Download Annual GDP by production approach in current and constant prices

Annual GDP by production approach in
current and constant prices: main
issues1
Introduction
This paper continues the series dedicated to extending the contents of the Handbook “Essential SNA:
Building the Basics”2. The aim of this paper is to provide some background to understand the
compilation of two tables included in the Minimum Requirement Data Set (MRDS), the first data set
that a country must have before it can claim to have implemented SNA:
 Value added and GDP by industry at current prices;
 Value added and GDP by industry at constant prices.
To understand how these tables are compiled and what data sources are required to do so, much of
the paper is used to outline the production approach to GDP compilation. The relevant SNA
transactions that are discussed include: output, intermediate consumption and taxes (and subsidies)
on products. The concepts behind constant price estimation have been outlined in an earlier paper in
this series3. For the constant prices table discussed here, we will focus mainly on the deflation
method, as applied to the production approach to GDP compilation.
The current paper will discuss the compilation of the two MRDS tables in general terms, highlighting
concepts and procedures at a high level of abstraction. The application to particular industries will
follow in subsequent papers.
GDP by production approach: compilation steps
Starting point for the compilation of GDP by the production approach is the accounting framework
for production of goods and services. The relevant SNA transaction is output (P1)4 which measures
the amount of goods and services produced during the accounting period. In order to generate this
output by a particular production process, inputs are required, such as raw materials, energy etc. The
costs of these inputs are measured by the transaction intermediate consumption (P2), abbreviated
henceforth as IC. The difference between output and IC is known as value added (B1). This definition
constitutes one of the fundamental identities of national accounts:
Value Added = Output - Intermediate consumption
Note that the value added referred to is gross value added (B1g). This means including consumption
of fixed capital (CFC). This transaction (belonging to the capital account) serves to reflect the decline
1
This paper has been prepared with the technical assistance of DevStat Servicios de Consultoría Estadística in consortium
with ICON Institute.
2
Henceforth called the “Handbook” ; it can be found at the following link:
http://epp.eurostat.ec.europa.eu/portal/page/portal/product_details/publication?p_product_code=KS-RA-11-002
3
National Accounts in Constant Prices, part 1: Elementary Indexes and part 2: Aggregated Indexes
4
The next paragraphs are based on another paper in this series: Introduction to the SNA 2008 Accounts, part 1: Basics.
1
in the value of the fixed assets. When the amount for CFC is deducted from gross value added we get
net value added (B1n).
GDP is constructed from gross value added by adding taxes on products (D21) and by subtracting
subsidies on products (D31). The following example illustrates the relationship between the above
concepts:
B1n
K1
B1g
D21
D31
Value added, net
Consumption of Fixed Capital
Value added, gross
Taxes on products
Subsidies on products
Gross Domestic Product
1499
222
1721
141
-8
1854
Figure 1 GDP by production approach
As can be seen from figure 1, GDP consists of the sum for the total economy of gross value added
and taxes minus subsidies on products. Note that the GDP derivation only applies to the total
economy, not to individual sectors. Also, strictly speaking, GDP is not a transaction, it does not have a
transaction code. It is a macroeconomic aggregate, consisting of different individual transactions.
Output: measurement issues
The central issue in the compilation of value added is the measurement of output. The key concept in
this respect is production. According to SNA 2008 (6.2): “Production is an activity, carried out under
the responsibility, control and management of an institutional unit, that uses inputs of labour,
capital, and goods and services to produce outputs of goods and services”. Therefore, in order to
measure output we have to make an inventory of all productive processes for all institutional units
that yield products (either goods or services) in the SNA sense. Not all economic production qualifies
as SNA production. An example is the production of services by members of the household for their
own final consumption, such as cleaning of the dwelling, preparation of meals, caring for children.
SNA introduces the production boundary to separate economic production into a part that qualifies
as SNA production and a part that does not qualify as such.
