National Income Accounting Fundas

The stock markets went on a celebration yesterday with Mr. Manmohan Singh suggesting that India is capable of staging a 8-9% growth even in today’s scenario. Its anyone’s guess if this is really possible or is it just a pipe dream. The aim of this post is not to go into an elaborate academic debate on whether this is indeed possible, but is an attempt to explain some of the basic fundas of National Income Accounting. With budget just around the corner, its time to arm yourself with the jargon…

National Income Accounting is essentially the framework which helps measure the economic activity that occurs in a given period of time. There are primarily three ways to measure this:

1. Aggregating the amount of goods and services produced – The product approach
2. Aggregating the income of people who produce the goods and services – The income approach
3. Aggregating the expenditure of people who purchase the goods and services – The expenditure approach

The value of goods and services produced in an economy is by definition equal to the amount that buyers spend on them. And the buyer’s expenditure on these goods in indeed the seller’s income. So irrespective of the method we choose to measure the national income, we end up with the same answer. However, each of these methods sheds light on different aspects of the economy and hence we end up calculating the national income through all the three approaches.

Lets now shift focus to GDP or the Gross Domestic Product, one of the most widely tracked economic measure. While GDP can be calculated through any of the measures explained above, I like the expenditure approach the best as it can bring up interesting insights on the economy as a whole.

The exenditure approach basically works very much like our individual home budgets. Out of our total annual income we use a portion towards consumption, a portion towards purchases of goods and service and the balance is used as “investments”.  It is these investments that have the potential to increase our wealth in the future.

Using the same analogy for the country as a whole, we can derive that the total savings of the country is the summation of savings by the private sector (individuals included) and the savings of the government. In our country, the government runs a deficit, meaning its outspends its income. So the savings in the private sector, finances the government deficits and the balance is what we have towards investments.

If we need to invest more than what we have, we either look out for alternate sources of revenues (reducing current account defecits) or manage to borrow from others (through capital account surplus).

Given our extremely high rate of savings of about 35%, we are definitely better off in using our own money for investments rather than depending on foreign capital to fuel economic growth. This has been a boon to us in these times of global recession when we are still talking of growth rates of 5-6% when the overall global economy is shrinking. Nevertheless, our ability to continue attracting foreign capital can fuel us into faster growth.