1. Copyright 2010, The World Bank Group. All Rights Reserved. Introduction to the System of National Accounts (SNA) Lesson 4 Intermediate Consumption and Value Added 1

2. Copyright 2010, The World Bank Group. All Rights Reserved. Intermediate Consumption “Intermediate consumption consists of the value of the goods and services consumed as inputs by a process of production, excluding fixed assets whose consumption is recorded as consumption of fixed capital”. (SNA 2008, 6.213) “Consumed as inputs” means either “disappears during the production process” or “is physically transformed in some way” 2

3. Copyright 2010, The World Bank Group. All Rights Reserved. Overheads By “overheads” we mean things like the costs of keeping the accounts, seeking finance for the business, finding new customers, market research and advertising. In a bread factory, these are part of intermediate consumption as much as wheat grain and water. Overhead expenses may be itemized in company accounts but a subsidiary of a multinational company may show them as a single line entry such as “head office expenses”. 3

4. Copyright 2010, The World Bank Group. All Rights Reserved. Intermediate consumption is not equal to purchases of inputs We earlier noted that sales are not the same as output because some production may go into stocks of finished goods. In exactly the same way, purchases of goods for use as inputs are not the same as intermediate consumption. Intermediate consumption is equal to purchases of inputs minus the increase in stocks of inputs. 4

5. Copyright 2010, The World Bank Group. All Rights Reserved. Borderline issues Payments to government Income in kind Gross fixed capital formation Valuables Research and development and Military equipment 5

6. Copyright 2010, The World Bank Group. All Rights Reserved. Payments to government (1) Some are intermediate consumption Most payments to government by producers are taxes on production. But some charges made by government are intermediate consumption. If the government provides a service commensurate with the charge, then it is a payment for a service and is part of intermediate consumption. Examples could be charges for certifying that accounts are correct, charges for inspecting vehicles to make sure they are road-worthy, passport fees …. 6

7. Copyright 2010, The World Bank Group. All Rights Reserved. Payments to government (2) Some are Taxes on Production “Taxes on production” are broken down into “Taxes on products” and “Other taxes on production”. Taxes on products – Depend on the values or quantities of products – Only paid if there is some production – Examples: VAT, sales taxes, customs duties, excise taxes Other taxes on production – Are not related to the values or quantities of products – Must be paid by a producer even if no production – Examples: employment taxes, taxes on vehicles, taxes on land and buildings 7

8. Copyright 2010, The World Bank Group. All Rights Reserved. Does government provide a service commensurate with the charge? Yes Intermediate consumption No Does the charge depend on the value or quantity of goods or services produced? Yes Taxes on products No Other taxes on production 8

9. Copyright 2010, The World Bank Group. All Rights Reserved. Payments to government (3) What goes into Intermediate consumption? Clearly if it is established that the payment to government is in exchange for a genuine service, it must go into intermediate consumption. If it is established that it is a “tax on products”, it is not relevant because it is excluded from the Basic Price of output. But what do we do if it is decided that it is an ”other tax on production”? From the producers point of view an “other tax on production” is just a cost of production like any other. It may seem arbitrary, but in the national accounts we exclude it from intermediate consumption. 9

10. Copyright 2010, The World Bank Group. All Rights Reserved. Income in kind versus Intermediate consumption Income in kind Transport to work Housing that can be used by all members of the family Cheap or free tickets for people working for airlines or railway companies Free coal for coal miners Food and meals for factory workers Intermediate consumption Protective clothing and uniforms Housing for construction and mine workers Meals for soldiers on active service Fares and hotel cost for business travelers First aid and medical check- ups 10

11. Copyright 2010, The World Bank Group. All Rights Reserved. Intermediate consumption versus Capital formation Maintenance and repairs of buildings and equipment are intermediate consumption but major renovations are Gross Fixed Capital Formation (GFCF). In the 1993 SNA, expenditures on computer software and on mineral exploration are GFCF. (In the 1968 SNA they were included in intermediate consumption.) In the 2008 SNA, expenditures on R&D and on weapons are GFCF. (in the 1993 SNA they were included in intermediate consumption.) 11

12. Copyright 2010, The World Bank Group. All Rights Reserved. Valuables Valuables were an innovation of the 1993 SNA. Valuables are objects that are purchased in the expectation that they will not lose their value and may even become more valuable over time. If business buy “valuables” they are capital formation not intermediate consumption. 12

13. Copyright 2010, The World Bank Group. All Rights Reserved. Research and development and Military equipment Research and Development R & D consists of expenditures on creative work undertaken on a systematic basis in order to increase the stock of knowledge, and use of this stock of knowledge to devise new applications. (SNA 2008, 10.103) In the 2008 SNA R&D is GFCF and no longer intermediate consumption. Military Equipment Expenditures on military equipment are treated as fixed capital formation. Expenditure on durable military goods such as bombs and torpedoes are recorded as inventories until used when they are recorded as intermediate consumption and a withdrawal from inventories. (SNA 2008, 6.232) In the 1993 SNA weapons were treated as intermediate consumption 13

14. Copyright 2010, The World Bank Group. All Rights Reserved. Value Added We have now defined gross output and decided what is to be included in intermediate consumption. The difference between these two is Value Added. It is the value that has been added in changing inputs into outputs through adding labour, capital and (some would say) entrepreneurship. It is a key aggregate in economics and in particular for studies of productivity and economic growth. 14

15. Copyright 2010, The World Bank Group. All Rights Reserved. Dissecting Value Added: What is in there? 15

16. Copyright 2010, The World Bank Group. All Rights Reserved. Components of Value Added Compensation of employees Other taxes on production (minus other subsidies on production) Gross operating surplus 16

17. Copyright 2010, The World Bank Group. All Rights Reserved. Gross operating surplus has two components Consumption of fixed capital CFC is the decline in the value of fixed capital assets through obsolescence and use in production. It is a cost of production and ideally it should be treated like any other item of intermediate consumption. Net operating surplus After deducting CFC, we are left with net operating surplus Some will be used to pay income taxes and what is left will go to those who have a “proprietary interest” in the business – banks, shareholders and owners. The operating surplus of an unincorporatede enterprise is called “Mixed Income”, not operating surplus. 17

18. Copyright 2010, The World Bank Group. All Rights Reserved. What have we learned? Intermediate consumption (IC) consists of all current production expenses including overheads. IC includes payment to government for any services provided but excludes «other taxes on production». Intermediate consumption (IC) is deducted from output to get value added. Value added is a balancing item and includes compensation of employees, other taxes on production, consumption of fixed capital and net operating surplus. 18