation to the economy. Also used to understand and analyse the sectoral situation of depreciation in industry and trade in comparative periods.
(b) To show the achievements of the economy in the area of research and development which have tried cutting the levels of depreciation in a historical time period.
9. Note: NDP is not used in comparative economics, i.e., to compare the economies of the world because different countries may adopt different logic in setting the rates of depreciation or even no logic at all.
10. GNP Gross National Product (GNP) is the GDP of a country added with its ‘income from abroad’ which includes
(i) Trade Balance: the net of exports and imports. (in India’s case it has always been negative except the three consecutive years 2000-03 when it was positive, due to high levels of ‘services sector’ export during the years on account of the booming BPO industry).
(ii) Interest of External Loans: the net outcome of interest payments on borrowings and interest receipts on moneys lent (In India’s case it has been always negative as the economy has been a ‘net borrower’ from the world economies.
(iii) Private Remittances: the net outcome of the money which inflows and outflows on account of the ‘private transfers’ by the Indian nationals working outside India (to India) and the foreign nationals working in India (to their home countries). On this front India has been always a gainer-till early 1990s from the Gulf region (which fell down afterwards in the wake of the heavy country-bound movements of the Indians working there due to the Gulf War) and afterwards from the USA and the European nations. Basically, during the year 2016, India is to be the highest receiver of this fund to the tune of $67 billion
Ultimately, the balance of all the three components of the ‘Income from Abroad’ segment may turn out to be positive or negative. In India’s case it has been always negative (due to heavy outflows on account of trade deficits and interest payments of the foreign loans). It means, the ‘Income from Abroad’ is subtracted from India’s GDP to calculate its GNP.
11. Gross National Product GNP = GDP + Income from Abroad.
GNP = GDP + (– Income from Abroad) = GDP – Income from Abroad, in the case of India. This means that India’s GNP is always lower than its GDP.
Uses of the concept GNP are :
(a) ranks the nations of the world in terms of the volumes (GDP)– at the Purchasing Power Parity – India is ranked as the 4th largest economy of the world (after the USA, Japan and China)- while as per the nominal / prevailing exchange rate of rupee India is the 13th largest economy.
(b) It is the more exhaustive concept of national income than the GDP as it indicates about the quantitative’ as well as the ‘qualitative’ aspect of the economy, i.e., the ‘internal’ as well as the ‘external’ strength of the economy.
(c) It reflects the reliance level of the economy on production behaviour and pattern of an economy, on the outside world
12. Purchasing Power Parity (PPP) developed by the Swedish Economist Gustav Cassel, is a method of calculating the correct/real value of a currency which may be different from the market exchange rate of the currency. Using this method economies may be studied comparatively in a common currency. This is a very popular method handy for the IMF and WB in studying the living standards of people in different economies. The PPP gives a different exchange rate for a currency which may be made the basis for measuring the national income of the economies. It is on this basis that the value of gross national product (GNP) of India became the Fourth largest in the world though on the basis of market exchange rate of rupee it stands at the thirteenth rank.
This concept works on the assumption that markets works on the law of one price. Identical goods and services must have the same price in different markets when measured in a common currency. If this is not the case it means that the purchasing power of the two currencies is different.
In theory, the value of the currencies in terms of of their market exchange rate should converge with their market values in terms of the PPP in the long run. But that might not happen due to many factors like the fluctuations in inflation level of money supply follow up to the exchange rate regimes and other.
For the calculation of the PPP, a comparable basket of good and services is selected of the identical qualities and quantities. The other difficulty in computing PPP arises out of the flaw in the one price theory i.e, due to transportation cost, local taxes, level of production, etc. The prices of goods and services cannot be the same in different markets (this is correct in theory only ,not possible in practice.).
13. Net National Product NNP = GNP – Depreciation or, NNP = GDP + Income from Abroad – Depreciation.
uses of NNP are :
(a) This is the ‘National Income’ (NI) of an economy.
(b) When we divide NNP by the total population of nation we get the ‘per capita income’ (PCI) of that nation i.e. ‘income per head per year’.
14. Cost and Price are two issues related to National Income
There are two sets of costs and prices –and an economy needs to choose at which of the two costs and two prices it will calculate its national income.
