GDP at Constant Prices – Production Approach

1. GDP at Constant Prices – Production Approach UN-ESCWA 22 – 25 September 2007 Cairo

2. Main Aggregates Involved • Output (P.1) • Intermediate consumption (P.2) • (Taxes-subsidies) on products & imports (D.21 – D.31) • Value added / GDP (B.1) – main interest • Compensation of employees (D.1) • Mixed income (B.3) + Operating surplus (B.2)

3. Value Added at Constant Prices – the Concept • Production approach GDP = ∑VA, over industries – the main aggregate of interest • It has no physical counterpart in the real world, unlike Expenditure approach GDP. • VA - balancing item of “production account” - not observable - change in current-prices VA not decomposable into price and quantity components. • VA at constant prices is defined and measured as (output at constant prices) minus (IC at constant prices). • Constant prices: previous year’s prices for annual chain-linked series and prices of the “base” year for fixed-base year series.

4. Methods of Estimating GVA at Constant-Price [See Handout-2] • Different methods of constant-price estimation are characterized by the use of the techniques and the number of indicators: • (i)    extrapolation or deflation technique • (ii)   double or single indicator. • Also depends on the choice of indicators and the variables used for the purpose: • (i)   whether the indicator relates to output or input and • (ii)  type of variable on which the indicators are based. • Theoretically, doubleindicator methods are generally superior.

5. Practical problems of using double indicator methods: ·  More demanding in terms of data. ·  When GVA is a small portion of output and when the relative prices change drastically, the doubleindicator method sometimes gives erratic result (even negative value added). • Thus, doubleindicator methods are not uniformly recommended.

6. Double Indicator Methods (1) 1. Revaluation of output: QYt x PY0 - QCt x PC0 2. Double Deflation: Yt / IPYt – Ct / IPYt 3. Double Extrapolation: Y0 x IVYt - C0 x IVCt , using volume index as extrapolator or Y0 x IQYt - C0 x IQCtusing quantity index as extrapolator

7. Double Indicator Methods (2) 4. Extrapolation-Deflation combination: Y0 x IVYt - Ct / IPCt or Yt / IPYt - C0 x IVCtusing volume index as extrapolators Y0 x IQYt - Ct / IPCt or Yt / IPYt - C0 x IQCtusing quantity index as extrapolators.

8. Single Indicator Methods Single output-related indicator methods • Direct deflation by price index of output: VAt / IPYt or VAt / CPIt • Direct Extrapolation by gross output volume index: VA0 x IVYtwith IVYt = Yt / IPYt • Direct Extrapolation by physical quantity output index: VA0 x IQYt

9. Single input-related indicator methods (1) • Direct deflation by price index of inputs: VAt / IPCt • Direct deflation by wage rate index: VAt / IWt •  Direct Extrapolation by volume index of inputs: VA0 x IVCt

10. Single input-related indicator methods (2) • Direct Extrapolation by an index of compensation to employees deflated by wage rate index: VA0 x SALt / IWt • Direct Extrapolation by an index based on physical quantities of inputs other than labour: VA0 x IQCt

11. Single input-related indicator methods (3) • Direct extrapolation by an index of numbers of workers : VA0 x INt • Direct extrapolation by an index of man-hours worked: VA0 x IHt • Direct extrapolation by an index of man-hours worked adjusted for change in labour productivity: VA0 x IHt*

12. Preferred Methods of Output Measurement at Constant Prices (1) • In Production account, the balancing VA is derived from output, intermediateconsumption and (Taxes - subsidies) on products & imports. • The double-indicator and output-related single indicator methods of estimating VA at constant prices involve measurement of output at constant prices.

13. Preferred Methods of Output Measurement at Constant Prices (2) • Generally, turnover / sales deflated by an appropriate price index is considered as the conceptually appropriate method. • But under conditions of hyper inflation, when prices change very rapidly, price indices become increasingly unreliable. • In such situations, volume indicators are expected to yield better results.

14. Preferred Methods of Output Measurement at Constant Prices (3) • The EUROSTAT Handbook on price and volume measures in national accounts (2001) classifies methods of estimating output at constant prices into three categories: A, B and C. It recommends ‘A’ methods for each industry and considers the ‘C’ methods undesirable. [See Handout – 3]

15. A/B/C Methods – EROSTAT Handbook • The Handbook generallyclassifies the methods for ‘market output’ as follows: • A methods: Appropriately deflated turnover OR volume measures – with detailed product categorization ensuring reasonable homogeneity and very little change in quality. • B methods: Turnover deflated by a less appropriate deflator and, in general, all volume measures. • C methods: Use of all other indicators, especially 'Input' indicators.

