The NIA is based on a circular flow model

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Economic terminology: basic concepts of macro-economic models and
statistics (part 1)


The system of the national income accounts

a.       Definition and function

The ”national income accounts” (NIA) is a system of concepts comprising all those parameters by
which a country’s (or a region’s) level of economic activity, the level of wealth of its population, its
economic growth, the composition of its production and the distribution and utilisation of its income are
normally measured. The amounts covered by the NIA refer to the period of one year. Indicators (such as
 national income, gross domestic product etc.) are used as a measure of success of a country’s
economy and economic policy. It is important to know their significance and their limits within the
framework of an analysis of a development situation with an economic dimension.




b.       Basic models and principles:
The NIA is based on a circular-flow model. The economy is divided into two poles: production
(business) and consumption (households). In the simplified basic model the entire output flows from the
businesses to the households, which in their turn supply the businesses with the labour needed to
achieve this output. In capitalist economies, characterised by private ownership of  means of
production, the  capital used to finance the production process also appears as something supplied
( factor input) by private households to businesses (as it is private persons who supply the corporate
          1
capital).

In exchange for the ”factor inputs” they supply, the households receive - to the value of the products and
services produced - the entire income created in the businesses in the form of wages, profit, interest
and rent, which they, in turn, spend entirely on the acquisition of the products produced in the
businesses.




1
    The problems of using the terms ”factor input” and ”capital” in the meaning shown here will be dealt with in the explanation of
    these terms.
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Fig. 1: The simple economic cycle


                                                 Factor inputs

                                                   Income                              Households
    Businesses


                                                   Expenditure

                                                 Consumer goods

                               flows of goods and services

                               flows of money


Hence:
Output (supply) = income = expenditure (demand)

This identity of the output, income and expenditure (or supply and demand) on which the accounting
system of the NIA is based can also be constructed if one takes into account that

        (a)         businesses retain portions of profits in order to increase the corporate capital and to
                    finance  investments;
        (b)         the private households do not spend all their income but save portions thereof.

In case (a) the profits retained are simply considered income of the businesses and the investments
financed with them as their expenditure (demand).
As far as argument (b) is concerned, we must bear in mind that the reduction in expenditure for
consumer goods resulting from  savings are compared with expenditure for  investment goods,
which do not result from the income of the year in question but from earlier savings and borrowing. As
decisions to save and to invest are of course, made independently of one another and are not
co-ordinated with one another, it would be pure coincidence if the reduction in expenditure due to
                                                                     2
savings were just as large as the expenditure for investment goods.
Depressions, marked by excess supply, and inflationary situations, marked by excess demand, bear
witness to the fact that severe discrepancies can occur often enough between supply and demand, that
                                                                   3
is between the amount of income and the amount of expenditure.
How therefore is equality of supply and demand - which in reality rarely exists - constructed within the
framework of the NIA?

The identity (and here identity is used as mathematical equation of supply and demand, or of income
and expenditure) in the accounting system of the NIA tells us nothing about a fictitious state of
equilibrium but results only from a trick of definition. That portion of production that cannot be sold owing
to lack of demand and thus remains as stock is interpreted as involuntary  investment, as  “net
changes in business inventory (involuntary inventory investment)” (and thus as expenditure on the part
                  4
of the business).

However, if demand exceeds the supply of goods produced, stocks (if present) must be reduced and
this is defined as a negative investment, and the sum of all investment expenditure decreases by the
corresponding amount.

2
  The assumption that these are compensated by the amount of the interest rate has proved untenable in reality.
3
  Here the entrepreneur’s investment decision, influenced by fluctuating profit prospects, often plays the decisive role.
4
  That portion of production that does not leave the corporate sector is therefore defined as investment, irrespective of whether it
  is investment or consumer goods; that portion which goes to the households is defined as consumption. If the sum of all values
  produced is identical to the sum of all income, that portion of the income that is not used for consumption (the savings) must be
  equal to that portion of production that is not consumed (the investments as defined here).
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If, therefore excess supply is interpreted as demand (of the stock department) of the business for its
own supply (that of the production department) supply and demand must be identical.