(i) Cost: Income of an economy i.e. value of its total produced goods and services may be calculated at either the ‘factor cost’ (input cost for the producer like raw materials, labour costs, rent etc) or the ‘market cost’ (factor cost + indirect taxes like Cenvat/central excise and the CST which are paid by the producers to the Central government in India + the state taxes) In general, they are called ‘factor price’ and ‘market price’ also.
15. In India, income is calculated at factor cost due to lack of uniformity in central and state taxes, and so is the case with most of the developing countries (but among the developed economies it is calculated at the market cost).
Once the GST is implemented this aberration will end.
(ii) Price: Income can be derived at two prices– constant and current. The difference At constant prices the values computed with reference to a past year known as the ‘base year’ ignoring the subsequent increase in prices on account of inflation.
At current prices the present day inflation is added. Current price is, basically, the maximum retail price (MRP) which we see printed on the goods selling in the market.
16. National Income at Current Prices or Nominal Income is the value arrived at by multiplying the volume of final goods and services of a year by current prices or prices in that year.
17. Real National Income is NI at constant prices = value of final goods and services calculated by multiplying volume of final goods and services by prices in a base year.
18. GDP Deflator is a measure of the level of prices of all domestically produced final goods and services in an economy in a particular. This is calculated to find the overall increase in level of prices given by (Nominal Income/Real NI) x 100
19. Recently in 2015 the GOI has changed the method of NI accounting in alignment with international practices. The new series on National Accounts Statistics has been introduced after a comprehensive review of both the database and the methodology employed in the estimation of various aggregates. Besides shifting the base year from 2004-05 to 2011-12, the series incorporates latest available data from surveys and Censuses, new economic activities, expansion of coverage of activities, improvements in procedures and to the extent possible, the latest recommendations of System of National Accounts, 2008 in the compilation of national accounts.
20. A change in base year for computing national accounts pushed up the economic growth rate for 2013-14 to 6.9 per cent, while earlier estimate on the basis of old series was 4.7 per cent.
Similarly, the economic growth rate for 2012-13 has been revised upwards to 5.1 per cent, compared with 4.5 per cent estimated earlier.
These changes follow a revision in the base for calculating national accounts to 2011-12 from 2004-05.
21. Some comments on this change were
Base Year Change: Base Year is changed every five years or so to better reflect present economic conditions when calculating the national income and inflation. National income or GDP grows faster when the country starts with a lower base. The previous base year, 2004-2005 was an excellent year for the Indian economy with the growth rate touching 10 percent. Consequently, GDP growth rate was slower when measured with reference to it. The new base year 2011-2012 was an year of economic stagnation. Because of the lower base, GDP measurements with reference to it show unexpected growth.
GDP at Market Prices: The GDP is now measured at market prices. The transition to market prices from factor costs ((factor cost + indirect taxes like Cenvat/central excise and the CST which are paid by the producers to the Central government in India + the state taxes) was needed to bring Indian economic data at par with global best practices. Both these changes are a step in the right direction indeed. It is the way these changes have been executed is the problem.
22. India’s per capital income rose by 7.4 per cent to Rs 93,293 in 2015-16, compared to Rs 86,879 in the preceding fiscal, government data.”The per capita income at current prices during 2015-16 is estimated to have attained a level of Rs 93,293 as compared to the First Revised Estimate for the year 2014-15 of Rs 86,879 showing a rise of 7.4 per cent,” as per data on Provisional Estimates of Annual National Income and Quarterly Estimates of Gross Domestic Product 2015-16. Per capita income is a broad indicator of prosperity.” (ET 31 May2016)
23. Some Issues relating to India’s Growth
During 2015 among Advanced Economies (AEs), growth was virtually stagnant in Japan at 0.8% while the Continental Europe was slated to report only marginally higher growth at 1.5%. The recovery in North America, including in the USA was modest and UK a modest 2.4%. Growth rate among emerging and developing economies (EMDEs) was also low. China’s growth rate was to fall to 6.8% from 7.4%, while that for Russia (-3.4% from 0.6%) and Brazil (-1.5% from 0.1%) Of the other BRICS nations, South Africa was estimated to grow higher at 2.1% up from 1.5%. Against this backdrop of negative to modest positive growth rates for the large economic powerhouses and major EMDEs, India’s economy posted a growth rate of 7.6% with potential for even higher growth rates.
