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Dr. Harry Hillman Chartrand, PhD

Cultural Economist & Publisher

Compiler Press

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h.h.chartrand@compilerpress.ca

215 Lake Crescent

Saskatoon, Saskatchewan

Canada, S7H 3A1
 

Curriculum Vitae

 

Launched  1998

 

 

Macroeconomics

2.0 System of National Accounts

 

 

0. Introduction

Scholar's say national income accounting dates back to either: William the Conqueror's 11th century 'Doomsday Book' of England or William Petty's 17th century Political Arithmetick or Francois Quesnay's 18th century Tableau économique (Economic Table or what today is called 'an input-output table).  In fact, it was not until 1944 that the concept became an accounting reality.  

Discussions during World War II between the United States, the United Kingdom and Canada resulted in the framework and rules for what became the System of National Accounts.  Discussions drew on extensive statistical development in the United States by:

  W. C. Mitchell who established the National Bureau of Economic Research and was a member of the American Institutional School of Economics;

Joseph Schumpeter's statistical work on business cycles; and,

especially, Simon Kuznets work on national income. 

Such statistical evidence and analytic tools were used to erect the most extensive accounting system in human history.  The dream of Physiocrat Frenchman Francois Quesnay was finally realized.  

From these streams of thought the System of National Accounts (SNA) was born with Canadian statisticians as midwife.  In 1947, the United Nations issued standards for national SNAs together with associated sub-sets such as the Standard Industrial Classification, Standard Commodity Classification, et al.  They are used by all Member States today including the European Union.  In  addition the Census of Population and the Business Enterprise are consistent with these definitional standards.

A parallel U.N. system of  'material balances' (SMB) was adopted for Second World countries, i.e. the 'command economies' of Communist Nation-States or Second World.  More in class.  The U.N. no longer publishes the 'material balances' manual.

The following concerns the 'top level' of the SNA.   Definitions need be kept in mind as we construct the Standard Model of Macroeconomics or a Nation-State's economy.   Before doing so, however, it is important to note that the word 'economy' derives from the ancient Greek oikos meaning ‘house’ and nemo meaning ‘manage’, i.e. managing the house.  It shares its root with ‘ecology’ deriving from oikogie meaning modes of life and relations within the house.  Economics as management of the household therefore raises the question: What is the relevant household? 

In its original sense it was the self-sufficient or autarkic rural estate.  Management, however, ascended to higher orders as the self-sufficient village, town, city and most recently the Nation-State.  A global society in which there is contiguous urban development separated only by natural barriers – mountains, oceans and deserts - has been called the Ecumenopolis – the World City - by urban planner Constantinius Doxiadis; its global reality is visible in a composite photograph of “The World at Night” published by NASA in 2000.  It has grown brighter since.  If seeing is believing then this picture provides visual evidence of humanity enframing its home planet with fiber-optic cable creating a global nervous system called the Internet or Worldwide Web (WWW) including a myriad of satellites encircling and surveying the planet.  We see a World City whose shimmering lights soar out into the infinite blackness of space.  However, there is no true Global Economics, i.e., there is no generally accepted model for managing the economy of our planet or beyond.

 

1. Gross Domestic Product (MKM C5/102-8)

GDP is the aggregate total of all final goods and services produced within a country measured in dollars and cents per unit time.  It is generally considered the best available measure of the productive capacity of a Nation-State, and, in turn, GDP per capita (per person) is commonly accepted as a primary measure of the overall well-being of a Nation-State's citizens.

In the Standard Model it is assumed:

  • first, all factors of production are ultimately owned by households including share ownership of all firms;

  • second, only 'final goods & services' are included to avoid double counting, i.e., it excludes goods & services firms buy from one another and used as 'intermediate' inputs to their own production process;

  • third, Government buys goods & services from firms.  Government produce nothing itself, everything is privatized; and,

  • fourth, GDP always equals Gross Domestic Income (GDI) - the aggregate earnings of domestic factors of production such as capital, labour and natural resources.   GDP GDI is thus an accounting identity.

