National Income: 2 – From Production Value to Added Value – Getting to GDP

Last time, we looked at the production value in Ireland’s national accounts.  Between market and non-market output this is estimated to have been €790 billion in 2021.  This represents a lot of activity but, just like turnover, there is also a lot of double counting in production value.  The classic textbook example is the loaf of bread where the aggregate production value is the sum of the output of the farmer who grows the wheat, the miller who makes the flour, the baker who makes the bread and the retailer who sells it.  Adding up aggregate value of their production does not give us the income of those involved as each stage includes the production value of the stages that preceded it.

Intermediate Consumption

To better reflect the value that is produced at each stage we must subtract the costs of current goods and services purchased for use in production.  For the farmer this is the seeds, for the miller it is the wheat, for the baker it is the flour for the retailer it is the actual loaf of bread.  We have already subtracted the cost to the retailer of buying the loaf of bread with the deduction for goods and services sold in same condition as purchased. But for the other stages of production goods, and services are purchased and are transformed or used in the production process.  These purchase of these goods and services is referred to as intermediate consumption.  Subtracting intermediate consumption from production value gives the value added at each stage of production.

We might like to include some government services as intermediate consumption.  Policing, the legal system, roads and other government services contribute to firms’ ability to produce output.  However, we have no way of dividing such collective services into the amount used by households and the amounts used by firms.  Thus, it is assumed that all government services are final services consumed by households.  This leads to an underestimate of intermediate consumption.

In 2021, the intermediate consumption in the Irish economy was estimated to be €390 billion.  Gross value added in the Irish economy is estimated to have been around €400 billion.  Thus, the €1 trillion of turnover resulted in gross incomes (for persons or businesses yet to be determined) of around 40 percent of that amount.

Taxes and Subsidies on Products

Almost every transaction we enter involves taxes of some form of another, or at least they should.  The buying or selling of goods and services is no different.  It can be argued that this is part of the value of a transaction – it must be if the final user, such as the consumer pays it – but it goes to neither the worker nor the business owner; it goes to the government.  In 2021, taxes on products came to €26.5 billion.  On the consumption side this includes VAT (€16.5 billion), Excise Duty (€6 billion) and EU Customs Duty (€0.5 billion), while for capital transactions Stamp Duty (€1.5 billion) is included.  As these are included in the expenditure of final users they are added to GDP.

On the other hand, the amount of product subsidies paid by government is subtracted from GDP.  In Ireland, these include subsidies for public transport, health insurance and third-level education.  A total of €1.5 billion of such subsidies were paid in 2021.

Double Counting?

In several places above emphasis was placed on the need to avoid double counting.  However, it appears we are doing just this with the inclusion of taxes on products in GDP, at least from the perspective of production.  These taxes are collected by government and go, in part, to fund the production of the non-market output such as government provision of health and education services.  So, given that we have already included the production of such services in GDP is it double counting to also include in GDP taxes that are used to fund them? 

In a sense, it is. Consider a hypothetical situation where the government abolished VAT and Excise Duty but required households to pay directly for health services used.  Let’s just assume that nothing else changes.  The production of non-market output will fall by €22 billion but this will be offset by a €22 billion rise in market output.  However, there will be a €22 billion reduction in the amount of product taxes added to GDP.  In aggregate terms, production is still the same but nominal GDP is lower.  And, in the simple case of no other changes, all that has happened is that the method of paying for what is produced has changed – there has been an institutional change.  Of course, GDP in volume (or real GDP) is unaffected as the tax and price changes will be picked up by the deflators.

Irrespective of where the economic incidence lies, taxes on products are certainly included in the market price of output and form part of the expenditure of final users.  Also, if there was some way of excluding VAT from consumption expenditure, then there would be no direct way of determining the household savings rate and related measures.

Of course, it could also be argued that the subtraction from GVA of subsidies on products to get GDP leads to an undercounting.  Again, the reason for doing so is the desire for an equivalence between the output and expenditure approaches to GDP.  So, it is not so much that the inclusion of taxes and subsidies on products leads to a double counting in or undercounting of GDP; it is more a desire to maintain the equivalence between the different approaches to measuring GDP.  Here we have seen it in terms of the output approach, but it also arises with the income approach when taxes and subsidies on production affect the factor income earned from production.