Output                  =         Income          = Expenditure
                                  (of private households (for consumption or investment
                                   or business)                  or inventory investment)



c.           Composition, distribution and utilisation of the national
             income in accordance with the system of the NIA

1.           Composition

The income of a country is created by the manufacture of goods and services (both are termed
somewhat inaccurately in the NIA as ”production” and the result thereof as ”product”). The sum of all
values created in this process over the course of one year (i.e. the value added (VA) of the economy) is
termed gross domestic product (GDP).
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The goods and services produced are valued always at their current market price.
The level of economic activity in a country is measured as a rule by the amount of the gross domestic
product  at market prices. Within the framework of the output method of national income the gross
domestic product is ascertained and presented as the result of the contributions of the individual
companies or economic sectors. (See Fig. 2)


Fig. 2: Corporate level - output and contribution to GDP


                       Purchase of bought-in
                       materials and services

                       Depreciation                                                                                    Gross VA at market
                       Indirect taxes                                                                                  prices=contribution to
    Gross                                                                                                              GDP at market prices
                       (-subsidies)                                                      Net VA at market
    output                                                                                                             = net output
                                                                                         prices=contribution to
                                                                                         net domestic product
                       Wages and salaries                                                at market prices
                                                            Net VA at factor
                                                            costs = contribution
                       Profit and interest                  to net domestic
                                                            product at factor
                       Rent                                 costs


                       Undistributed profits



It must be borne in mind that the contribution of a business or sector to the gross domestic product does
not correspond to the total value of the output achieved in the year in question, the gross output.
Rather, the contribution towards GDP is only that value created within a business above the value of the
products and services purchased from other businesses, the bought-in materials and services. This
is the value added (=VA) of the business.

If we add the gross outputs of all businesses, the bought-in materials and services supplied by other
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businesses would by counted double, because they form part of the output of the supplying business.

5
     Exception: Government services provided free of charge are valued according to their costs (see also 4. below).
6
     For instance, the value of the grain is included in the value of the flour, which in turn is included in the value of the bread. If we
     were to add the outputs of the farmer, the miller and the baker we would have counted the value of the grain three times.
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The share of the value added in the gross output of a company or sector is termed the value-added
quota. This expresses to what extent the turnover of a business or branch is based on its own inputs.

        turnover = production sold
                   = gross output (production manufactured) minus change in inventory

Thus the value-added quotas are very low generally in commerce, but extremely high in the service
sector.

GDP at market prices results from the sum of the gross value added (determined on the basis of the
market prices) of all businesses and economic sectors within a country’s borders.

2.      Differentiations in determining the domestic product

The concepts already indicate that the term ”domestic product” is not clearly defined and that the more
specific term ”gross domestic product at market prices”, to which the previous explanations referred, is
not the sole category with which statements are made about the production and income level of a
country or region. The gross domestic product is contrast by net domestic product, and the domestic
product at marked prices by a domestic product determined at factor costs; and finally it is not the
domestic product but the national product which is measured. The content and the relevance of these
differences will be discussed here.

Gross/net:

With reference to the parameters: national product, domestic product, value added and investments,
the difference between gross and net is based on the question: is that part of the production
representing the  depreciation of means of production which serves to replace worn-out means of
production (so-called  reinvestments), is included (as in the case of gross values) or not (as in the
case of the net values) in statements about the scale of production.
For statements about production level and economic strength it is of no importance whether the
production serves the purpose of replacing worn-out machines, expanding the machinery pool or
expanding the supply of consumer goods; gross figures suffice for statements of this type. Net values
are considered more suitable for statements about income level and wealth, as deprecation is that part
of income that a business sets aside every year for the replacement of worn-out means of production.
This portion of the business income can also be interpreted therefore as costs for using means of
production. Expenditure for the purchase of means of production is not included in the cost account to
the full amount in the year of purchase but distributed proportionately among the years of use as
depreciation.