Alternatively, Gross National Product (GNP) is the aggregate total of all final goods and services consumed within a country measured in dollars and cents.  The essential difference with GDP is imports, i.e., goods and services not employing domestic factors in their production.  Most economists accept GDP but  Adam Smith, among others, believed GNP more accurately measures the well being of a nation. 

 

i - Concepts

To track GDP requires three basic concepts: Stocks, Flows and Equality of GDP & GDI.

 a) Stocks & Flows (measured in dollars and cents per unit time)

A stock is a quantity that exists at a moment in time.  A flow is a quantity added to or subtracted from a stock. 

i - Capital & Investment

With respect to GDP:

Capital (K) refers to the stock of plant, equipment, buildings, inventories of raw materials, semi-finished goods and housing stock;

Depreciation (D) refers to the decrease in the capital stock resulting from wear and tear; and,

Investment (I) refers to the flow of new capital where gross investment is the total flow of new capital and net is the flow of new capital less depreciation

ii - Wealth & Income

With respect to GDP:

Wealth refers to the stock of all property - moveable and immoveable, tangible and intangible - including financial assets; 

Income (Y) refers to the flow of money earned by supplying factors of production; and,

Disposable Income (Yd) refers to gross income less net taxes (total taxes minus transfers from Government to households)

iii - Consumption & Saving

With respect to GDP:

Consumption (C): refers to disposable income spent on final goods & services, and,

Savings (S) refers to disposable income minus consumption equalling an addition to wealth.

 

b) Equality of Gross National Income (GNI) & Expenditure (GNE) (measured in dollars and cents per unit time)

In an open economy the Standard Model engages 4 actors: households, firms, government and the rest of world operating in three markets – factor, goods & services and financial markets (P&B Fig. 22.2; R&L 13th Ed Fig. 1-4).  The flows involved include:

i - Households

With respect to GDI:

GDI (Yi) refers to total earnings of households for supplying factors of production to firms and other countries including profits & dividends, and,

Disposable Income (Yd) refers to Y - Net Taxes (NT: taxes minus transfers from Government to households).

With respect to GDE:

Consumption (C) refers to total spending by households for goods and services produced by firms, and,  

Savings (S) refers to Y - Yd used by firms to finance Investment.

ii - Firms

With respect to GDI:

Revenue refers to earning of firms from sale of sales of goods & services and financial transactions to Government and other countries

With respect to GDE:

Investment (I) refers to expenditures by firms for depreciation, new plant & equipment, buildings and additions to inventories paid out of savings and foreign investment.

iii - Government

With respect to GDI:

Net Taxes (NT) = Total taxes from minus Transfers from Government to households

With respect to GDE:

Government Expenditures (G) refers to goods & services purchased from firms, foreign and domestic.

Surplus = G - NT < 0

Deficit = G-NT > 0 financed by borrowing

Debt = accumulated deficits minus surpluses

iv - Rest of World

With respect to GDE:

Exports (X) refers to sales of goods & services and financial transactions to other countries;

Imports (M) from all other countries including goods & services and financial transactions, and,

Net Exports (NE) = X – M

NE > 0 =  trade surplus

NE < 0 = trade deficit

 

c) Accounting Identity (measured in dollars and cents per unit time)

GNE (Ye) = C + I + G + NE

GDI (Yi) = household earnings from supplying factors of production to firms including profits & dividends spent on C + S + T

Identity: Yi = C + S + T Ye = C + I + G + NE

where

 I + G + X  (injections) S + T + M (leakages)

Leakage = income not spent on domestically produce goods & services including savings, taxes and imports

Injection = expenditure by firms, government and exports

 

iii - Measuring GDP  (MKM C5/108-111)

GDP can be measured in 3 ways by: Expenditure, Factor Income or Value Added (all measured in dollars and cents per unit time)

a) Expenditure (Statistics Canada)

Personal expenditure on consumer goods and services (not include new residential housing part of investment)

Business investment: plant & equipment including new residential housing, inventories of raw materials, semi-finished products, unsold final product

Government expenditures on goods and services excluding transfer payments

Export of goods and services

Imports of goods and services

Exclusions include:

 intermediate goods & services (to avoid double counting goods & services firms buy from each other as 'intermediate' inputs to their production process)

used goods (already counted when new)

financial products

b) Factor Income (Revenue Canada)