Could taxes and subsidies on products be excluded from GDP? Yes. However, that would lead to a gap between the output and expenditure approaches to measuring GDP.  There is an attractiveness in having a theoretical equivalence between the different approaches to measuring GDP.  However, a wedge caused by taxes means that in practice they will not be equivalent.  Thus, one can view the tax adjustments being our effort at making them equivalent.

Under-Counting?

The system of national accounts is based on production and output.  Consumption plays a role but only the consumption of output that is counted in production is included.  As noted, this is derived on turnover and intermediate consumption. 

The contribution of the Encyclopaedia Britannica to value added was the company’s turnover from the sales of its volumes minus its intermediate consumption to produce them.  This would have declined as users switched to online options, such as Encarta and latterly Wikipedia, and in 2013 the company announced it was ceasing the production of printed volumes.  This ended the contribution of printed encyclopedias to GDP.  What contribution does Wikipedia make to GDP? Very little actually.

Wikipedia does not have a turnover in the sense of charging for the services it provides.  Wikipedia is a non-profit entity.  For the user-value produced, Wikipedia has a relatively modest wage bill.  These costs are covered by donations.  The production focus for GDP means there is an emphasis on costs rather than benefits.  It is likely that Wikipedia provides much greater benefits than Britannica, if only because of the number of people who can access it, but makes a smaller contribution to GDP.  If Wikipedia was to collapse, GDP would be largely unaffected, but the significant value users get from the service would disappear.  GDP is a measure of production based on prices not consumer surplus based on benefits.

Similar outcomes can be seen for other digital technologies such as search engines.  Users derive huge benefit from search engines, but because they are provided for free they make little direct contribution to GDP.  Users perform billions of searches on Google each day but the value of this service consumption is not included in GDP.  For GDP, Google is mainly an advertising company.  In national accounts, Google’s turnover is the mainly the amount it collects in advertising revenue.  This is a significant amount but will be well below the value users get from using the services that Google provide.

This suggests that, similar to government services, the value of certain private services may be undercounted in GDP.  While true this is not necessarily a reason to discard GDP. GDP has limitations because of what it is: a measure of output that can contribute to national wealth. GDP is a flow that can lead to changes in national wealth, and there are other things that can change national wealth.

The output included in GDP should give rise to something that can be included on a national balance sheet.  If Wikipedia and Google give their main products away for free, then that means there is no direct way they can give rise to something that can be included on a national balance sheet.  In one sense, this means that GDP undercounts the value of these services. It does. But in the sense that GDP was created for, it more accurately reflects the value of the output produced that gives value that can be added to national wealth – though not necessarily of the country in which the output is produced.

Anyway, after those few digressions, we can now see how production value is translated into value added and subsequently into GDP.

The Output Approach to GDP

Using the output approach gives us Gross Value Added (that will go to persons and businesses) and adding the government net take from taxes and subsidies on products to GVA gives us Gross Domestic Product (GDP). 

  ITEM €million
  Production Value 790,000
less Intermediate consumption (390,000)
equals Gross Valued Added at basic prices 400,000
plus Taxes on products 26,500
less Subsidies on products (1,500)
equals Gross Domestic Product 425,000

This is an important measure of an economy and taking the components of the phrase in reverse we have:

  • Product: the value added of the output produced (including taxes)
  • Domestic: activity that that takes place within a country’s borders
  • Gross: before depreciation or the cost of replacing capital used

Irish GDP in 2021 was around €425 billion.  With a population of 5.1 million this is just over €85,000 for every man, woman and child in the country.  With an average of around 2.4 million in employment during the year, it is about €180,000 per worker.  GDP is one of many Irish macroeconomic indicators that is distorted by the presence of MNCs here.  Our next journey will be the steps to go from GDP to national income.

Irish Economic Association Annual Conference 2023 (Updated)

The 36th Annual Irish Economic Association Conference will be organised by the Economic and Social Research Institute and held in the Sheraton Hotel, Athlone on Thursday, May 4th and Friday, May 5th, 2023.