Production within the production boundary includes the following major components for the main
institutional units:
 Production supplied to the market by enterprises, where the goods or services fetch a welldefined price (market output);
 Production of collective goods and services by government units with no market price (nonmarket output);
 Production for own final use by enterprises, e.g. for the purpose of capital formation.
Production in households operating as unincorporated enterprises is included in market output or
output for own final use. All other household activities are excluded, with two exceptions:
 Own-account production of housing services by owner occupiers;
 Production of domestic and personal services by employing paid domestic staff.
An important aspect of measuring output in current values has to do with valuation, i.e. the
expression in money terms. Market output can only be valued once the goods or services enter a
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market, where price formation takes place. Not all output of goods will do so during an accounting
period. The alternative is that such goods are added to the inventory, to be sold during a future
accounting period. The question of what price to use for valuing such inventory goods during an
accounting period is not an easy one, suffice it to say here that there are various possibilities, each
with a different outcome for the valuation of that part of output that goes into inventories. The
important point here is that output is different from sales (or turnover). Total sales during an
accounting period can come from output in the same accounting period or from inventories built up
during previous accounting periods. Total output during an accounting period can either be sold on
the market or go into inventory, to be sold in a future accounting period.
It may therefore be a while before produced goods reach the final users and a sale takes place. This
may be true even without the goods going into inventory. National accountants record the output
when the production is completed (this is called accrual based accounting), and not when cash from
sales changes hands (this is called cash based accounting).
It may also happen that the production of a particular good (or the rendering of a service) has not
been completed at the end of the accounting period. Since resources have been used up during the
accounting period, it would be wrong not to take into account any output at all since this would lead
to an imbalance between uses and resources. National accountants repair this potential discrepancy
by recording work-in-progress in the accounts as a measure of output that has been completed
during the accounting period. This is especially important in construction, where there may exist a
considerable gap between start and finish of a project, and the break in accounting periods may
easily fall in between.
Another valuation issue related to output is the treatment of taxes. Output is valued at basic prices,
i.e. excluding all product taxes (but including subsidies when relevant) and excluding any margins for
transport or trade services that may be added to come to the price that final users pay for the
product.
Output: data sources
In setting up a compilation system for output in current values, countries need to establish data
collection schemes for each of the institutional sectors that contribute to SNA production. The
Handbook addresses at length the issues related to the proper mobilization of data sources to enable
the systematic breakdown by institutions and by activities of all SNA productive transactions5. The
following enumeration identifies the main sources needed for annual output measurement in
current values:
 For non-agricultural non-financial incorporated enterprises, production statistics based on
surveys are commonly used; such surveys are often sample surveys on the enterprise
population as identified in the business register; alternatively, turnover statistics based on
sales are a possible source of data; when available administrative data sources (including
annual accounting reports) may be used;
 For agriculture special data sources set up in the framework of agricultural statistics are the
main source on data for output; detailed information on crop physical output, livestock
5
See especially chapter 5 of the Handbook, on statistical infrastructure
3



headcount and composition and their market prices can be used to make estimates for
agricultural output in current values;
For non-market output of government units an indirect method is often used, based on an
alternative compilation of value added, the one based on adding up the various value added
components (such as salaries); adding these value added components to the outlays on
intermediate consumption will give an indirect estimate of output; hence the main data
source for government units are often detailed budget data on the various government
expenditures; for market output of government units information on sales is often available;
For households in their capacity of unincorporated enterprises, data are often difficult to
come by; sometimes a household survey may yield partial data; often special methods need
to be set up, as part of measuring the informal sector, to capture data on household
productive units;
Special methods of estimating output exist for particular activities, such as financial activities
(banking, insurance), for domestic trade (output is taken as the difference between sales and
purchases of the traded goods) and the production of housing services by owner occupiers
mentioned earlier;
Breakdown by industries
As the above general remarks already indicate, in practice the procedure of compiling output is
achieved by splitting up the total economy into ISIC industries. The following table gives a breakdown
at the highest level of ISIC aggregation.