Wages, salaries and supplementary labour income including take-home pay, taxes withheld plus fringe benefits

Corporate profits including dividends paid and retained or undistributed profits

Interest and misc. investment income including net interest payments by households, land rent and imputed rent for owner-occupied housing

Farmers’ income & income from non-farm unincorporated businesses

c) Value Added

As noted above, certain expenditures are excluded from GDP.  These include, among others, intermediate or 'producer' goods & services, used or second-hand goods and financial products.   In the case of intermediate inputs this is done to avoid double counting when firms buy inputs from each other for their production process.  GDP is calculated by summing up the value added by each agent that excludes the cost of inputs.  Consider the following simplified table:

 

Agent

Output

Value Added

Market Price

Farmer's Input *

 

-

$100

Farmer

Wheat

$100

$200

Miller

Flour

$100

$300

Baker

Bread

$100

$400

Store

Retail

$100

$500

Total

 

$500

$1500

* Imputed cost of land, equipment, seed, fertilizer, pesticide, labour & profit

In the case of used goods, no new inputs are employed, no value is added, no factor income is generated.  Their sale is a transfer of ownership not the result of production.  Financial products like stocks and bonds are not included because they are Savings (S).

d) Net vs. Gross Domestic Product

Gross Domestic Product (GDP) = NDP + depreciation or capital consumption

Net Domestic Product (NDP) = gross domestic product minus depreciation of capital goods.

e) Why Expenditure & Income Approach to GDP?

While GDP and GDI must be equal they are calculated using different sources.  Expenditure data are collected by Statistics Canada using the Census and surveys while income numbers are collected by Revenue Canada using tax data.   This allows Stats Canada to check one against the other and introduce (and explain) any error term to ensure the identity.

 

iii - Price Level and Inflation (MKM C6/123-135)

As will be seen (5.2.1 Money) dollars and cents are the most useful measure of economic activity.  For example, you can't compare apples and oranges but you can compare their prices.  Nonetheless dollars and cents measurement has its problems.  These include price inflation and deflation. 

For example, if the price of a chocolate bar goes up you still get only one at the new price.  For purposes of GDP, measured in dollars and cents, there has been an increase but there is no corresponding increase in the number of chocolate bars.  Overtime the discrepancy between monetary or nominal GDP and real GDP measured by the number of chocolate bars plus of all other goods & services grows ever wider. This makes knowing if the economy is growing, shrinking or stagnating difficult.

 

2. Nominal vs. Real GDP (MKM C5/108-111)

To measure real GDP the aggregate price level is calculated.  This is the average for the prices of all goods and services included in GDP.  This is done using a price index.   The two major indices are the Consumer Price Index (CPI) and the GDP Deflator (P&B 7th Ed CPI & Core Inflation Fig. 21.7; R&L 13th Ed Fig. 29-5).  It should be noted that there are special price indexes for all major industries due to their different mixes of inputs in production.

a) Consumer Price Index (CPI) (MKM C6/124-127)

The CPI measures the average level of prices of goods and services purchased by typical urban Canadian family.  It uses a base year to calculate cost of the typical ‘basket’ of goods and services then calculates cost of same basket in subsequent years to determine change in price level where:

 CPI = current cost of basic/base period cost x 100

b) GDP Deflator (MKM C5/110-11)

The GDP Deflator measures the average level of prices of all goods & services in GDP.  Nominal GDP is valued in current year prices while real GDP is valued in base year prices, or:

GDP Deflator = Nominal/Real GDP x 100

Because the GDP Deflator isn't based on a fixed basket of goods & services, it has an advantage over the Consumer Price Index. Changes in consumption patterns or the introduction of new goods and services are automatically reflected.

c) Meaning of Inflation Numbers

The CPI is often used for cost of living adjustments showing changes in the purchasing power of money and allowing measurement of how much income must increase in nominal terms to purchase the same basket of goods in subsequent years.  The GDP Deflator is used to measure the real growth of the overall economy.  Like a balloon nominal GDP swells the balloon simply because of increased prices rather than growth in the real quantity of goods & services produced.  The deflator shrinks the balloon back to measure the real increase in output of an economy.