The IEA 2023 will have two presentation types: 1) Full paper presentation; and 2) Flash Talks.

Full conference presentations are 25 mins in length and require the submission of a full draft paper.

Flash Talks are a new initiative aimed at encouraging early stage researchers wishing to get exposure of their research to the wider economics community. This can be early work in progress. The talks will be 5/10 mins each with a maximum of 3 slides. Flash Talk submissions only require an extended abstract (2 pages approx).

The submissions deadline is 23:59 GMT on Friday 24 February 2023.   Submissions can be made via the conference website which is available at:

https://iea2023.exordo.com/

The Conference will feature two international plenary lectures – the Edgeworth Lecture and the ESR Lecture.  A number of prizes will be awarded including the Denis Conniffe prize for the best paper by a young economist, the Brendan Walsh prize for the best paper published in the Economic and Social Review, the Novartis prize for the best health economics paper, and the Irish Society for Women in Economics (ISWE) prize for the best paper presented by a women economist.

National Income: 1 – From Turnover to Production Value

In aggregate terms, Ireland’s national income in 2021 was around €230 billion (using modified Gross National Income, GNI*). This comes from an economy where the aggregate turnover is probably around €1 trillion. There is a lot of money flowing around but as is often quoted but rarely attributed: “turnover is vanity, profit is sanity and cash is reality.”

The table shows a progression from turnover to production value. All bar the top two rows are in line with the latest estimates for 2021 from the CSO. Aggregate figures for turnover and for the cost of goods and services purchased for resale in same condition as received are not provided by the CSO within Ireland’s national accounts but the figures shown are within the ballpark. Turnover is not significant within the national accounts framework where the emphasis is on production, value added and income. The sequence shown isn’t how the national accounts are compiled but can serve as a setting off for examining where our income comes from.

Goods and Services Purchases for Resale in Same Condition as Received

Of the roughly €1 trillion of turnover in the Irish economy in 2021, around €300 billion was due to the selling, both wholesaling and retailing, of goods and services that somebody else made. Those doing the selling are looking to gain a small margin. The wholesale sector in Ireland (G46) has a turnover of around €150 billion, some of which is linked to MNC-activities, while the more domestically-orientated retail sector (G47) has a turnover of around €50 billion. Both have operating margins in the low single digits. It will also be the case that the same goods will be included in the turnover of both. The turnover of wholesalers includes sales to retailers and the turnover of retailers is based on the sale of those same goods to customers. Subtracting the cost of goods and services sold in the same condition as purchased leaves around €700 billion of turnover from goods and services that are made – market output. This is the value of output that is produced for sale at market prices.

Non-Market Output

There will also be output that does not get picked up in turnover. There are two main types of non-market output. There is output that is produced by someone for own final use and output that is produced for sale at prices that are not economically significant.

There are lots of activities that could be included in production for own final use and around €35 billion of such activity was included in the national accounts for 2021. One of the main elements is the housing services that owner-occupier households provide to themselves. Owner-occupiers do not buy the housing services that they consume, but instead own the asset that produces them. An imputed value is included in the national accounts for the housing services produced, and consumed, by owner-occupier households. These are based on market rents and around €18.5 billion of such imputed rents were included in non-market output in 2021. Household cooking and cleaning undertaken by workers who are paid is also included in output but any cooking and cleaning done by households themselves is not.

Firms can also produce output for their own final use but as firms do not undertake final consumption their output for own final use only includes capital assets, as capital formation is a final use. Firm may have in-house production of capital assets such as machinery, software, and research and development. They do not sell the capital assets produced but use them in their own production. The 2021 figure is not yet available but in 2020, businesses in Ireland in the industry sector (NACE C) produced around €15 billion of capital assets for their own final use.

There is also non-market output which is provided at prices that are not economically significant (which includes having no price at all). The most important component of this other non-market output is the provision of health, education, and other services by the government sector. There will also be some non-market output from non-profit institutions serving households. In total, the value of such non-market output was estimated to be €50 billion in 2021. As there is no market price this value is based on the costs of production, of which labour costs will be the most significant in many instances.  While consistent and measurable, the sum-of-costs approach does mean that such non-market output can potentially be undervalued relative to output included using market prices.

