National accounts: Part 2 MEASUREMENT ECONOMICS ECON 4700

2 This chapter Principle components of the SNA –Income and expenditure accounts –Input-output tables –Financial Flows and national balance sheet accounts –Balance of payments

3 Common features and concepts The system portrays the: –“what we do” –“how we do it” –“where we’ve been” of economic transaction It unlocks the door to understanding much about the economic standards and lifestyles of the population.

4 Common features and concepts Two key concepts dominate in the system of accounts: –For the I-O and IE accounts it is production. –For the financial flow and balance sheet accounts it is financing and wealth accumulation.

5 Common features and concepts: recurring concepts and themes Production: Production (or economic activity) is at the heart of the of the SNA. It defines the production boundary of the accounts. Broad view: SNA would include the value of unpaid work Narrow view: Would exclude all non- monetary transaction. Controversies will be dealt with later.

6 Common features and concepts: recurring concepts and themes Production: in the Canadian SNA production is recognized as being largely made up of goods and services produced and exchanged for money (i.e., the market or money exchange economy).

7 Common features and concepts: recurring concepts and themes Two exceptions: –Illegal activities fall within the accepted conceptual boundary of production. They are by convention excluded from the Canadian CPI because of difficulty at arriving at a reliable statistical estimate. 1.4% of GDP 100% of GDP –Illegal activities vs. legal money exchange economy that has gone underground to avoid taxes. –Last one is not serious in Canada.

8 Common features and concepts: recurring concepts and themes In principle, GDP includes all production, without regard to its legality. In practice, illegal activities such as the sale of narcotics, although deemed productive in an economic sense in that they satisfy a demand expressed on the market, are left out of official statistics because there is no way of measuring them with sufficient reliability. The official GDP thus refers, by and large, to legal production. Other criminal activities such as robbery or extortion are a transfer of wealth from one person or group to another. They are not productive and do not enter GDP at all.

9 Common features and concepts: recurring concepts and themes By excluding illegal activities from GDP, the production boundary is contracted. In other cases, the production boundary is expanded beyond the money exchange economy when non market activities which parallel market activities are included in the definition of production. –Owner-Occupied Housing: No payment involved for the rental of the dwelling but there is a value in the services provided that is equivalent to the net income that could have been derived from renting the property commercially.

10 Common features and concepts: recurring concepts and themes Other imputations: –Own account production –Food provided to employees instead of wages –Other income in-kind: lodging provided to hotel staff, camp workers, and domestic servants. –Services rendered by banks and other financial institutions for which there is no explicit charge.

11 Common features and concepts: recurring concepts and themes Gross and Net: Production may be measured on a gross or net basis depending upon whether before or after allowance for capital consumption. These allowances are changes against production that cover depreciation or the using-up of fixed capital in the process of production. Net production recognizes that part of current output is required to replace depreciating fixed durable goods.

12 Common features and concepts: recurring concepts and themes National and Domestic: The national concepts relates to activities of residents of a country and the domestic concept to activities occurring within the geographical boundaries of a country. Market price and factor cost: Two levels of valuation are are frequently referred to in the SNA: Market price and factor cost. The two concepts are designed to meet different needs.

13 Common features and concepts: recurring concepts and themes Market price: Includes that broad spectrum of taxes on expenditures (i.e., indirect taxes). The basic difference between direct and indirect taxes in national accounting is whether the tax is levied on income received by a factor of production or whether it is considered a cost. Indirect taxes that are embodied in the market price are sales, property and excise taxes, and custom duties. Market price valuation is more appropriately applied to final demand analysis where the relevant variable is the final price paid by the purchaser.

14 Common features and concepts: recurring concepts and themes Factor cost: represents the sum of incomes of factors of production as measured by the cost of labour and capital inputs in the production process. Direct taxes levied on incomes are a part of the factor cost valuation as incomes are measured before tax deductions. The factor cost concept is is regarded as most useful for the analysis of production.

15 Important definition Gross Domestic Product or GDP can be defined as the market value of all production for final demand within a given country for a given period. GDP is the most comprehensive of output measures.

16 Important definition (cont’d) Production for final demand means production of goods and services that will not be used for further production in the same country and during the same time period. Thus spending by households for the goods they will use at home is final demand i.e. the goods the household buys will not be used to produce other goods and services. Similarly, investment by business is part of final demand as investment goods are durable and will not be used up within the same time period.

17 Income and expenditure accounts Income and expenditure accounts, as the name suggests focus on income generated by productive activity and final consumption on that production. The main tables are designed to show the principal components of final demand and the main types of income arising from production. They yield the same GDP. IEA are the most widely used component of the SNA First published in the latter half of the 40s. In 1952, historical period, were published.

18 Income and expenditure accounts The major contribution of the IEA is in tracing the impact of production through four broad sectors of the economy: –Persons and unincorporated businesses –Government –Corporate and government business enterprises –Non-residents Grouped in such a way that each entity is expected to behave in a similar way.

