Real versus Nominal GDP

Nominal GDP is the money value of all the goods and services produced in a year. Nominal GDP is calculated at the current market prices. However, Nominal GDP does not truly indicate the real performance of the economy as the prices changes over time.

Back to Basics: Suppose, India as a country only produced cars in its economy. In the year 2016, India produced 100 Cars which were sold at RS 100,000 each. India’s GDP in this case will be RS 10,00,00,00 (100*100000).

In the year 2017, supposedly due to demonetization India only produced only 90 Cars, but their price has risen to RS 15,0000. India’s GDP in the year 2017 will be 1,35,00,000.

The Increase from RS 10,00,00,00 to RS 1,35,00,000 is the nominal GDP. The GDP of India has risen not because we have produce more units of Car but because the prices of the car have increased.

Therefore, the Nominal GDP does not capture the changes in the real economy.

Real GDP

The real GDP is calculated as the money value of all the goods and services produced in a year using the constant set of market prices that have prevailed in the certain chosen base year. The Real GDP is calculated at a fixed set of prices so that only the changes in real output or real production of goods and services is captured.

Back to Basics: Suppose, India as a country only produced cars in its economy. In the year 2016, India produced 100 Cars which were sold at RS 100,000 each. India’s GDP in this case will be RS 10,00,00,00 (100*100000).

In the year 2017, supposedly due to demonetization India only produced only 90 Cars. If we take the year 2011-12 as the base year and assumes that the price of the car in that year was RS 90,000. Then, India’s Real GDP will be 90*90,000= 81,00,000.

The Nominal GDP is RS 1,35,00,000 whereas the Real GDP is RS 81,00,000. The difference is due to the prices which have risen from 90,000 in the base year to RS 15,00,00 in the current year.

Limitations of the Concept of GDP/Economic Growth

Note for Students: The following examples will make it clear why GDP is not a perfect measure of Well Being.

• Suppose, due to unemployment in the economy the youth drifts towards Crime. To overcome the crime rate, the government decides to hire more police personnel. Due to the hiring of police personnel, the economic activity in the economy increased as the newly employed personnel will be paid salaries, which they will spend on purchasing goods and services. Hence Production of Goods and services will increase. The final outcome is increase in the GDP.

Now tell me is this increase in the GDP is worth considering? The GDP has risen due to wrong reason, i.e., increase in crime.

In the above case, the GDP fails to capture the deteriorating situation of the society.

• Suppose, the Government of India decides to mine resources from the fragile Western Ghats. The mining of the resource leads to the production of resources which are used in the production of goods and services. The increased production will lead to increase in the GDP.                                 But, due to mining activity, the population near the Ghats were disposed of or removed. At the same time, the mining activity has made the region prone to flooding. The floods in the coming year will destroy valuable life and property. The loss due to dispossession and flooding will not be captured in the calculation of the GDP. Thus, in this case also GDP has risen but at the cost of negative externality in the form of loss of livelihood and lives.

Economic Growth versus Economic Development

The two-argument provided above are also valid for the shortcomings of growth.

Economic Growth is a monetary concept. It only takes into account the value of goods and services produced in the economy. It tells how much a country has progressed in terms of economic indicators like GDP, Per Capita Income, Production, employments etc. It measures only quantifiable outcomes.

Let’s Understand Growth

The First Stage:

The story so far is very impressive a business-friendly government with pro-business policy increased growth and employment.

The Second Stage:

The Third Stage

The Fourth and Final stage: The Crisis

The above model is just an easy explanation of a complex system. Is it really the pro-business policies of the government that have led to the crisis?

The answer is no. It is the lack of balanced policy or a single point focus on the growth that has led to the crisis.

What has the Government missed in the process?

• If at the very beginning, along with pro-business policies, the government had adopted the policies to promote education, skill development, research and innovation, health and social empowerment, the outcome could have been very different. A progressive education and health sector along with technological advancement would have taken care of skilled and educated labour needed in the production processes.

The First lesson, therefore, is “Along with the policies to promote Physical Capital the government must promote the policies of Human Capital”. Therefore, the first difference, “Promotion of Physical Capital is a growth oriented measure, but promoting the Human capital along with Physical Capital is a development oriented measure”.

• In the above setup, the government had adopted a policy of excessive deregulation of the economy. The problem with excessive deregulation is that it does more harm than good. If the government have moved cautiously with the deregulation, it could have avoided the crisis.

