In my last post Going through Indian Macroeconomic Aggregates from the New Series (2011-12): Production Approach, I looked at key macroeconomic aggregates of the New Series of National Accounts (base year 2011-12) related to the “Production” or “Value Added” approach of GDP estimation. In this post, I will talk about the macro aggregates (of the New Series) thrown up by the “Expenditure” approach to GDP estimation. More specifically, I will compare India’s GDP composition (by expenditure) with that of the rest of the world (ROW).
Before I go any further, here is the equation based on which GDP is estimated by the Expenditure approach.
GDP = Private Final Consumption Expenditure (PFCE) + Government Final Consumption Expenditure (GFCE) + Gross Capital Formation (GCF) + Exports - Imports.
For those who’re not familiar with this identity or those who’d like a little Econ 101 refresher:
In the Expenditure approach, GDP is estimated as the sum of expenditures on final goods and services produced in the domestic territory of a country. Final goods/services are acquired for final (as opposed to intermediate) consumption or investment. The broad final expenditure categories for an economy are 1) PFCE or final consumption expenditure by households and Nonprofit institutions serving households (NPISHs), 2) GFCE or the value of goods/services produced by the general government for own use, 3) GCF or investment expenditure, and 4) Net Exports (Exports - Imports).
The first three categories are intuitive enough, but why are Net Exports included while estimating GDP, you ask? This is because in order to estimate GDP correctly through the Expenditure approach, we have to account for that part of domestic product that is bought by foreigners (i.e. add exports) and also for the domestic expenditure made on buying imports, which are not part of GDP (i.e. subtract imports).
With that introduction, I’m going to reproduce the first table from the release titled “New Series Estimates of National Income, Consumption Expenditure, Saving and Capital Formation (Base year 2011-12)” published on 30th Jan 2015, in which MOSPI debuted the New Series of National Accounts.
Table 1: India’s Key Aggregates of National Accounts at Current Prices
I’m going to focus on the second box (with the head “Final Expenditures”).
PRIVATE FINAL CONSUMPTION EXPENDITURE (PFCE)
1. India’s Private Final Consumption Expenditure was ~60%1 of GDP in 2013-14 (see Table 1). This means that 60% of the expenditure on final goods and services in India in 2013-14 was undertaken by households, underscoring the importance of private consumption for our economy.
How does this compare with other nations? See the chart below based on data provided by the World Bank. There are some interesting results here.
Chart 1: Private Final Consumption Expenditure (PFCE) as a % of GDP. Even though this chart is titled Household Final Consumption Expenditure (% of GDP) by the World Bank, it represents PFCE since these figures includes the final consumption expenditure of NPISHs.
Source: World Bank (http://data.worldbank.org/indicator/NE.CON.PETC.ZS)
2. PFCE (as a % of GDP) for the US and for Sub-Saharan Africa is almost the same. (?)
USA’s PFCE as % of GDP was 68% in 2013, almost the same as Sub-Saharan Africa’s 67%. This appears strange at first glance, given that the US and Sub-Saharan Africa are at completely different stages of economic development. Sub-Saharan Africa is a poor, under-developed geography that is starved of capital formation/investment expenditure. This explains it’s high PCFE (as a % of GDP). With weak investment expenditure, consumption expenditure dominates.
The US on the other hand is arguable the most developed economy in the world. That said, given its mature stage of economic development, US GDP growth is quite modest compared to that of India or China. For context, US GDP (at constant 2010 prices) grew at an average 1.6%2 y-y over the 10-year period from 2004-13, while Indian GDP grew at close to 8%2 y-y during the same period.
Now, consumption is important no doubt, but it is Capital formation or investment (in the form of factories, buildings, machinery, stocks etc.) i.e. what you save/invest today, that drives future growth. (I’m going to do a separate post on this subject).
USA’s sub 2% y-y growth rate does not require a high rate of gross capital formation (GCF) (as a % of GDP). Also, various factors including stagnant wages, credit-driven consumption, inadequate social security etc. have all led to a systemically low rate of domestic household saving along with high consumption. The end result is that private consumption (PFCE) is an especially high % of US GDP (68%) as seen in the chart above, while GCF for the US is not particularly high (when compared with other nations).
Bottom-line: Due to very different reasons, USA’s and Sub-Saharan Africa’s PFCE (as a % of GDP) is almost the same.
3. China’s PFCE in 2013 was 36%, much lower than the US’s 68%, EU’s 57%, India’s 60%1 and Russia’s 54%.
Here’s why. China’s wealth is very unequally divided. The vast majority of its population (working class) has very low disposable income. Most of the wealth belongs to the top few % of the population, who tend to invest locally in property/stock market and in assets abroad. Their spending does not create the kind of virtuous domestic spending cycle that begets more spending by putting money in the hands of other domestic spenders.
Also, increasing domestic consumption and/or alleviating income inequality have not been a priority for the government (at least so far). The government has focused mainly on investment and manufacturing for international markets. Despite the recent slowdown, China is still the “factory of the world”.
Given these factors, PFCE for China is quite low compared to other nations.
4. With all that context, India’s PCFE of ~60%1 (close to the world average) is a good, balanced place to be. While there are a lot of dynamics that that feed into such a metric, at the outset, avoiding the extremes of the US and China is prudent.
GOVERNMENT FINAL CONSUMPTION EXPENDITURE (GFCE)
A little background is needed here before we delve into the numbers.