19 Aggregates associated with IEA GDP Income based Wages, salaries, and supplementary labour income Corporation profit before taxes Interest and miscellaneous investment income Accrued net income of farm operators Net income of non-farm unincorporated businesses Inventory valuation adjustment Net domestic income at factor cost Indirect taxes less subsidies Capital consumption allowance Statistical discrepancy GDP at market price GDP Expenditure based Personal expenditure on goods and services Government current expenditure on goods and services Government investment –Fixed capital –Inventories Exports of goods and services Deduct: Imports of goods and services Statistical discrepancy GDP at market price

20 Aggregates associated with IEA Net national and domestic income: National income is defined as the sum of all incomes of residents in a country arising as a result of the current production of goods and services; some of the income is generated abroad. Domestic income is defined as the sum of all incomes derived from the economic activity taking place within the geographical boundary of the country; some of that income is generated by non-residents.

21 Aggregates associated with IEA Personal income: Sum of all income of resident persons from productive services rendered plus all transfer incomes from government, business and non resident sector. The main component is labour income. The other components are: –net income of unincorporated business –Interest –Dividends –Other investment income. Personal income is measured before tax deductions and contributions to social security schemes paid by employees. Included are incomes of Universities, Labour Unions Professional organizations, etc.

22 Aggregates associated with IEA Personal disposable income: Personal income minus : –Direct taxes –Licences and permit costs paid to government including hospital and medical insurance premiums paid under publicly operated plans. Personal disposable income is equal personal expenditure on goods and services and transfers to business and non-residents plus personal savings.

23 Aggregates associated with IEA Final Domestic Demand: Measures personal expenditure on goods and services, government current expenditure on goods and services, and business and government investment in fixed capital. It differs from GDP by excluding investment in inventories and exports of goods and services. It includes the import content of the measured variables.

24 Definitions of the sectors Persons and unincorporated businesses: Includes –Net income of self-employed or unincorporated businesses –Private non commercial institutions serving persons Labour unions Universities Religious institutions Charities Professional associations Social clubs

25 Definitions of the sectors Government Sector: The sector covers a broad range of activities carried out directly by the various levels of government or their agencies. The essential characteristic of these activities is that are non commercial in nature. It covers three main group of activities: –The departments of the three levels of government Defence, national security, provision of health, education, etc. –Schemes administered by public authorities for the purpose of providing social security services. Canada pension plan, workers’ compensation. –Agencies, commissions, and boards financed from public funds National research council, National Film Board, NCC

26 Definitions of the sectors Corporate and government business sector: The sector covers privately controlled corporate enterprises together with government business enterprises Non-resident sector: The sector includes all transactions of non-residents with Canadian residents.

27 Definitions of main transaction categories What we find here are income flows and other charges against production, as well as the major demand components of GDP. A) Wages, salaries and, and supplementary labour income: all earnings from employment of Canadian residents including payments in kind such as free board and lodging. –Commissions –Bonuses –Tips, vacation and sick leave –Does not include: income from self employment, income from independent professional practice or income from farmers –They are estimated before deductions such as taxes, and contributions to EI, and pensions. –Supplementary income = expenditures by employers that can be regarded as peyment for an employee’s services: employers’ contribution to pension fund, EI, and workers compensation.

28 Definitions of main transaction categories B) Corporation profit before taxes: Net earning from economic activity from privately held corporations. Represents the share of these corporations in GDP Measured after deducting for depreciation Includes gains or losses that arise from the effects of price changes on inventory values. International rules state that given that these gains or losses do not arise as a result of current economic production and therefore should not influence profits. In Canada, these adjustments are not made directly to profits but as a separate inventory valuation entry. Does not include capital gains Dividends included C) Interest and miscellaneous income: Measures interest income of persons and government investment income before deduction of direct taxes. Bond and mortgage interest Paid and imputed interest on deposits with banks. Excludes interest on public dept since it is regarded as a transfer and not a productive service.

29 Definitions of main transaction categories Demand components of the expenditure based estimates of GDP A) Personal expenditure on consumer goods and services (C) includes: Outlays on all new goods and services except the purchase of a dwelling. Commissions of dealers’ margins on used goods. Purchases of used imports and from the business sector Imputed rents Spending by Canadians temporarily abroad but excluded are expenditures by foreign residents temporarily in Canada are excluded. Expenditures considered business costs B) Government current expenditure on goods and services includes: Outlays of all three levels of government Locally administered elementary and secondary school systems and government administered hospital care services. All general operating expenses including wages and salaries, office supplies and repair and maintenance costs. Expenditures for military equipment and defence installations are not capitalized but appear as current outlays. Total government outlays much larger than this component because of transfers such as interest on public debt, subsidies to producers, etc.

30 Definitions of main transaction categories Demand components of the expenditure based estimates of GDP C) Investment in fixed capital: Business and government investment in fixed capital is defined in broad terms to include the production of physical productive assets that yield a service in the future (e.g., factories, dwellings and machinery), i.e.,it is that part of final expenditure not consumed, exported or added to inventories during the accounting period. Included: New durable tangible assets with a life time use of one year or more. Alterations and improvements to existing stock which extend the life of the asset beyond that originally anticipated are treated as fixed capital but not regular repairs and maintenance. Consumer durable goods not investment. D) Inventories E) Imports and Exports

31 Uses of IEA Uses fall into three categories: –Analysis: discover key variables and relationships suggested by theory –Forecasting: short term and long term projections of the growth of the Canadian economy. –Policy: Implications of policy change such a change in farm subsidies on farm income or a change in interest rates on GDP and C.

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