A
B
C
D
E
F
G
H
I
J
K
L
M
N
O
P
Q
R
S
T
U
Agriculture, forestry and fishing
Mining and quarrying
Manufacturing
Electricity, gas, steam and air conditioning supply
Water supply; sewerage, waste management and remediation activities
Construction
Wholesale and retail trade; repair of motor vehicles and motorcycles
Transportation and storage
Accommodation and food service activities
Information and communication
Financial and insurance activities
Real estate activities
Professional, scientific and technical activities
Administrative and support service activities
Public administration and defense; compulsory social security
Education
Human health and social work activities
Arts, entertainment and recreation
Other service activities
Activities of households as employers; undifferentiated goods and services producing activities of
households for own use
Activities of extraterritorial organizations and bodies
Table 1 ISIC 4 Industries at section level
For each industry output and IC are compiled. Gross value added is then calculated as the difference
between output and IC. Next, gross value added for the total economy is compiled as the sum of
value added for each industry. Adding to this the net product taxes (i.e. taxes minus subsidies) will
give GDP.
This calculation of GDP with its breakdown by industry of value added constitutes the basis for the
table on value added and GDP by industry at current prices of the MRDS mentioned in the
introduction. It should be noted that the level of detail used for the compilation is usually much
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greater than the breakdown given in the published table. Data collection on output or sales should
take place at the most detailed level of ISIC, i.e. the 4-digit class level. The breakdown in the
published table can be ISIC section or 2-digit division. This does not constitute a problem, since
annual output and value added data in current prices can be aggregated easily from detailed class
level to any higher level of this hierarchical classification.
Intermediate Consumption
Intermediate consumption (IC) consists of the value of the goods and services used up as inputs in a
process of production. As is the case for output there are demarcation issues here as well.
Compensation of employees (wages and salaries) are not part of IC, but certain types of goods and
services provided to employees may be part of IC, such as tools, clothing and accommodation
services. More important is the boundary with gross fixed capital formation. Expenditures on durable
producer goods that are small, inexpensive and used to perform relatively simple operations (such as
hand tools) may be treated as intermediate consumption when such expenditures are made
regularly. Also outlays on ordinary maintenance and repairs on fixed assets that are required to keep
the fixed assets in good working order are usually part of IC.
Valuation issue also arise for IC. Purchases of IC goods should be distinguished from the actual use in
production processes. The alternative is storage into inventory. Accounting IC transaction is also
accrual based, registering the transaction when goods and services are actually used, rather than
when they are paid for. Finally, IC is valued in purchasers’ prices, including product taxes (but
excluding subsidies) and including margins for trade (wholesale and / or retail, depending on the
procurement details) and for transport.
It should be noted that the value added obtained by subtracting IC in purchasers’ prices from output
in basic prices is taken to be valued at basic prices as well.
Data sources for IC are often similar to those of output: production surveys may include questions on
expenditures; agricultural statistics include data on inputs, such as seeds and fertilizer; government
budget data include detailed breakdowns on expenditures of inputs; etc. Ratios of IC over output
often prove useful. Such ratios (e.g. 40% of output is used for inputs; 60% remains for value added)
should not fluctuate greatly between years at detailed breakdown by activity and institution. It is not
uncommon that such ratios based on earlier measurement are used to impute IC for some activities,
based on the current levels of output.
Taxes, Subsidies on Products
Since the compilation of GDP by the output approach includes net product taxes (taxes minus
subsidies), and since these are not included in output, they have to be added to the total of gross
value added. Data usually come from administrative sources, e.g. from the tax office or the Ministry
of Finance. Product net taxes include net taxes on imports and include non-deductible VAT (value
added tax). The issue of VAT often leads to confusion. The thing to remember is that on all
productive transaction involving intermediate use, there is VAT paid on inputs by producers and VAT
charged to customers on outputs. The actual VAT amount paid by producers to the tax authorities is
the net VAT (the amount charged to customers minus the amount paid on inputs). Only final
consumers cannot further charge VAT in this productive chain, so they pay most of the actual VAT
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supplied by the domestic economy. However, for some goods or services the VAT rules of a country
may stipulate only partial deductibility, or no deductibility at all.
