New rationale

The formula to calculate the GDP and resultant figure of 7.5 per cent growth against the expected 4.7, caught everyone by surprise.

Today, the concept of GDP to measure economic performance seeks transition from its earlier methodology to one that examines economic activity on a broader scale. In September, the Central Statistical Office (CSO) released GDP growth rate figures for April-June, 2015-16.

The economy grew at only 7 per cent for that period as against 7.5 per cent in the previous quarter. Though growth has slowed down, the news did not create as much of a storm as the previous data release.

In February, the CSO changed the formula to calculate the country’s GDP and the resultant figure of 7.5 per cent growth as against the expected 4.7 per cent caught everyone by surprise, including the Chief Economic Advisor Aravind Subramaniam and RBI Governor Raghuram Rajan.

Whether the new formula to calculate GDP and shift in base year actually hypes the growth rate or not? Does it amount to the classical problem of statistics – lies, damn lies and statistics? What, therefore, is the rationale of GDP as a measurement tool and its relevance to the Indian economy? Today, GDP in particular and economic growth in general is understood to symbolise overall progress. However, GDP as it is today, is a specialised tool and to read it as an indicator of general well-being is erroneous and inappropriate.

Nevertheless, over the last 70 years, economic growth – measured by GDP – has become the sine qua non for economic progress. Per capita GDP is frequently used to compare quality of life in different countries. Governments often use changes in GDP as an indicator of the success of their economic and fiscal policies. On the other hand, economists emphasise that GDP measures economic activity rather than economic well-being.

Originally, the GDP as a concept took shape in the US in 1937 as a useful signpost for the government to run its fiscal policy. The GDP growth reflected increased economic activity, jobs creation, higher income, and provision of basic amenities. Most importantly, it gave the government the tool with which it could decide on the appropriate tax rates on its citizenry to carry out war activities.

The history of world GDP has seen two pivotal points: the 1980s and the first decade in the new millennium. Between 1961 and 1981, global GDP increased by $10 trillion. In the next 20 years, it increased by roughly $20 trillion and $40 trillion in the first decade of the new millennium. The Indian GDP mirrors a similar trend and witnessed the fastest pace of growth between 2000 and 2010.

Given the GDP’s overarching importance in today’s world, it is important to get its measurement right. The challenge to correctly calculate GDP of the Indian economy arises owing to the presence of unaccounted income which is estimated to account for 75 per cent of the formal GDP.

According to the findings of a confidential report compiled by the National Institute of Public Finance, New Delhi which highlighted that the main source for unaccounted income was the higher education sector, real estate deals and mining income. Otherwise, problem pertains to the absence of “reliable” estimates of unaccounted income generated in India and held within and outside the country.

A 2010 World Bank study of 151 countries concluded that India’s `Shadow Economy’, defined as legal activity concealed from the authorities, was equivalent to a fifth of official GDP. That is roughly double the level of the best rich countries, but below the global average and most other emerging nations.

Given these challenges, the CSO has taken the first step and attempted to include various parts of the economy that were previously ignored. The two main changes in the revised GDP calculations are the shift to the GDP at market prices from the GDP calculated at factor costs and the revision of the base year from 2004-05 to 2011-12.

Broader canvas

Further, the new formula to calculate India’s GDP growth rate covers a broader canvas of the economy. The revised calculation is comprehensive in character because it includes wider data on corporate activity, personal expenditure and informal business sectors.

For instance, the database to measure commercial activity includes more than 5,00,000 firms in the new method than only 2,500 companies in old method. Moreover, the agriculture and livestock sectors are now comprehensively covered, have increased the total production in livestock sector and reflected at Rs 9.1 billion in the new GDP series.

Today, the CSO has tracked private funds and records details which have helped boost the GDP growth rate. Earlier, the practice in the old series ignored private investments and only collected data on government-managed funds. Clearly, it is incorrect to ignore the vibrant financial sector in the country – but the challenge is to obtain accurate details on transactions.

The father of economics, Adam Smith in his classic work “Wealth of Nations” states, “The real price of everything, what everything really costs to the man who wants to acquire it, is the toil and trouble of acquiring it.” A nation’s prosperity must be measured in terms of its value of consumption.

If the calculation of GDP is to transition from a pure statistical exercise of measuring economic activity to estimating economic well-being, it is essential that more  parts of the economy has to be measured and included in this omnipotent figure. The next step could be to also include house hold activities that add value to people’s lives but do not have a monetary value attached to it.

(The writer is Assistant Professor of Economics, Christ University, Bengaluru)