In business accounting, of course, depreciation serves not so much as reality-oriented recording in
accounts of the actual depreciation process but usually serves to manipulate the amount of the
dislocated profit by selecting suitable depreciation rates. In the case of excessive depreciation (e.g.
25% per year on a machine with a working life of ten years) higher costs, and therefore lower profits,
than the actual values appear in the company accounts. Lower or undisclosed profits result in a
reduction in the taxes imposed on earnings. Conversely, a business that is running a loss can ”conjure
up” profits (on paper) by lowering the depreciation rates and thus attempt to look more attractive to
potential shareholders and lenders.

Manipulation of this type does not play any role, of course, in the NIA, as the deprecations here are
calculated according to constant rates defined for the various means of production.

The unequal treatment of investors and employees is illustrated by the depreciation phenomenon in this
system of economic accounts. All those costs that members of the workforce must pay so that they can
continually provide the production process with their labour cannot be deducted from the income as
costs, but are calculated as their private (taxable) income. If they were to deduct these reproduction
costs, as does the entrepreneur, from their income, the income distribution statistics would present a
completely different picture.
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Returning from these remarks to the content of the gross and net amounts we can draw the following
conclusion:


In the case of value added, domestic and national product as well as investments (but not, for instance,
gross and net output, which differ by the amount of the bought-in materials and services) the following
applies:

                     gross values           =          including depreciation

                     net values             =          not including depreciation


At market prices / at factor costs:

As we have already mentioned, the standard for determining the parameters of the NIA is basically the
market price of the goods and services produced. The relevant values ”at factor costs” are determined
basically according to the same principle of evaluation but, unlike this, it makes one correction. In place
of the effective market prices manipulated by the influence of the State (artificially raised by sales taxes,
artificially lowered by subsidies) the prices remaining after the deduction of indirect taxes and
government subsidies are used as the basis for determining the  value added and the  national
          7
product .

The term ”at factor prices” results from the view that the NIA is based on corporate value added as the
sum of the remuneration to be paid to the  factors of production (labour,  capital and land) for their
contribution to the production process in the form of wages and salaries, interest and profit as well as
rent.

The factor costs, composing the corporate value added and - at the level of the economy as a whole -
the net domestic product at factor costs, are equivalent therefore to the (gross) income of all those who
provide labour, capital or land for the production process. If we add the indirect taxes to these factor
costs and subtract the (cost-reducing) subsidies we obtain - at the level of the economy as a whole - the
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net domestic product valued at market prices .

The valuation at factor costs gives a more realistic picture of the economic performance of a company
or of an economy than the valuation at market prices, as the subtraction of the indirect taxes and
subsidies eliminates at least one source of the discrepancy between production costs and market
      9
price .

Whereas the valuation at market prices gives us a better idea of the amount and distribution of
expenditure and about the total income of the economy (including government revenue) the valuation at
factor costs - though with substantial reservations - its more suitable as an indicator of the development
of the level of activity of the economy and it composing sectors.

7
    Indirect taxes are those taxes added by per cent to the price of a product, in many countries the general value added tax (VAT)
    (this is added by per cent to the corporate value added) and the product-specific taxes such as mineral oil, tobacco and spirits
    tax.
8
    This interpretation of valued added as the sum of the factor costs covers all types of profits (also e.g. profits from speculation) as
    costs incurred, as they are seen to be remuneration for the contribution of the factor capital for the production of goods and
    services. The term ”costs” is without doubt quite misleading here. As value added is determined on the basis of market prices
    (and the correcting by indirect taxes does nothing to change this), and not as the sum of the costs incurred in the production of
    goods and services, it is not appropriate to define this as the sum of the ”factor costs”. Any surplus is defined away by this; the
    price - minus the indirect taxes - is regarded per se as the cost price, as the sum of the cost. It is appropriate, however, to see in
    the value added the sum of all income resulting from a business, irrespective of whether or not this income is based on a
    productive contribution.
9
    For instance, let us presume that the productive activity of a region consists only of food and cigarette industry. The value added
    at market prices is 50 in both sectors. Thus each sector contributes 50% towards the resultant national product at market prices.
    The cigarette industry appears to be of great importance to the region’s economy.
    But a tobacco tax of 100% is levied on the price of cigarettes, whereas the price of food is reduced by 50% due to government
    subsidies for agricultural products. The value added “at factor costs” is 25 in the cigarette industry and 100 in the food industry
    (this applies only under the simplifying assumption that no bought-in materials and services flow into the two branches of the
    economy). The national product at factor costs is therefore 125; with the food industry contributing 80% and the cigarette
    industry 20%. The significance of the cigarette industry was severely overestimated in the valuation at market prices.
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Conclusion:
Valuation at market prices: incl. sales tax and subsidies
Factor costs: without sales tax and subsidies



