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Measuring Economic Performance Readings • Lequiller François and Derek Blades, 2006, Under standing NATIONAL ACCOUNTS, Organization for Economic Cooperation and Development, Chapter 1 and 2. Link • Bureau of Economic Analysis “Introduction to the National Income and Product Accounts” Link Measuring the Economy • National accounts are the core statistical measure of the economy. • Accounts cover many features of the economy but organizing concept is Gross Domestic Product (GDP) All goods sold in an economy share a common unit of measure: the price at which they are sold. Sum up the value of goods Gross Domestic Product (GDP) • “GDP combines in a single figure, and with no double counting, all the output (or production) carried out by all the firms, non-profit institutions, government bodies and households in a given country during a given period, regardless of the type of goods and services produced, provided that the production takes place within the country’s economic territory.” L & B p. 15 GDP is a measure of production • Value added at production establishment i Value Addedi =Sales + inventories -raw materials, semi-processed inputs and energy costs. • GDP is the sum of VA across establishments. GDP iValue Addedi Economic Concept • Value Added is production at firm level due to the combination of capital equipment and workers. • Value added is not equal to profits because the costs of worker and capital are not deducted. Link • Accounts are created by national statistical agencies • UN System of National Accounts is the “internationally agreed standard set of recommendations” used by most countries. • Annual data for many countries available at Link the UN Production Approach Sub-aggregates • Divide production establishments into sectors usually along the line of – Agriculture: Natural Resources (Agriculture, Forestry, Fishing) – Industry: Goods production (Mining, Manufacturing, Utilities, Construction) – Services: Trade, Transport, Communication, Services Other Activities (ISIC J-P) Transport, storage and communication (ISIC I) Wholesale, retail trade, restaurants and hotels (ISIC G-H) Construction (ISIC F) Manufacturing (ISIC D) Mining & Utilities Agriculture, hunting, forestry, fishing (ISIC A-B) Hong Kong: Value Added by Sector 60 50 40 30 20 10 0 2010 1970 UN Main Aggregates Link Dynamics of Industrial Structure Demand • • If we add up the value added at all stages of production we derive the value to the end user. Sum of Final Demand Aggregates equals Sum of Value Added Expenditure Approach • Purchase of Final goods by end users are divided into two categories: 1. Consumption: Household expenditure (durables, nondurables & services); government (nondurables & services) expenditure; nonprofit expenditures 2. Investment: Inventories, Fixed Investment (equipment, structures) Some Asian Expenditure Shares: 2010 People’s Republic of China 1 90 0.9 80 0.8 70 0.7 60 0.6 50 0.5 40 0.4 30 0.3 20 0.2 10 0.1 0 1 0 2 Japan 3 4 5 Republic of Korea 6 7 8 9 -10 Household consumption expenditure General government final consumption expenditure Gross fixed capital formation Changes in inventories Source: United Nations Main Aggregates Database 10 Reconciliation • Some demand for domestically produced value added comes from abroad, some domestic demand is satisfied by overseas goods. GDP = Consumption + Investment + Exports – Imports Exports – Imports = External Balance = Trade Balance = Net Exports <> 0 HK Exports & Imports 250 200 150 2010 2008 % of GDP 2006 2004 2002 100 2000 1998 1996 Exports of goods and services 1994 1992 50 1990 1988 1986 1984 1982 0 1980 Imports of goods and services 1978 1976 1974 1972 1970 UN Main Aggregates Link Value Added and Income • Production establishments are where income is generated. Funds raised can be paid for labor and finance costs, left over money is profit income. • Sum of domestic value added (GDP) is equal to wage payments plus financial and profit income referred to as “operating surplus and mixed income.” Income Approach to Measuring GDP Value Added distributed as income to Employees, Owner/Creditors, & Gov’t 1. Compensation of employees (Wages, Benefits) 2. Net operating surplus (Profits, Net Interest, Rental Income) Value Added 2010 1.58 Trillion HK$ 3. Taxes on Production Compensation of employees Value Added Compensation of employees Gross operating surplus Taxes on production 17 1,606,092 828,139 753,171 24,782 Gross operating surplus Taxes on production 1% 47% 52% • Using GDP to Measure Economic Performance • Measuring stick of value is prices of goods in terms of money, but arbitrary changes in the stock of money arbitrarily change prices/the measure of value over time. • Comparing value across time requires abstracting from those arbitrary changes in value. What is Economic Growth in a world of many goods? • We need to combine the many goods produced or consumed in an economy into one measure. + + + + =? Value vs. Volume • Consider the sales of a hypothetical single good k (for example, k = apples). • Dollar Value of sales (called vk) is the product of the volume of goods sold (called qk) measured in the goods natural units (i.e. bushels of apples) and the dollar price per good (called pk) vk = pk*qk • Growth of value can be decomposed into growth of volume and growth in prices. Share of Value • We could measure total value for the economy. • Divide our economy into K categories of goods indexed by k = 1,…, K. • Value of sales of good k, vk. GDP is represented as the sum of value across goods GDPt Vt v v v ... v 1 t 2 t 3 t K t Value weignts and Inflation Vectors k t • The weight of k in the economy v could be k v defined as wk which add up to 1 across V sectors. • For every type of good at time t, an inflation vector representing the growth rate of prices. k pt pk k 1 gt pt 1 Real GDP Growth • Growth of value can be decomposed into growth of volume and growth in prices. (1 g ) (1 g ) (1 g ) vk t pk t (1 g ) q t k qk t (1 g ) vk t (1 g ) pk t k t k t v p vtk1 ptk1 • Instead we could construct a weighted average gt REALGDP w gt w gt w gt ... w gt 1 t 1 q1 2 t 1 q2 3 t 1 q3 K t 1 qK Notes on Price Indices: New Goods • Weights change as production structure of the economy changes k pt k t 1 • Market baskets used to construct p don’t need to stay the same over long-periods. • K categories of goods don’t need to stay the same over long periods. • New goods can be introduced as long as matched goods are compared in every t and t-1 period. GDP Growth 14 12 A v 10 e r a g 8 e % G r o w t h 6 4 2 0 1971-1975 1976-1980 1981-1985 1986-1990] Hong Kong 1991-1995 USA World 1996-2000 2001-2005 2006-2010 Inflation • We also decompose the growth of the aggregates into growth in prices (inflation) and growth in V P Q volume (output). (1 gt ) (1 gt )(1 gt ) (1 g ) P t (1 g ) V t (1 g ) Q t Midterm Exam • Thursday, October 24th, 2013 – When: 1:30-2:50 p.m. – Where: TBA • Bring writing materials and calculator. • Coverage: Globalization-Human Development • Semi-open book: Bring 1 A4 size piece of paper with handwritten notes on both sides. Comparing GDP across Countries We want to compare output in two countries though those are measured in different currencies. Exchange Rates • Exchange Rate: S - # of domestic currency units purchased for 1 US$. • An increase in S is a depreciation of domestic currency and a decrease in S is an appreciation. Atlas Conversion Method • Exchange rates are volatile, so convert to US dollars using SATLAS= 3 year average. GDP pe Capita, US$ 60000 50000 Axis Method 40000 30000 20000 10000 0 2000 2001 2002 2003 2004 2005 2006 Hong Kong SAR, China 2007 Singapore 2008 2009 2010 2011 2012 Link • Major project to compare prices internationally implemented by the World Bank with the help of UN and national statistical agencies. • ICP has been implemented by UN Statistical Office since 1968. PPP’s 1. Divide expenditures into k = 1,..,K categories of goods. 2. All j = 1,..J countries (in 2005, J = 146) report total expenditure in domestic k currency of all categories v j . 3. Sample prices of representative goods from each category in each country. 