Taxes and subsidies on products should be distinguished from taxes and subsidies on production.
These are included in value added (gross and net) at basic prices. Excluding taxes and subsidies on
production from value added at basic prices will yield value added at factor costs, the money
available for the remuneration of the factors of production, such as labour and capital.
Compilation in constant prices
So far we concentrated on the compilation of the MRDS table of value added and GDP by industry at
current prices. Comparing annual GDP estimates in current prices between years is complicated by
the fact that changes in GDP can occur because of volume changes or because of price changes in the
transactions that make up GDP, i.e. output, intermediate consumption and net product taxes. This is
perhaps easiest to understand for market output of goods. Such goods are produced in physical
quantities and marketed with well-defined prices per units of physical quantity. Volume changes in
output are then value changes due to changes in produced physical quantities, valued at a fixed
price, e.g. last year’s price. Price changes of output on the other hand are value changes of a fixed
quantity due to changes in price. The total value change of output for a particular good can thus be
decomposed into a volume change and a price change. This idea can be generalized to output of
market services, to non-market output and to output for own final use, although the proper
valuation involved may be more problematic, as we saw before. Similarly, value changes in
intermediate consumption of particular inputs can be decomposed into volume changes and price
changes. And even for product taxes and subsidies this can be done, e.g. by interpreting the volume
change as arising from the application of last year’s tax rate to current year’s output (assuming taxes
are levied this way) and the price change as the difference between the value change and this
volume change6.
The table of the MRDS on value added and GDP by industry at constant prices serves to express value
added and GDP by industry at fixed prices of a previous period, e.g. last year’s prices or prices of
some other reference year. By comparing these constant price values with the current price values of
the reference year, we automatically obtain the volume changes.
It is important to note that constant price values of value added and GDP by industry cannot be
derived from direct compilation on the basis of source data as was the case for current prices
estimates. Data sources yield only value data, and the decomposition of value changes into volume
and price changes is made analytically. Two methods are available to do this: the deflation method
and the extrapolation method7. Both methods rely on indexes. The deflation method uses price
indexes to deflate current period values. The extrapolation method uses volume indexes to
extrapolate current values of an earlier period. To apply these methods additional data need to be
collected, either on price indexes or on volume indexes. Note that such indexes are usually compiled
at monthly or quarterly frequency. Such indexes need to be aggregated over time into yearly indexes
to apply them to annual value added.
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One peculiar consequence of this decomposition is that the effect of a new tax is part of the price change and
not of the volume change
7
These methods and the required theory on indexes are explored in the papers National Accounts in Constant
Prices, part 1: Elementary Indexes and part 2: Aggregated Indexes.
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Collecting such short-term indexes opens up the possibility to compile value added (and GDP) at
quarterly frequency as well, e.g. by extrapolating last year’s values with quarterly volume indexes to
constant prices estimates and then inflating these to current prices estimates. In such a way a system
of quarterly GDP compilation based on short-term indicators can be set up. However, this is beyond
the requirements of the MRDS.
It should also be noted that deflation methods are generally preferred to extrapolation methods.
One of the reasons for this is the need to properly account for quality changes of products. Over
time, products often change in quality, e.g. because of new technological developments. This may
happen without a significant price effect. Volume indexes tend to exclude such quality change, e.g.
when based on changes in numerical quantities. Hence, constant prices measures based on
extrapolation with such volume indexes will also exclude such quality change effects and might
therefore lead to biased results. Any implicit price changes based on such volume changes may then
be biased as well.
Value added in constant prices
Starting point for the compilation of GDP by the production approach in constant prices is the
identity for (gross) value added given earlier, but now expressed in constant prices (abbreviated as
CP):
Value Added (CP) = Output CP) - Intermediate consumption (CP)
GDP in constant prices is constructed from gross value added in constant prices by adding taxes on
products and by subtracting subsidies on products, both in constant prices.