Domestic / national product:

The domestic product represents the value of the goods and services produces within the borders of a
country, irrespective of whether the production of goods and services is performed by foreign or
                                                       10
domestic businesses, or by foreign or domestic labour .

The national product represents that value accruing to residents from production processes,
irrespective of where the goods or services are produced. The production location is not decisive here
but the (permanent) abode of those receiving income from the production processes. Profits of national
entrepreneurs abroad and salaries obtained abroad by labour resident in a nation are therefore included
in the national product, the income of foreign labour and the profits of foreign companies are not (exactly
                                                            11
the opposite applies in the case of the domestic product) .


Mathematically, the relationship between domestic and national product is as follows:

             Domestic product
             -  Income of foreigners domestically
                (wages, salaries, interest, profits)
             +  Income of residents abroad
             =  National product = resident product

The differentiation between domestic and national product is particularly important when considering
the developing countries, where large production sectors are in the hand of foreign businesses. The
domestic product, which includes the investment income of these companies, often far exceeds the
national product accruing to the inhabitants of the country in question. This makes measurements of
wealth and growth on the basis of GDP in these countries especially difficult.
The differentiation between the concept of domestic and resident product is particularly important at the
regional level where - owing to commuters - the regional product can differ very greatly from the national
product of the region’s inhabitants. In regions (and this applies especially to urban regions) with a large
commuter surplus the regional product exceeds the national product (and vice-versa!).

             Conclusion:
             Domestic product:
             With reference to the geographic location of the production of goods and       services
             National product:
             Resident product: with reference to the residence (or company domicile) of those obtaining
             income from the production process.



3.           Distribution

When considering the production side of the national income we normally use the domestic product as
the point of departure, i.e. we add the value added of all the production processes within a country’s
borders. When we want to know about the distribution of the resultant income, the country’s population
is a more suitable point of reference than area. Therefore we use the national product, that is the
product whose value becomes the income of the residents as the point of departure in that case.

10
     The same applies to the regional product. Here, too, what counts is where the goods and services are produced and not
     where the company or the product is from.
11
     In some countries economic statistics, foreign labour or firms are not classed as ”foreigners” if their permanent residence is
     inside the country.
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The net national product at factor costs, that is that part of the total product not retained by the business
as the equivalent for the replacement of absolute means of production and not transferred to the State
as sales tax (indirect taxes) before it becomes somebody’s (and not resulting from government
subsidies) is termed national income.

The national income represents the sum of all factor payments of the domestic economic units (private
persons or businesses) involved in the production process. This is equivalent to the sum of all income in
the from of wages, salaries, interest, profits and rent (as gross income, i.e. prior to deduction of the tax
applicable to the individual income type), irrespective of whether it is retained in the business or, for
instance, distributed to the shareholding private households as dividends.

As a rule, the distribution of the national income is not shown with reference to groups of persons or
income classes in the NIA but according to income type. The income from entrepreneurial activity and
assets (profits, dividends, interest, rent etc.) is compared with the income from dependent employment
(wages and salaries). The total income of individual persons can therefore be composed of both income
types (e.g. wages and interest on savings). The share of the national income of gross income from
dependent employment is termed labour’s share in national income.

                         12
Transfer income is not directly covered by this distribution. It is contained in the gross income, the
redistribution of which of which finances the transfer income by means of taxes and social insurance
contributions. Transfer income only comes to light in the presentation of the net income resulting from
the recording of the redistribution of income by the State. It is only in the distribution of the national
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income according to the (disposable) net income of the economic units that the share of the total
income accruing to the State becomes visible. In order to record this fully we must, however, take into
account the indirect taxes and subsidies not contained in the national income, that is we must take the
net national product at market prices as the point of departure.