Changes in Stocks

As we want to get the production value within a particular time period (such as a year) an adjustment is made for changes in stocks. It could be that some of this year’s turnover is derived from the sale of goods made last year (i.e., a decline in stocks) or there could be output made this year that is not sold (i.e., an increase in stocks). In 2021, it is estimated that more output was produced during the year than was sold during the year which resulted in a positive figure for the change in stocks, of around €5 billion.

Production Value

Adding these four items: market output (€700 billion), output for own final use (€35 billion), other non-market output (€50 billion), and changes in stocks (+€5 billion) gets us to the total value of goods and services produced in the economy and included in the national accounts. Thus, the value of production in the Irish economy was estimated to be €790 billion in 2021. In a future post, we will pick up the sequence and follow how this production value is transposed into GDP and subsequently to National Income.

Professor Christopher Whelan, RIP

Prof. Chris Whelan passed away this week. He was Professor Emeritus of Sociology at UCD, a former Research Professor at the ESRI and Member of the Royal Irish Academy. The funeral notice is here. A brief summary of his career is provided by the ESRI.

Chris began his career with the Institute as a Research Assistant in 1972, becoming Research Professor in 1992. During this time, Chris coordinated research programmes in the areas of social inclusion, social cohesion and quality of life, publishing extensively on these topics and on economic and social change in Ireland during bust and boom. He left the ESRI in 2009 when he was appointed to the Chair in Sociology in UCD, but continued his connection with the Institute as a Research Affiliate.

The full tribute from the ESRI is available at the following link:

https://www.esri.ie/news/esri-pays-tribute-to-chris-whelan

Barrington Prize, 2022/2023

The Statistical & Social Inquiry Society of Ireland is delighted to open a call for entrants for the Barrington Prize for its 176th session, which takes place between September 2022 and June 2023. More details are given below.

Call for entrants
The Barrington Medal is awarded annually by the Council of the Statistical and Social Inquiry Society of Ireland under the auspices of the Barrington Trust (founded in 1836 by the bequest of John Barrington). The award, which includes both a silver medal and €1,000, is intended to recognise a promising new researcher in the economic and social sciences in Ireland. This will be the 173rd anniversary of the lecture series and the recipient will be the 132nd Barrington Lecturer. Recipients in the past 35 years include:
Deirdre McHugh, Don Thornhill, George Lee, Alan Joyce, Daniel McCoy, Brian Lucey, Kevin O’Rourke, Siobhan Lucey, Mary Walsh, Philip Lane, Aidan Kane, Donal O’Neill, Peter Clinch, Colm Harmon, Ronnie O’Toole, Cathal O’Donoghue, Paul McNicholas, Mary Keeney, Liam Delaney, Martina Lawless, Cal Muckley, Orla Doyle, Yvonne McCarthy, Ronan Lyons, Mark McGovern, Rebecca Stuart, Karina Doorley, Daragh Clancy, Barra Roantree, Niall Farrell and Paul Kilgarriff.

The lecture should be based on a paper of not more than 7,500 words addressing a topic of relevance to economic or social policy and of current interest in Ireland. In treating the issue of economic or social policy, the paper may either report the findings of a statistical research study dealing with some aspect of the problem or deal with the underlying theoretical considerations involved, or preferably combine these two approaches. It should be written in a manner that makes it accessible to non-specialists in the area. More technical material may be included in an appendix. The paper is published in the Journal of the Society, so it should not have been published before (nor should it be published subsequently without the prior consent of the Council of the Statistical and Social Inquiry Society of Ireland).

Candidates, who at the time of their submission must be not more than 35 years of age, should at least submit a detailed abstract of approximately 1,000 words on the proposed lecture, with preference being given to full papers. A short CV and the name of a proposer who is familiar with their work should also be submitted. Entries will be accepted from 1st June to 31st August, 2022 and should be sent to the Honorary Secretaries of the Society, via email, using the email address secretary@ssisi.ie, as should any queries regarding this call for entrants.