4. Construct average of those prices (relative to “anchor” economy) for each country j basic heading type of good k . p k j p k ANC WDI provides PPP data for many countries using US$ as anchor currency Hong Kong PPP per Category PPP Xrate Classification Name 2005 1101 Food and non-alcoholic beverages 8.81547906 1102 Alcoholic beverages and tobacco 10.1680743 1103 Clothing and footwear 6.11435997 1104 Housing, water, electricity, gas and other fuels 9.09847987 1105 Furnishings, household equipment and household maintenance 7.61334163 1106 Health 2.9312812 1107 Transport 9.40016616 1108 Communication 6.83789147 1109 Recreation and culture 5.24897067 1110 Education 3.25951882 1111 Restaurants and hotels 8.98215569 1112 Miscellaneous goods and services 5.61784877 1501 Machinery and equipment 7.5934365 1502 Construction 4.15019416 7.78 7.78 7.78 7.78 7.78 7.78 7.78 7.78 7.78 7.78 7.78 7.78 7.78 7.78 PPP Conversion Factor • PPP is a value weighted average of relative prices of all K goods. PPPjAC $ w1j p1j p1ANC w2j p 2j 2 p ANC ... wKj p Kj K p ANC ,......, w n j v nj Vj PPP 2010 China Hong Kong Korea Japan Singapore PPP 3.94638098 5.34545752 827.345987 111.389068 1.04012836 PPP/XR 0.582922 0.688032 0.71566 1.268959 0.762831 XR 6.770269 7.769167 1156.061 87.77988 1.363508 One benchmark for thinking about whether a currency is undervalued or overvalued. If PPP < XR, then domestic goods are relatively cheap, currency is undervalued. GDP in Intl$ • PPP’s are used to construct comparable measures of GDP for multiple countries by converting them into international dollars. GDPj [ Intl $] Per capita GDP in international dollars is headline way of comparing living standards. GDPj PPPjINTL $ GDP per capita, PPP (current international $) 2005 Hong Kong SAR, China $35,677.92 China $4,114.57 India $2,299.76 Indonesia $3,216.81 Malaysia $11,754.53 Korea, Rep. $22,783.27 Thailand $6,750.94 Singapore $45,374.24 • Use real GDP growth rates to construct path of constant price International $GDP for comparisons of production levels across time and space. GDP per Capita, PPP Constant 2005 International $ 60,000.00 50,000.00 40,000.00 30,000.00 20,000.00 10,000.00 0.00 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Singapore Hong Kong • Developing countries tend to be relatively cheap with PPP’s being lower than exchange rates. • OECD countries tend to have more similar price structures, though they tend to be relatively more expensive. • High income, non-OECD countries tend to be relatively cheap. • Compare values measured in different currencies using the PPP and exchange rate method. Is China the Biggest Economy in the World? • Discuss Subramanian Link Country NameIndicator Name 2005 2006 2007 2008 2009 2010 2011 2012 China GDP (current LCU) 18493.7369 21631.4426 26581.0306 31404.5427 34090.2813 40281.65 47261.92 52760.77 China PPP conversion factor, GDP (LCU per international 3.447589843 $) 3.46627859 3.6247 3.82281305 3.76702264 3.97864056 4.18192048 4.23068287 United States GDP (current LCU) 12564.3 13314.5 13961.8 14219.3 13898.3 14419.4 14991.3 15684.8 5364.250895 6240.53782 7333.305 8215.03492 9049.66191 10124.4758 11301.487 12470.982 Exchange Rate Method • Exchange Rate Method can be a useful measure if you are going to convert income in one area and spend it in another. – Ex. Your Swiss food company projects that it can at most get a 20% share of the market for Mexican processed foodstuffs. Converting the size of Mexico’s processed food expenditures from Pesos to Swiss Francs is useful info for estimating profits. . • But macro aggregates are often used to give an idea of living standards, here exchange rates are not as useful because they are highly variable and not so representative.. PPP vs. Exchange Rate Conversion • Exchange rates are easily available so exchange rate is a “quick and dirty” comparison. – Measures how many US dollars someone could buy with average income. • However, money goes farther in some countries as many types of goods are relatively cheap (especially in developing countries). – PPP conversion measures how much the goods purchased by the average person would cost in the US. Better measure of living standards. GDP in US$ by Conversion Method 2005 GDP per Capita $7,000 40000 $6,000 35000 $5,000 30000 25000 $4,000 US/Intl$ US/Intl$ 2005 GDP per Capita $3,000 20000 15000 $2,000 10000 $1,000 5000 $0 Low income Lower middle income Middle income Exchange Rate PPP Upper middle income 0 High income: OECD High income: nonOECD Exchange Rate PPP