4.           Utilisation

Consumption, savings, investment:
The income utilisation analysis in the NIA differentiates first of all only according to the two general
possible applications of disposable income: consumption and savings. The type of goods demanded for
consumption is not subject of discussion.

The term savings comprises every non-consumptive utilisation of income, i.e. both putting aside for
later use and immediate use for investment. According to this definition, the purchase of means of
production from the current income of the respective period represents savings (and at the same time of
course an investment). Investment is expenditure for the purchase and the production of goods that
are not for consumption but for the purchase and the production of goods which are not for consumption
but for the production process. Beyond the purchase of means of production in the strict sense, this
includes expenditure for all objects intended for commercial use (e.g. property, residence). Only those
goods are termed investment goods which are used for a large number of production processes in the
long term (longer than one year) and thus increase the stock of means of production process, i.e. used
entirely for the product (such as flour for bread).

Investment expenditure comprises expenditure for the replacement depreciated means of production,
reinvestments (or also: replacement investment) and net investments which increase the stock of
means of production of the national economy, the so-called capital stock. Re- and net investments
together form the gross fixed capital formation. As the modification of stock keeping is defined in the
NIA system during an accounting period as net change in business inventory/involuntary inventory
investment, its sum is to be added when obtaining the total gross investment. The amount of the
reinvestments corresponds by definition to the amount of the depreciation. Reinvestments are therefore

12
     This refers to that income not related to a direct contribution towards the production of goods and services in the respective
     period, that is pensions, grants etc., i.e. all types of welfare benefits provided
13
     NB: In the case of disposable income of private households we no longer differentiate according to income type; rather this
     contains both the net income of entrepreneur households as well as that of employee households.
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not a concrete, materially identifiable ”species” of purchased means of production (we cannot see from
looking at a machine whether it is to serve as a replacement for an old machine or to expand production)
but only a value equivalent to the depreciation. Net investments are determined as the difference
between the investment goods expenditure mentioned (gross fixed capital formation) and the amount of
depreciation. Depreciation in this context can be understood therefore as savings of companies for the
purpose of financing reinvestments.

The propensity to save can be determined as the portion of the savings of the disposable income of
the private households or as a proportion of the total savings (including depreciation) of the GNP at
market prices. When determining the propensity to invest we can use either the net or the gross values
as our point of departure:
        - proportion of net fixed capital formation of the NNP at market prices
        - proportion of gross investments of the GNP at market prices


Public consumption and public savings:
Public expenditure can also be subdivided into consumption and into investment expenditure; in
addition to this there are the state social security benefits which do not belong to either of the two
categories, because they result only from the redistribution by the State between various groups of
private economic subjects and are covered in the income accounts (as expenditure to the recipients of
transfer income). The government revenue used for investment expenditure (creation of material
infrastructure etc.) is, according to the above definition of savings, public savings. All other public
services offered free of charge (the services offered in exchange for remuneration, e.g. railway, postal
service are included in the consumption of the respective beneficiary) are subsumed under the term
public consumption. This is in the end administrative services of the State in the broadest sense of the
word and includes, for instance, all expenditure of the military budget. Public consumption is comprised
above all of wages and salaries of civil servants and expenditure by the State for consumables. As the
parties demanding these services cannot be specified and do not appear as purchasers, the State itself
is understood as the demanding party, as the consumer of the services it produces.

The contribution of the State to GDP is to be clearly differentiated in general from public expenditure
and from public consumption. This does not cover the expenditure by the State, which also includes
expenditure for bought-in materials and services produced by other sectors of the economy, but only
the value added by the State which, owing to lack of a market price for the ”values” created, such as
safety, order or education, is measured against the sum of the factor income of the civil servants (and
thus represents only part of the public consumption).

