Measuring Economic Performance

1. Measuring Economic Performance

2. 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

3. Economic Growth • Rate of Increase of Production. • If Qt is a measure of production, the simple net growth rate is • Implying

4. 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. + + + + =?

5. (Simple) Average Growth • If there are K goods then we could calculate the average growth rate of each type of good. • Problem: Taking the simple average of the growth of different types of goods may give a distorted picture of average growth, since different goods are of different importance in the economy.

6. Weighted Average Growth • Instead we could construct a weighted average where the weights add to 1. • An even weight is wk=1/K but we could adjust the weights to be indicate the importance of each good in the economy.

7. 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)

8. All goods sold in an economy share a common unit of measure: the price at which they are sold. Gross Domestic Product (GDP) Sum up the value of goods • “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

9. GDP is a measure of production • Value added at production establishment i • GDP is the sum of VA across establishments.

10. 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 the UN Link

11. Production ApproachSub-aggregates • Divide production establishments into sectors usually along the line of • Primary: Natural Resources (Agriculture, Forestry, Fishing, Mining, Quarrying) • Secondary: Goods production (Manufacturing, Construction, Utilities) • Tertiary: Intangibles Production

12. Hong Kong: Value Added by Sector Hong Kong Census and Statistics

13. Expenditure Approach • Purchase of Final goods by end users are divided into two categories: • Consumption: Household expenditure (durables, nondurables & services); government (nondurables & services) expenditure; nonprofit expenditures • Investment: Inventories, Fixed Investment (equipment, structures)

14. Some Asian Expenditure Shares: 2010 People’s Republic of China Source: United Nations Main Aggregates Database Source: United Nations Main Aggregates Database

15. Using GDP to Measure Economic Performance

16. 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.

17. 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.

18. Aggregate Growth • Growth of volume measures true/real growth in the production of goods as opposed the change in the arbitrary measure of value. • To measure economy wide growth we could average the growth of production across all the different goods produced.

19. Growth Rates of Products and Ratios

20. 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 • The weight of k in the economy could be defined as which add up to 1 across sectors.

21. Aggregate Growth • Macroeconomic aggregates such as GDP and its sub-totals are the sum of values of sales (or purchases) from different firms. • We also decompose the growth of the aggregates into growth in prices (inflation) and growth in volume (output).

22. How statistical agencies calculate volume growth. • Construct representative market basket of each category of goods, k. For example, if kwere apples, the market basket could consist of a certain number of Red apples, Green apples, Fuji apples depending on how many of each of these are purchased. • Sample goods of type k at time t and at time t-1 to assess the price level of the market basket at each time period.

23. Building Blocks for Volume GrowthValue and Inflation Vectors • For every type of good at time t, measure and construct an inflation vector representing the growth rate of prices. • Convert the dollars spent on good k into their purchasing power measured at time t-1 prices.

24. Conceptually, if we think of value of good k as the product of price and quantity vk = pk*qkwe can think of value divided by the inflation vector as the quantity of goods produced at time t measured at the value in terms of the previous period prices.

25. Volume Growth • Sum the inflation adjusted values across the types of goods and divide by value in previous period

26. Volume Growth cont. • Conceptually, the numerator of volume growth is the sum of goods produced at time t valued at the price prevailing at time t-1 while the denominator is the sum of goods produced at time t-1valued at the price prevailing at time t-1. The yardstick of value, dollar prices in time t-1 prices, are the same in the numerator and denominator.

27. Volume Growth cont. • Conceptually, we can also think net volume growth as a weighted average of the growth rate of quantities of each type of good.

28. We can rewrite the numerator as • Collect terms • Rewrite

29. Note that and divide through by Vt-1 . • Define as a weight • By construction, the weights add up to one, so volume growth is a weighted average of the growth of production of each type of good

30. Volume Levels • To compare the level of aggregate quantities at different points in time, total up the growth that appears in between periods. • Calculate the growth rate for all periods using the prices from the immediately previous periods to adjust current values. • Choose a reference period, ref, preferably in a recent period and set a constant price series equal to value in that period

31. Chained Index • Define the constant price series recursively in all periods using the equation The relationship between the levels of the chain volume index at any two points t and t+T is the product of the growth between the two points.

32. Comparing GDP across Countries We want to compare output in two countries though those are measured in different currencies.

33. Market Basket Index? • Construct an international market basket of goods produced and purchased around the world. For country j, PPPjcould be the relative price of the market basket relative to price of the market basket in US$. • Problem: Judging the cost of living by the cost of the international market basket may not be fair if customers in the local market can buy the types of goods which are cheaper at home.

34. 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. Link

35. PPP’s • Divide expenditures into k = 1,..,K (in 2005, K = 155) “basic heading” categories of goods. • All j = 1,..J countries (in 2005, J = 146) report total expenditure in domestic currency of all categories . ICP Handbook

36. PPP’s cont. • Sample prices of representative goods from each category in each country. • Construct average of those prices (relative to “anchor” economy) for each country j basic heading type of good k . Note: Measured in # of j country Currency units per anchor country currency units. Example. If Japan = j and anchor is USA, and 1 kg. rice is 400 yen in Japan and $2 in USA :

37. PPP in Anchor Currency. • Define quantity of good of type k valued • Calculate price of j’s market basket in j’s prices relative to price of j’s market basket in anchor country prices. Numerator in j currency, denominator in

38. Conceptually PPP is the cost of the goods purchased by consumers in their country relative to the cost of those same goods in anchor country terms.

39. GDP in Intl$ • PPP’s are used to construct comparable measures of GDP for multiple countries by converting them into international dollars. Per capita GDP in international dollars is headline way of comparing living standards.

42. Large Variations in Labor per Person (www.ggdc.net)

43. Variation in Labor Force Participaton

44. Main Differences in Countries are Due to Variation in Labor Productivity

45. Pre-Industrial RevolutionSource: Angus Madisson, Measuring the Chinese Economy

46. Productivity Catch Up: EuropeSource: Groningen Growth & Development Center 1990 US$, Average Output per Hour (Y/L)

47. Productivity Catch Up: Latin AmericaSource: Groningen Growth & Development Center

48. Productivity Catch Up: East AsiaSource: Groningen Growth & Development Center