GDP at Constant Prices – Production Approach

UN-ESCWA

22 – 25 September 2007

Cairo

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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)

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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.

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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, double indicator methods are generally superior.

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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 double indicator method sometimes gives erratic result (even negative value added).

• Thus, double indicator methods are not uniformly recommended.

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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 IQCt using quantity index as extrapolator

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Double Indicator Methods (2)

4. Extrapolation-Deflation combination:

Y0 x IVYt - Ct / IPCt

or Yt / IPYt - C0 x IVCt using volume

index as extrapolators

Y0 x IQYt - Ct / IPCt

or Yt / IPYt - C0 x IQCt using quantity

index as extrapolators.

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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 IVYt with IVYt = Yt / IPYt

• Direct Extrapolation by physical quantity output index:

VA0 x IQYt

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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

 

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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

 

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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*

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Preferred Methods of Output Measurement at Constant Prices (1)

• In Production account, the balancing VA is derived from output, intermediate consumption 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.

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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.

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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]

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A/B/C Methods – EROSTAT Handbook

• The Handbook generally classifies 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.

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‘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.

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‘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 represents theoretically correct method.

• Second, using appropriate volume indicator. The Manual specifies appropriate volume indicator for

each ISIC group / class. [See Handout – 3]

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‘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]

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‘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]

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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.

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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.

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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

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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)

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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.

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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

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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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