The relationship between income utilisation, effective demand and supply:
The utilisation of the gross national product by private households, by companies and by the State for
consumption and formation of savings may deviate quite substantially from the composition of the
supply of goods and services produced by these domestic economic subjects (i.e. that is the national
product). The amount of the income used for consumption is identical with the value of the consumer
goods sold by the companies (this applies to the modes of a ”closed economy”, that is neglecting
foreign trade) but not necessarily also with the produced consumer goods; any consumer goods
produced in excess are placed in storage and appear in the NIA under ”net changes in business
inventory/involuntary inventory investments”. Consequently, the savings may deviate from the value of
the investment goods produced.

An additional deviation factor appears when we consider foreign trade. Portions of the GNP are used for
purchasing foreign products and portions of the GNP produced are demanded by foreigners.
Differences between domestic supply and the demand of residents for domestic products can quite well
be balanced out by this (that is by an export surplus if there is a deficit of domestic supply). For this
reason, an export surplus is sometimes termed “foreign investment”. Differences between domestic
supply and demand may possibly be reinforced by foreign trade.

In order therefore to derive the GNP from the final demand of all residents we must subtract the value of
the demand for imported goods and services from this and add to it the demand of foreigners for
portions of the national product.
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5.        Conclusion

The NIA finally differentiates one and the same object, or an object slightly modified according to type
and volume, namely the value of the total quantity of goods and services produced (without including
the intermediate products returning to the production process as bought-in materials and services!)
according to various criteria such as
          contribution of the sectors of the economy to its production
          share of the various types of cost in the total value
          share of the types of income in the sum of the gross income
          share of private households, the State and companies in the sum of the net income
          ultimately disposable for those sectors
          division of the total income between consumption and savings
          share of consumption and investment goods as well as net exports and stockbuilding in the
            total demand for the goods and services produced.
In order to avoid double-counting, it is always important to bear in mind, which portions are to be
                                                     14
allocated to which whole according to which criteria .




d.      Application of the NIA
As a rule, the aggregated parameters of the NIA are used for recording the level and speed of economic
development. They are considered decisive measures of success for the economy and the economic
policy of the country.

Economic growth is measured by the annual growth of GDP or of the national income. In order to
determine the actual, the ”real” (as opposed to ”nominal”) growth of the goods and services produced,
we must adjust the values in order to allow for the inflation rate when we compare the GDP of different
years. We determine the value of the GDP not at the prices of the current year but at the prices (held
constant) of a certain baseline year and compare the values which have been adjusted to take account
of inflation.

In order to estimate the level of development of an economy or the level of wealth of a region we must
determine the ratio of the absolute parameters of the NIA to the relevant reference parameters. When
measuring wealth it is best to base the national income on the number of inhabitants (per capita
income) (for the problem of scale cf. 4.8.1.5.). If, however, we wish to make statements about the
economic capacity of a region, GDP is a more suitable indicator (of the volume of production) with the
number of employed people as the reference quantity. We obtain one measure for labour productivity
by determining the ratio of the result of the production of goods and services to the number of those
                                    15
involved in the production process .


14
   Old age pensions or grants, for instance, are clearly to be regarded as income. In the distribution of the national income,
   however, they do not appear at first, as national income is defined as the sum of the income representing remuneration for a
   contribution towards creating the national product of the period in question (the problem of interpreting entrepreneurial profits as
   remuneration for a contribution towards the production of goods and services has already been pointed out above). Transfer
   income such as pensions or students grants, however, does not result from immediate ”factor contributions” (although it was
   directly related to ”factor contributions” made earlier or expected later) but from the redistribution of the gross income extracted
   directly from the ongoing production process by the State; therefore it occurs first as part of the disposable (net) income. It
   would be counting double to add it to the gross income of the employed or of the property owners; both social security
   contributions (as part of gross income) and the resultant social security benefits they finance would be counted, but the
   corresponding income is only earned once. Either it is counted for the person whose input it is attributed to or to the person who
   ultimately disposes of it, but never to both.
   The situation is different in the case of civil servants. Their salaries are paid from taxes and therefore financed from gross
   income. But this is not a mere redistribution from ”value-creating” factor income recipients to non-value-creating students or
   pensioners but the payment - albeit indirect - of an input made, of a contribution towards the GNP. A teacher’s income
   represents part of the factor income, but a student’s grant does not.
15
   The amount of GDP per employed person is, however, not influenced by efficiency alone, but also by the amount of time spent
   working. In order to obtain a statement as to the efficiency of the economic activity, that is about productivity in the true sense of
   the word, we must exclude the influence of changes in working time and calculate the GDP per working hour.
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The question as to how much per capita income actually tells us about wealth, the GDP per working
hour about productive capacity and the real growth rates of GDP and national income about economic
development are the central points of the discussion about the applicable of global economic data and
are to be examined in greater detail in the following section.