Still Indian has been growing below its potential due to following challenges:
a) Lack of investment in infrastructure- both physical and financial
b) High level of Financial Exclusion
c) Skill gap, which has implications for employability
d) Decline in Gross Capital Formation & dwindling domestic savings rate
Government and RBI have been taking steps to overcome them in a sustainable manner.
RBI has for long been focused on inclusive growth through policies like selective credit control, priority sector lending norms, lending to weaker sections of the society, service area approach and through the financial inclusion drive.
RBI’s policies on expansion of branch network in rural and semi-urban centers have also been part of this initiative.
The two newly licensed full-service banks, eleven payment banks and soon to be licensed small finance banks, would provide further impetus to accessibility of finance and render the credit intermediation process more efficient, thereby contributing to a sustainable and inclusive growth.
The MSME sector, which has the potential to foster strong growth by creating local demand and driving consumption. Presently, MSMEs contribute nearly 8 per cent of the country’s GDP, 45 per cent of the manufacturing output and 40 per cent of the exports. They provide the largest share of employment after agriculture and are nurseries for entrepreneurship and innovation.
RBI has launched several initiatives in this regard. To specifically address the issue of delayed payments to the MSME sector, TReDS has been conceptualised as an authorised electronic platform to facilitate discounting of invoices/bills of exchange of MSMEs.
The present legal system does not facilitate an easy closure/takeover of unviable firms. In order to overcome such problems and to salvage value in firms in distress, enactment of a Bankruptcy Code has been made recently.
The initiatives of Government of India i.e. ‘Make in India’, ‘Skill India Mission’ and ‘Digital India’ also ties in neatly to provide further push to the sector.
24. The following recent economic trends bode well for the growth prospects and the overall macroeconomic situation of India?
a) Steep decline in oil prices
b) Plentiful flow of funds from the rest of the world
c) Potential impact of the reform initiatives of the new government at the centre
d) Calibrated fiscal management
Model Objective type questions:
1. In the Indian context, translating economic success into human development advances will requires public policies aimed explicitly at broadening
a) Distribution of benefits from growth and global integration
b) Increased public investment in rural areas and services
c) Political leadership to end poor governance
d) Both A and B
e) All of the above
2. A variety of measures of national income and output are used in economics to estimate total economic activity in a country or region. All are especially concerned with counting the total amount of goods and services produced within some
d) Both a and c
e) All of the above
3. Which of the following observations is / are not correct?
A) All high income countries are necessarily developed countries.
B) The high income economies compromising less than 20 percent of world population, contribute more than 50 per cent to world PPP GNI.
C) The developing countries are those with low, lower-middle, or upper-middle incomes.
Select the correct answer using the codes given below
a) Only A
b) Only B
c) Both A and C
d) Both B and C
e) All of the above
4. Development is conceived of as a process that involves major changes in
a) Social Structures
b) Popular attitudes
c) National Institutions
d) Both B and C
e) All of the above
5. Which of the following core values should serve as a conceptual basis and practical guidelines for understanding the “inner” meaning of development?
c) Freedom from servitude
d) Both a and b
e) All of the above
6. Development in all societies must have which of the following objectives?
(A) To increase the availability and widen the distribution of basic life-sustaining goods.
(B) To raise levels of living, including in addition to higher incomes, the provision of more jobs.
(C) To expand the range of economic and social choices available to individuals and nations.
Select the correct answer using the codes given below:
a) Only C
b) Both B and C
c) Both A and C
d) Only A
e) All of the above
7. Economic development is generally defined to include
(A) Improvements in material welfare, especially for persons with the lowest incomes
(B) Eradication of mass poverty with its correlates of illiteracy, diseases and early death
(C) Changes in the composition of inputs and outputs that generally include shifts in the underlying structure of production away from agricultural growth.
Select the correct answer using code given below:
a) Only A
b) Both A and B
c) Only C
d) Both B and C
e) All of the above