Ideally, all components that go into the construction of GDP in current prices need to be estimated in
constant prices separately, by using the deflation method at very detailed level. In practice, many of
these objectives may be out of reach. A first problem is that deflators for intermediate consumption
do not exist as such. IC is a composite transaction, consisting of many separate inputs, each of which
needs to be deflated separately. Details of input structures are generally difficult to obtain. If known,
such input structures can be used to construct synthetic deflators for IC (as weighted averages of the
input deflators, with the input structures supplying the weights). The method of deflating output and
IC separately, each with its own index, is called double deflation. If proper deflators for IC cannot be
found, a next best option is to apply the same deflator for both output and IC. This is the method of
single deflation. This corresponds to the direct deflation of value added with the single deflator. In
practice this is the method that many countries start out with for market goods producing activities.
A next problem is that proper price indexes must be found for the various types of output. We
already saw that there are many problems with the proper valuation of some types of output,
making it difficult to determine what a proper price index is in the first place. And even if such a price
is properly conceived of, there may not be a suitable price index available for its measurement.
The use of deflation methods for output (or for value added in the case of single deflation) is limited
by the availability of price index data. The accurate measurement of price developments is one of the
main aims of economic statistics, so price indexes will be available in most countries, especially
consumer price indexes (CPI). However, deflating output (valued in basic prices) with CPI is incorrect,
since CPI captures price development in products as they are consumed by final users, i.e. valued in
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purchasers’ prices. Only for products without trade and transport margins is the use of CPI justified
(assuming no change in taxation). This is the case for most services. For goods, many countries rely
on producer price indexes (PPI), which are commonly available for ISIC sections B – E.
In cases where deflation is problematic or not possible, extrapolation methods may provide
alternatives. This is especially the case for the output of services. Volume changes of services may be
defined in terms of performance indicators (number of passengers transported for transport
services, number of patients treated for health services etc.) which can be valued by applying a
proper fee (charge per performance unit, such as fee per passenger, fee per patient). One can then
construct volume indexes for service activities by comparing total performance between different
time periods. However, even if calculated at very detailed level, such measures exclude quality
changes, which will make their use problematic.
Finally, there are a number of ISIC activities where standard deflation is not really possible, such as
construction, financial intermediation, ownership of dwellings and non-market output of government
units. For these specific cases, there are separate methodologies for constant prices estimation that
countries need to follow. We will encounter some of these in future papers (including numerical
examples).
Concluding remarks
This paper set out to provide some background on the methodology of compiling the MRDS tables on
value added and GDP by industry in current and constant prices. The main issues for the compilation
in current prices are the proper delineation of output, the mobilization of data sources on output and
IC for all relevant economic activities and main institutional sectors and the need to achieve a
reasonable degree of exhaustiveness, by focusing in the non-observed parts of the economy and the
informal sector. These issues need to be addressed in the earliest phase of SNA implementation, and
the Handbook is therefore particularly relevant here.
The main issue for the compilation in constant prices is the deployment of a system of short-term
indicators that “fits” the framework in current prices, i.e. for each of the main components of GDP
there are either suitable price indexes for deflation or suitable volume indexes for extrapolation. In
an early phase of SNA implementation, this may be difficult to achieve, and simplifications may need
to be made, e.g. by resorting to single deflation, or to extrapolation without taking quality changes
into account. High quality estimates of GDP in constant prices are one of the primary targets of SNA
implementation, with volume changes in annual GDP being the principle measure of economic
growth. Hence, it is important - even in the early stages of SNA implementation – to give the second
MRDS table its proper due as well.
To find out more …
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
Essential SNA: Building the Basics (2010 edition), Section IV.4
The 2008 SNA, European Commission, IMF, OECD, UN, World Bank, 2009, Chapter XV:
Price and volume measure.
Handbook on price and volume measures in national accounts, Eurostat, 2001.
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