e.       Criticism
In the following, the problem of applying the parameters of the NIA as a measure of economic success
is discussed in the form of a summary. In doing so it is useful to separate the question of whether the
respective categories are suitable as a measure of productive capacity from the question as to whether
they represent a suitable indicator of wealth. Increased output may be necessary to increase wealth but
should by no means considered a guarantee thereof.


1.         Suitability of GDP as an indicator of an economy’s productive capacity

Productive capacity is to be considered a decisive element in assessing a society’s level of economic
development. It is determined by the state (or level), of development of the productive forces,
which Marxist theory understands as the ability of man to use his natural environment. This ability
manifests itself in the level of training and in the type of means of production used. Both determine the
efficiency of the production process.

Productive capacity cannot be measured on the basis of the absolute quantity produced (or of its value)
but only as a ratio between earnings achieved and input of means. The economic activity is not
necessarily more efficient where more is produced, but only where more is produced with the same
input of labour (or input of capital). The productive capacity of an economy with a comparatively low per
capita income may be greater than that of others, if it uses its head start in terms of efficiency in order to
reduce working hours.

The most suitable measure of approximation for determining the productive capacity of an economy is
the  labour productivity of the economy as a whole, the GDP per working hour.

However, we can draw no immediate conclusion as to productive capacity from the amount of the per
capita income, as this can be influenced by
          - changes in the number of persons employed
          - changes in the working hours.

The GDP per working hour does not realistically reflect the productive capacity of an economy. Many
economically relevant outputs are not recorded whereas, owing to the problem of an adequate
evaluation of outputs, differing GDP values may result, although the production level is the same.

The questionability of GDP as a measure of productive capacity results (a) from recording problems and
(b) from evaluation problems.

Recording problems:
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GDP records only outputs which pass through the market, for which remuneration is paid .
GDP displays a rising trend with increasing division of labour (i.e. increasing proportion of outputs
passing through the market) without this increasing the total volume of output performed. Not the output
                                                              17
itself but the remuneration paid formally for this is recorded .

Evaluation problems:

16
   For instance the output of a housewife is not included in GDP. If the same activity is performed by domestic personnel or service
   companies (laundries for instance) GDP is greater. If a man marries the housekeeper employed in his household GDP drops,
   although the same person may possibly receive the same amount of money (now ”pocket money”) for the same work.
17
   A doctoral dissertation written by a research assistant under his/her employment contract is included in GDP in the extent to
   which the person concerned is paid for it. If the same doctoral dissertation is financed by a post-graduate scholarship it is not
   calculated as a contribution to GDP, as the scholarship is not defined as remuneration for a service but as a subsidy.
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Output per se can only be expressed by quantities. But, as quantities of different products cannot be
added together properly, we need a standard when calculating the total output of a region with which the
quantities of heterogeneous products can be made comparable. As has already been shown, the
exchange value, or market price, is used here for calculating GDP. This is without a doubt the most
practicable method but, in view of the importance of monopolistic and/or State price manipulation in
contemporary economic life, it is very doubtful - as the traditional economic theory assumes - whether it
is also the most objective method, as it expresses the appreciation of the beneficiaries. But where
goods and services may be under- or overvalued the total value obtained therefrom, GDP is not a
                                18
reliable measure of productivity .

Development of physical productivity and of the GDP per working hour can therefore differ very greatly.
In addition to the questionable objectivity of the market price problems occur in interregional (or
international) comparisons owing to regional differences in price structure. Such differing values placed
on equal inputs make GDP figures of different regions only very conditionally comparable.