It should be noted that there are separate price indices for major industries, e.g., the health industry employs a very different basket of goods than the typical Canadian household.  Similarly, the auto or construction industries have very different typical baskets of goods & services and hence different rates of inflation.

However, the CPI suffers from technical biases:

substitution (substitute less for more expensive goods and services not reflected in base basket);

new goods not reflected in base basket; and,

quality change in goods & services.

In addition, non-market activity such as household production and the underground economy (illicit goods & services) are not reflected in nominal or real GDP. 

 

3. Happiness, Purchasing Power, Intra-Corporate Transfer Pricing  & the Knowledge-Based/Digital Economy

Beyond technical problems associated with measuring GDP there is the question of the adequacy of GDP per capita as a measure of national well-being or 'happiness'.  In this regard, it is assumed in Economics, following the insights of Jeremy Bentham (Observation #8), that the willingness of a consumer to spend $10 on a DVD means the consumer expects to receive at least $10 worth of utility or happiness.  One necessary adjustment involves making international comparisons and requires adjustment for purchasing power parity index of prices (MKM C12/ 292-4) including the commonly used 'Big Mac Index':

Purchasing power parity (PPP) is a theory which states that exchange rates between currencies are in equilibrium when their purchasing power is the same in each of the two countries.  This means that the exchange rate between two countries should equal the ratio of the two countries' price level of a fixed basket of goods and services.  When a country's domestic price level is increasing (i.e., a country experiences inflation), that country's exchange rate must depreciated in order to return to PPP. (Werner Antweiler, University of British Columbia)

Since the 1960s economist and other scholars have developed supplementary ‘social indicators’ to better measure the true well-being of a country's citizens.  Currently they include Bhutan's Gross National Happiness Index, the UN Development Index  and the OECD Life Index.  Such indices attempt to include things like health, leisure, the environment, freedom and justice (see: http://www.cbc.ca/news/business/peter-armstrong-economic-indicators-1.3754915.  The problem, of course, is quantifying such life affecting factors.  Compared to counting GDP in dollars and cents such efforts are problematic.

There is another problem with measuring GDP.  Generally tangible things, are easy to count, e.g., wheat, coal, cars, etc.  These constitute tangible imports or exports.  Other things, generally intangible things, are more difficult to count, e.g., intellectual property royalties, management fees, etc.  This puts a bias into the final count.  Furthermore, with multi- or trans-national corporations there is the problem of intra-corporate transfer pricing which involves, among other things, maximum avoidance of tax given the different jurisdictions in which they operate. 

And there is an emerging problem affecting calculation of real GDP - the Knowledge-Based/Digital Economy.   As recently noted by the former CEO of IBM, Sam Palmisano, in his article “The Global Enterprise” (October 14, 2016, Foreign Affairs), there has been:

… an explosion of data, and with it a re-calculation of economic value - asset values - affiliated with this data-rich environment.

Tangible assets, which are characteristic of the physical world, are being subjected to the economic headwinds of slow global growth.  But intangible assets, which are characteristic of the digital world, are finding their value increasing and economic wind at their back.

Consider Google Maps and other so-called 'free apps'.  The are not sold on the market so they are not included in calculation of GDP.  Yet they arguably have significant economic impact, e.g., reducing the costs of navigation and delivery of goods & services.   Furthermore, while they are 'free' in the sense of dollars and cents to the consumer they have a price visible in the Big Data voluntarily provided by consumers in exchange for the apps.   The scale of the problem is highlighted in Jacob Weisberg’s “They’ve Got You, Wherever You Are” (October 27, 2016, New York Review of Books) where he notes:

Facebook’s vast trove of voluntarily surrendered personal information would allow it to resell segmented attention with unparalleled specificity, enabling marketers to target not just the location and demographic characteristics of its users, but practically any conceivable taste, interest, or affinity.  And with ad products displayed on smartphones, Facebook has ensured that targeted advertising travels with its users everywhere.

For those so interested please see my article: Disruptive Solutions to Problems Associated with the Global Knowledge-Based/Digital Economy.

* Sample 1st Midterm Examination

 

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