National accounts are useful. Yes, they have their limitations, and, particularly in the case of Ireland, can be subject to distortions but they are useful.
One of those uses is measuring changes in living standards. If the growth of the inflation-adjusted measure of national income exceeds the growth rate of the population then it is likely that living standards are rising, at least on average. This is usually taken as the real growth rate of per capita GDP (or another variant).
For Ireland, this averaged around one per cent per annum for the first three decades post independence, it rose by an average of three per cent per annum over the next thirty years and has averaged around five per cent per annum in the period since the late 1980s which is where it was before the current crisis hit. These are useful summaries of our economic performance, though as is well known, such long-term averages do belie some significant volatility that Irish growth rates have exhibited.
2020 seems set to add to that volatility but let’s consider two things that are likely to muddy the link between the change in real per capita national income (as measured by, say, GNI*), and the impact of the crisis on living standards:
- Food consumption and the exclusion of domestic household production from national income;
- Education and the cost-based approach to including public production in national income.
Food Consumption
Restaurants have been closed for dining in since March. The CSO’s Monthly Services Index shows that the turnover value of services in Restaurants, Event Catering and Other Food Service Activities was over 50 per cent lower in April than in the same month last year. The contribution to value added and national income from restaurants will be significantly lower this year.
However, this does not mean we are eating less or even consuming fewer food-related services. The composition has changed. The CSO’s Retail Sales Index shows that our retail purchases from Food Businesses were 17 per cent higher in April than in the same month last year. The food we are not consuming in restaurants and other outlets has been replaced by food we are buying in shops.
In the national accounts, both the food and labour inputs are counted when measuring the value added of restaurants. For food we buy in the shops the domestic labour input used to turn that food into a meal is omitted from national income, but it still contributes to our living standards.
There’s no doubt there’s more to restaurants than the food we eat and the cooking and cleaning services provided to us. That is why we are willing to pay more for dining in. But we are still eating the meal we would have had in the restaurant or cafeteria so someone is still doing the cooking and someone is still doing the cleaning. It still adds to our living standards, it’s just that it has switched from market production to household production.
The drop in living standards implied by the fall in value added from restaurants in the national accounts won’t be as large as the figures suggest. We have been forced to move to something that does not have its value added included in the national accounts (nor generate as much Value Added Tax for the government which is also counted as value added when measured at market prices.)
And, separately, the employees who would have been paid from that lost value added have had a large part of their income replaced with government transfers.
Public Education
For market-provided services the value added is essentially the value of the output produced less than cost of intermediate consumption.
The value of market output is estimated using the prices people for it. After intermediate consumption has been subtracted from total revenue, value added is divided between labour through compensation of employees, government through taxes on products, and capital through gross operating surplus. Net operating surplus remains after a deduction for the consumption of fixed capital (depreciation). The additional value added that goes to users above the price paid (consumer surplus) is not measured.
Still, value added is a useful concept and represents a large share of the living standards and welfare benefits of the goods and services we produce and consume in market settings.
This does not hold for publicly-produced services such as education. These are paid for from general taxation. We do not have prices and revenues to provide an estimate of the value people place on these services (nor how much they would be willing to buy). Market prices might be absent but they do contribute to living standards.
The value added for public services in national accounts is essentially the sum of compensation of employees and depreciation, that is, it is the cost not the benefit that is included.
The value added of education is simply put at the pay bill for teachers and the cost of maintained school buildings. No benefit above that is included in national income aggregates.
Schools have been closed since the middle of March. Just like restaurants there has been a switch to domestic production. Yes, some online supports have been provided but the value of this is unquestionably lower (just as we are only willing to pay lower prices for takeaway meals). The shift to home-schooling has had a huge impact on living standards.
However, the value added of publicly-provided education services will be largely unaffected. The fact that the school children aren’t in school doesn’t matter for national accounts; all that matters is that teachers get paid.
Conclusion
The provisional Quarterly National Accounts for Q1 2020 show that constant price gross value added in Distribution, Transport, Hotels and Restaurants was down 10 per cent compared to the first quarter of 2020. This reflects the forced closure of most of these services towards the end of the quarter.
On the other hand the gross value added in Public Admin, Education and Health was up four per cent compared to the same period a year ago. This is despite the fact that schools were closed from the 12th of March.
This isn’t necessarily an argument to change the way national accounts are compiled. Should household production be included in national income? Maybe. Should the added value of public services be more than pay and depreciation costs? Maybe. For the time being we’ll be satisfied with an understanding of what the figures as currently compiled actually mean.
The drop in value added from restaurants doesn’t mean that we are not eating. The stability in value added from education doesn’t mean that our kids are being taught. National accounts are useful and the changes in the aggregates can be a useful proxy for changes in living standards. But not always.
One reply on “Measuring national income in the time of COVID”
It’s wonderful, Seamus, to have you ‘managing the shop’ here, as it were. And you’ve certainly provided food for thought in this post.
It’s just that I – and I suspect quite a few others – are stuffed to the gills with these macroeconomic and fiscal aggregates. Long ago on this site I lamented “Is there a microeconomist in the house?” Even at an aggregate level, there are five principal sectors in the economy – government, financial institutions, non-financial institutions, non-profit institutions serving households (NPISHs) and households. Sustainable increases in productivity and welfare require the simultaneous avoidance or minimisation (or both) of destabilising imbalances within and across all these sectors – and with the rest of the world – and the minimisation of the sustained capture of economic rents in all sectors.
For all sorts of reasons – some good and some bad – there seems to be an excessive focus on the government sector and macroeconomic aggregates.
The issue for me is that most people live in the micro. Economics started out as the science of household management – but households rarely feature in the analyses or data presented. As a result, I believe there are serious deficiencies in the understanding of the current political economy in Ireland. Households ultimately fund aggregate economic activity – finance is a separate matter. It would require some detailed digging to quantify them precisely, but, as I see it, there are three broad categories of households. In terms of disposable income there quite a few households at the top which exercise considerable political, economic and organisational power. This power secures their income, wealth and privilege and their sustained capture of economic rents. At the bottom of the pile there is a large number of low-income and low-wealth households with limited engagement in the formal economy who rely, mainly, on transfers and the provision of public services. The post hoc matching of taxation revenue with the expenditure on transfers and the provision of public services to these low-income households falls mainly on higher-income households with a progressive tax system – and this causes much resentment.
There are, however, hundreds of thousands of households in the middle tier which are fully engaged in the formal economy, but lack political, economic or organisational power. The excessively high cost of living (the price level of household final expenditure is more than 25% above the Euro Area average) and the inadequate provision, and often poor quality, of public services are imposing economic hardship on many, if not most, of these households. Quite a few are really struggling. The stock of social cohesion is fracturing.
This for me is the reality for most households – whether or not those at the top or the bottom (or their spokespersons) are prepared to admit it – but those in the middle now seemed to be prepared to express their fully justified disgust and anger. It goes a long way to explain the recent shifts we’ve seen in the political landscape. But the silence from the practitioners of the economics discipline in Ireland is deafening.