2.         Suitability of per capita income of a society’s wealth

The discussion about the concept of  ”quality of life” and the search for more significant indicators of
development indicate that per capita income is being increasingly questioned as a standard for the
living conditions and the wealth in a society.

The evaluation and recording deficiencies described above, which have caused national income to
appear questionable as a measure of productivity, apply to per capita income. Increased productivity by
a society leads by no means automatically to increased wealth or improved living conditions, although it
is reflected in an increase in total income. On the one hand, essential improvements in material living
           19
conditions are not included in the determination of per capita income (a), whereas, on the other hand,
”values” are included in the per capita income which, although they represent productivity, have a
questionable welfare effect (b), or values whose creation became necessary as a result of increased
production and therefore represent more a resultant burden of the economic process than an increase
in wealth for that population (c).

a) Material living conditions not taken into account:
Increased economic capacity can have a welfare-enhancing effect by means of a greater supply of
goods and services but also by a reduction in working hours with more leisure time or education time.
Per capita income covers only the first option. Societies which use the development of the forces of
production in order to relieve man of production tasks appear to have a lower level of economic
development if we take, as usual, per capita income (PCI) as the yardstick.

b) Outputs with a questionable welfare effect:
The equation of PCI and welfare is based on the theoretical assumption that the market mechanism
and, if these funds are administered by the State, the democratic decision-making processes of a
society channel the forces of production to those forms of utilisation which best satisfy the needs of all
members of the society. It is hardly disputed today that, in reality, neither the market mechanism nor the
election process fulfil these functions as intended. Economic and political power positions influence
private and state investment decisions decisively, and not necessarily for the improvement of general
18
   If, for instance, a valuable and very rare fuel is found in a region, that region’s GDP can increase drastically without
   considerable additional physical input. By contrast, in the case of the production of cheap agricultural goods in abundant supply
   a doubling of the yield achieved by increased efficiency has a relatively modest effect on GDP despite the substantial rise in
   productivity.
   Similar distortions resulting from the price structure occur for instance in countries with extreme income differences, if an upper
   class with excess purchasing power is willing to pay almost any price for luxury consumer goods which are short in supply. The
   resulting overvaluation of such luxury consumer goods, both with the regard to the costs needed to produce them and with
   regard to their useful value to society as a whole (however this might be defined in concrete terms), has the effect that a
   relatively large amount of emphasis is placed on them when determining GDP. If their production increases, the GDP figures
   increase relatively more than in the case of a comparably strong growth in the production of simple, cheap mass consumer
   goods. Production for the rich appears in a more favourable light in economic statistics than production for the poor. This is
   particularly the case in Third World countries.
19
   Immaterial living conditions, such as human rights, are not to be dealt with here, as they cannot be expressed in terms of
   economic indicators anyway.
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living conditions. War-orientated utilisation of increased economic power and the production, storage
and destruction of agricultural surpluses (even the destruction process represents a value added in the
system of concepts of the NIA, as it is equated with waste disposal and ultimately creates income...)
represent two extreme cases that illustrate the problem. Uneven distribution of purchasing power and
consumer manipulation are central elements in the real economic process of capitalist economies,
yielding production decisions with a questionable welfare effect. No statements as to how much is
produced but only statements as to what is for whom permit an adequate assessment of the material
living conditions.

c) Outputs representing a consequential burden of economic growth:
Economic growth is based inter alia on increasing division of labour in a society. This creates novel
needs requiring additional production. Large portions of the infrastructure serve this purpose. For
instance the increasing spatial separation of the place of residence, workplace and place of recreation
is one of those accompanying phenomena of economic growth that cause costs (transport and
communication systems) which would not have come about without this growth. A significant portion of
the production increase therefore serves only to maintain the production conditions that have become
necessary for this and not to improve the living conditions of the population. The automobile, which has
in many cases become indispensable for reaching the workplace is a typical example of this.

A much quoted, although macabre example of income increases not serving to increase wealth but to
eliminate the negative effects of growth is the increase in traffic accidents, which increases per capita
income.

Another category of outputs that increase per capita income but do not improve living conditions, only
maintaining them at best, are the measures to avoid or eliminate environmental damage caused by
expanding production.

				
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