Government final consumption expenditure (GFCE) represents expenditure by the government on goods and services that are used for the direct satisfaction of individual needs (individual consumption) or collective needs of members of the community (collective consumption).
More specifically, GFCE = the value of the goods/services produced by the government - own-account capital formation - sales + government purchases of goods/services produced by market producers that are supplied to households as social transfers in kind.
“Social transfers in kind” correspond to individual goods and services supplied to households as transfers (without any payment/quid pro quo in return) by the government or NPISHs, whether the said goods and services were purchased on the market, or whether they were produced (non-market production) by the government or NPISH. They include: 1) social benefits which involve goods and services supplied directly by the general government (e.g. housing), 2) social benefits that beneficiary households buy themselves and then have reimbursed (e.g. healthcare) and, 3) transfers of individual non-market goods and services produced by general government, particularly education and health.
1. Social transfers in kind are especially important in European “Welfare” type states where the government plays a big role in providing consumption goods/services to its population. Examples include Denmark, Sweden, Finland, Belgium, Norway, Netherlands, France, Germany, Greece (poster child for welfare state ruin) and Luxembourg.
In these nations, GFCE is a high % of GDP. For context, for the EU (which includes all the welfare states listed above), GFCE was 21% of GDP in 2013. At 26%, Denmark had the highest GFCE (% of GDP) amongst these states in 2013.
Source: World Bank (http://data.worldbank.org/indicator/NE.CON.GOVT.ZS) * Sub-Saharan Africa includes IDA & IBRD countries.
2. At 11%, India’s GFCE as a % of GDP is the lowest in the chart above, much below the world average of 17% for 2013. The reason for India’s low government expenditure (as a proportion of GDP) has been the government’s inability to raise taxes/revenue and finance government expenditure from sources other than debt. As a result, curtailing Fiscal Deficit, which the current government has done well (FD = 3.9% of GDP for 2015-16) has meant mainly cutting government expenditure, rather than raising revenue.
This is the subject of much debate right now. Many believe that it’s OK for the Fiscal Deficit to be higher, as long as the government spends on infrastructure and other areas that will help accelerate GDP growth in the future.
In any case, till the government can find means of raising tax revenues (tax payers accounted for just 1% of our population in 2013) and checking income tax evasion (which is quite rampant), government expenditure as a % of GDP is unlikely to rise significantly. Note: the Goods and Services Tax (GST) is a very constructive step in this direction. We’ll discuss why in a separate post.
While how Gross Capital Formation is calculated in India is a complex subject (I hope to take it up in a future post), here's what is included:
GCF = Gross Fixed Capital Formation (GFCF) + Changes in Stock (CIS) + Change in Valuables where:
GFCF = Acquisitions less disposal of new or existing tangible fixed assets (1. dwellings, 2. buildings and structures, 3. machinery and equipment, and 4. Cultivated biological resources, which include trees, livestock etc. that can be used repeated to produce products) + Acquisitions less disposal of new or existing intangible fixed assets (1. software, 2. mineral exploration costs, 3. entertainment, literary or artistic originals, 4. Other intangible fixed assets) + major improvements to tangible, non-produced assets including land and sub-soil assets (mineral deposits) + costs associated with transfer of ownership of non-produced assets.
CIS = changes in inventories of finished goods, work-in-progress goods and materials
Change in Valuables = net acquisitions of precious metals/stones, paintings, sculptures etc.
1. Since GCF is crucial for future economic growth, high GCF (as a % of GDP) is desirable for all nations that want to grow at a high-single-digit or double-digit pace. This is mirrored in the chart below, where China and India, the fastest growing economies in this group, have the highest GCF (as a % of GDP) ratios.
Chart 3: India’s GCF (as a % of GDP) was 37%* in 2012-13 while China’s was 49% for 2012. The mature, slower - growth economies of the US and EU had GCF (as a % of GDP) of 18-19% in 2012.
Source:www.datamarket.com (link here) *the World Bank estimates India's GCF at 35% of GDP for 2012. I've used 37%, the ratio derived from the New Series of National Accounts (at current prices) (Table 1).
NET EXPORTS
Finally, the chart below shows India’s Net Exports or External Balance of Goods & Services (as a % of GDP) vs. the ROW. As you can see, our Net exports (as a % of GDP) improved sharply to -3% of GDP in 2013-14, from -6.7% of GDP in 2012-13 mainly due to a fall in the imports of gold and capital goods.
Chart 4: External Balance of Goods & Services (as a % of GDP)
Source: World Bank (http://data.worldbank.org/indicator/NE.RSB.GNFS.ZS)
Ok, that's a lot of charts for one post. Ciao for now.
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1 The World Bank estimates India's PFCE at 58% of GDP for 2013. I've used 60% (for PCFE as a % of GDP in 2013-14) based on estimates from the New Series of National Accounts (at current prices) shown in Table 1.
2 1.7% is a simple average of USA's annual GDP growth rates (at constant 2010 US dollars) from 2004 - 2013 (based on World Bank data). To estimate India's average growth rate for the same period, I've used annual GDP (at market price) growth rates at constant 2004-05 prices, from the old series of National Accounts for the years 2004-2010. For the years 2011-2013, I've used GDP growth rates (at constant 2011-12 prices) from the new series. The simple average of these annual growth rates (2004-13) is 7.8%.
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