16. ‘Preferred’, ‘Alternative’ and ‘Other’ Methods – OECD Manual • The “A” methods of the EUROSTAT Handbook are the a theoretical best for each industry. • But, it is not always practical to follow them • Thus, the “preferred” measures for services, as recommended in the OECD’s Compilation Manual for an Index of Services Production (2007), are suggested for estimating output of services at constant prices. • The Manual also presents “alternative” and “other” indicators for compilation of Services production index.

17. ‘Preferred’ Methods – OECD Manual • The Manual, in general, suggests two “preferred” methods for each services industry – ISIC group (3-digit) and class (4-digit). • First, based on deflation of gross turnover at current prices by appropriate quality-adjusted price index - ‘A’ methods of the Handbook and representstheoretically correct method. • Second, using appropriate volume indicator. The Manual specifies appropriate volume indicator for each ISIC group / class. [See Handout – 3]

18. ‘Alternative’ Methods – OECD Manual • For the “alternative” methods too, the Manual, in general, suggests two for each ISIC group / class. • First, based on deflation of gross turnover at current prices by partially representative price index. • Second, using less appropriate volume indicator. The Manual specifies the volume indicators for each ISIC group / class. [See Handout – 3]

19. ‘Other’ Methods – OECD Manual • As for the “other” methods, the Manual, in general, suggests a single method – based on a single input-related indicator, viz. ‘employment’. • For some ISIC group / class, however, other input-related indicators are also suggested. [See Handout – 3]

20. Output at Constant Prices – Prescribed Methods • Handout-3 is a compilation of methods suggested in the EROSTAT Handbook and OECD Manual, separately for • Market output: sales; and value of products - ‘finished’ and ‘work-in-progress’, supplied to other units of the same enterprise, paid as compensation in kind and those bartered. • Output for own final use: own final consumption or gross fixed capital formation; • Other non-market output: supplied free, or sold at not-economically-significant prices to other institutional units. • Methods for ISIC sections ‘A’ to ‘F’ are from the Handbook and those for ISIC sections ‘G’ to ‘P’ from the Manual.

21. Trade Margin – output of distributive trade • Output of trading activities is the trade margin. • In theory: Difference between deflated sales and deflated purchases. • But, the required data are not available. • The OECD Manual suggests methods based on the assumption • margin-to-sales ratios are constant at constant prices. • This provides the basis for the prescribed method of deflating gross turnover by appropriate quality adjusted price indices.

22. Banking Services (1) • Output of Banking activities consists of: • Services of Issue Department of Central Bank • Fees and charges • FISIM • For Services of Issue Deptt. – recommended method: • Extrapolation by productivity-adjusted number of employees (preferred method) • Extrapolation by number of employees (alternative method) • For fees and charges Preferred method: • Fee income deflated by appropriate quality adjusted price indices OR • Extrapolation by volume indicator defined on numbers of loan, transactions and deposits appropriately classified

23. Banking Services (2) • For fees and charges, alternative method: • Fee income deflated by partially represented price indices OR • Extrapolation by volume indicator defined on numbers of - bank clearings - credit card transactions - debit card transactions - investment funds managed - securities transactions - loans - deposits • and least preferred method: • Extrapolation by number of employees (alternative method)

24. FISIM at Constant Prices • Proposed methods: • Deflation by volume of output indicators covering the activities that generate FISIM • Revalued FISIM obtained by applying base period interest margins to the stocks of loans and deposits. Revaluation made by the implicit price deflator for domestic final demand. • FISIM at current prices deflated by general GDP deflator or overall CPI. • Least preferred method: • Extrapolation by number of employees.

25. Insurance and Pension Funding Services • Output of insurance services at current prices = actual premiums earned + premium supplements - claims due and the change in the actuarial reserves and reserves for with-profits. • Proposed method: Deflation by GDP deflator • Output of pension funding services at current prices = actual pensions contributions + supplementary contributions - benefits due and the change in actuarial reserves. • Proposed method: Deflation by GDP deflator

26. Output of Non-Market Services • At current prices, output of non-market production = sum of production costs. • For constant price estimates for non-market outputs, deflation by market-prices based price index should not be used. • Preferred approach: extrapolation of base year value with directly compiled output volume indicators. [See Handout] • In practice, has to rely on simplified methods based on input measures to approximate the value of output at constant prices.

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