Dr Emma Howard of TUDublin, and chair of the Irish Society of Women in Economics (ISWE), has an opinion piece on TheJournal.ie examining the practice of economics and the work of some of her colleagues in Ireland. You can read it here.
Readers may also be interested to note that at the recent AGM of the Irish Economic Association, a motion was unanimously passed to make ISWE a standing committee within the IEA.
A recent speech by President Higgins can be read here.
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:
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.
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.
Disclaimer: this post represents my own views and not those of the Central Bank of Ireland
Two recent CSO releases shed light on the evolution of earnings in the first three quarters of 2020. Alongside employment and hours, understanding the impact of COVID-19 on earnings tells us how household incomes are affected by the shock.
In previous work, using data from the Financial Crisis, we found that earnings in Ireland were sensitive to economic conditions, notably changes in the unemployment rate. The workers most exposed to lower pay when labour demand falls are those with weaker bargaining power. For example, in our paper we focused on the lower wages of new hires during the last crisis.
When looking at changes in average earnings, such as from the CSO’s Earnings and Labour Costs release, it is important to take account of changes in the composition of employment. For example, if changes in employment are concentrated amongst lower paid workers, average earnings could rise when there is a negative aggregate demand shock. In a SSISI paper in 2012, Kieran Walsh showed that these compositional effects can be large. The CSO also noted the potential for compositional effects in the context of COVID-19 average earnings changes.
Tracking the earnings of the same workers in the same jobs can remove some of these composition effects, giving a clearer picture of underlying wage developments. The CSO does something close to this in its Labour Market Insight Bulletin 4/2020, showing changes in average gross weekly earnings conditional on workers being in employment in Q1 and Q3 2020. Earnings includes wage subsidies, where applicable, but exclude PUP payments.
The chart below, from the data in the CSO Bulletin, shows that for all sectors earnings fell by almost 4 per cent for workers in employment in Q1 and Q3. In some sectors, like Administrative & Support Services and Financial, insurance & real estate the changes are double-digit. In others, like Construction and Accommodation & food, earnings are up.
For comparison, during the financial crisis, and controlling for composition effects, average weekly nominal pay also fell by around 4 per cent, most of it between 2008 and 2009 (Lydon & Lozej, Table 2). At that time, the declines were largest in sectors connected to property market, like construction and real estate. The emphasis on nominal pay is important. Between 2008 and 2010, prices (CPI) also fell sharply, by over 5 per cent. This helped offset the fall in nominal earnings, cushioning the impact on households’ purchasing power. Price levels have fallen in 2020, by around 1.5 per cent, which suggests a fall in real earnings in the first three quarters of the year of around 2.5 per cent.
… changes in earnings positively correlated with labour demand, but important to control for hours
The changes in earnings between Q1 and Q3 are generally positively correlated with changes in labour demand, such as changes in employment or job postings. There are some notable exceptions like Accommodation & food – where employment fell by over a fifth, but average earnings rose marginally, by 0.4 percent; or Industry, where employment grew by 2.4 per cent, but average earnings fell by 6.4%.
Despite conditioning on workers in employment in Q1 and Q3, there are likely still many factors affecting earnings dynamics that are not picked up in the conditional averages. One example is hours-worked. As weekly earnings are the product of hours worked and hourly pay, higher or lower earnings could be due to higher or lower hours. This could matter in sectors with seasonal hours, like Accommodation & Food services.
To get at the the change in hours worked, and for a sample broadly aligned to the administrative earnings data, the CSO provided me with average actual hours worked by sector for employed persons interviewed in Q1 and Q3, from the LFS. I use this data to back out change in average hourly pay as the change in weekly earnings minus change in weekly hours worked. Readers should note that earnings data is from administrative sources (including wage subsidies), whereas the hours data is from a survey. Furthermore, the two matched LFS samples are six months apart and may not be exactly representative.
The chart below shows the data. The line in the chart is the change in average gross weekly earnings, corresponding to the bars in Chart 1. Whilst there are offsetting increases in hours in several cases, they are usually small. Furthermore, the direction of the change in hourly pay and earnings is roughly the same for most sectors, with the notable exception of Accommodation and food services. In fact, the increase in hours worked (10.5%, an increase from 32.1 to 35.5 hours per week) offsets a large fall in hourly pay (minus 10.1%). This fall in hourly pay is more closely alinged with the fall in demand (employment and job postings) that we have seen during COVID-19. Looking at the historic LFS data, it is clear that this hours increase in Q3 is not unusual. In fact, it is entirely predictable: the historic Q1 to Q3 change in hours is almost exactly the same as the 2020 figure, at 10.3 per cent.
The third chart below shows the correlation between the estimated change in hourly pay (conditional on working in Q1 and Q3) and the change in job postings by sector from Indeed. Job postings are generally a good indicator of labour demand, and, whilst postings are down across the board, we find that sectors where postings have declined the most have generally see larger falls in hourly pay.
It should be said that three quarters of data is a relatively short time period. Added to this is the fact that the COVID-19 shock has generated a very high degree of uncertainty. For firms in some sectors – such as exporters, industry or multinationals – the demand shock may may turn out to be less bad than initially feared. This might help explain negative earnings growth for workers in Industry, but positive employment growth. It is quite possible that in Q4 or Q1 2021 we may see a strong earnings growth for some sectors as employers unwind pay freezes that were put in place early-on the crisis.
… looking ahead
By combining administrative and survey data in novel ways, the CSO provides timely and granular insights on the COVID-19 labour market. This is crucial information for understanding the impact of the shock, and how policy might help mitigate it.
The decline in earnings in 2020 for employees working in both Q1 and Q3 is similar to falls seen during the last recession, albeit with a different sectoral pattern. There are other differences this time around. The most significant difference is the large and decisive policy response to COVID-19 – both fiscal and monetary. In November, over a quarter of workers were supported by Pandemic Unemployment Payments or Wage Subsidies. Furthermore, the government has committed to these supports remaining in place while restrictions remain in in place. Another important difference is healthier state of household balance sheets going into 2020, a factor which dragged on domestic demand during the last recession.
If the spread of the virus can be brought under control in 2021, this points to a potentially shorter duration shock than before. However, the longer restrictions continue, the greater the potential for behaviour to change – like less business travel or less bricks-and-mortar retail, for example – and the harder it becomes for some businesses to reopen. This would lead to permanent job losses, even after restrictions are lifted. Furthermore, if employment and (real) earnings shocks persist, there is greater potential for precautionary savings, with negative feedback loops for domestic demand. The fact most people who have experienced reduced employment or been laid off due to COVID-19 said they expected to return to the same job suggests a widespread perception of this as a short-term or temporary shock – albeit this was in Q3, before the most recent Level 5 restrictions.
Related to this, in services – the sector most affected by the shock – turnover picked up sharply during the summer easing of restrictions. Although some sub-sectors, like travel and accommodation remained far below pre-COVID levels. Job postings in services track tend to track turnover very closely, rising in the summer, before declining again in the move to Level 5. This suggests that permanent relaxation of restrictions, leading to increased demand, could undo some, but not all, of the labour market damage we have seen in 2020.