If for example, when the first stage boom had happened, the government should have adopted the policy of promoting new firms by encouraging competition, by providing the new firms with opportunities in the form of lower taxes, interest-free capital. Instead, the government followed the existence firms demand of more rebates, more deregulation which created a monopoly like the situation with restricting enter. The new firms would have competed with the older firms, and in the process, the poor performing firms would have thrown out of the market, and the best surviving firms could have produced efficiently and at a much lower price.

The second lesson, therefore, is “The role of government is to promote competition and healthy environment for the firms to operate and not to practice Crony Capitalism in nexus with old firms”. Therefore, the policy of excessive deregulation along with creating a monopoly kind structure is a growth oriented move, but promoting and encouraging new firms through fair competition is a development oriented measure”.

• The government promoted a policy of Land reforms which favoured firms and Businesses. Instead, the government must have come up with a policy which could have taken care of the poor and farmers. The government should have provided land at the fair market price along with the provision of forcing firms to undertake developmental activities like promoting primary health centres, secondary schools and another social sector initiative like computer training and skilling of rural youth who have lost their lands. This could have fastened the land reform process and makes it more acceptable to poor.

The Third lesson, therefore, is “A balanced approach towards resource redistribution does more good as compare to a one-sided measure of promoting business welfare”. The governments must force the firms to provide essential services in the areas of the land takeover. Therefore, land acquisition along with welfare of the region is a development measure.

• The last point is with respect to labour reforms. The flexibility of the labour market is the need of the hour. But it should be done keeping in mind the welfare of the labour. The government must do labour reforms which promote healthy employment along with bringing the labour in the social security net. The opening up of labour markets by killing unions and bargaining power of labour will only lead to labour exploitation and labour unrest and business loss. A better approach is to make labour market flexible for both employer and employee so that they can move out easily from one job to another. This can be done through proper contracts, well-functioning legal system, working social security net for labourers and skilling and training of labourers.

Therefore, the fourth lesson “Labour Market reforms carried with the welfare of the labour is a development oriented measure”.

The story in a nutshell, therefore, is “Growth is only a necessary condition and not a sufficient condition for promotion of well-being and raising the standard of living of the people”.

Measures of Economic Development

1. GREEN GDP

• Green GDP is a term used for expressing GDP after adjusting for environment degradations.
• Green GDP is an attempt to measure the growth of an economy by subtracting the costs of environmental damages and ecological degradations from the GDP
• The concept was first initiated through a System of National Accounts.
• The System of National Accounts (SNA) is an accounting framework for measuring the economic activities of production, consumption and accumulation of wealth in an economy during a period of time. When information on economy’s use of the natural environment is integrated into the system of national accounts, it becomes green national accounts or environmental accounting.
• The process of environmental accounting involves three steps viz. Physical accounting; Monetary valuation; and integration with national Income/wealth Accounts.
• Physical accounting determines the state of the resources, types, and extent (qualitative and quantitative) in spatial and temporal terms.
• Monetary valuation is done to determine its tangible and intangible components.
• Thereafter, the net change in natural resources in monetary terms is integrated into the Gross Domestic Product in order to reach the value of Green GDP.

Green GDP and India

• While explicitly green GDP is not measured in India, but environmental accounting has been done in India from last 2 decades
• A Framework for the Development of Environmental Statistics (FDES) was developed by the Central Statistics Office (CSO) of India in the early 1990s. The Compendium of Environment Statistics is being released since 1997.
• As per the recommendations of Technical Working Group on Natural Resource Accounting (NRA) in the later 1990s, a pilot project on NRA in the State of Goa was initiated during 1999-2000. Thereafter, resource accounting studies were carried out in 8 states on a different set of natural resources. Later a Technical Advisory Committee was constituted in the year 2010 under the Chairmanship of Dr Kirit Parikh to bring out a Synthesis Report combining the findings of all these studies. The report recommended the preparation of a National Accounting Matrix that would include environmental accounts. The High powered expert group under Partha Dasgupta was constituted subsequently in 2011 with the mandate of developing a framework for green national accounts of India and for preparing a roadmap to implement the framework.
• Following the guidance of International Organisation of Supreme Audit Institutions (INTOSAI) on the framework for of environmental auditing, the supreme audit institution of India (CAG) also conducts an environmental audit in India. This process was formalised with the introduction of specialized guidelines for the conduct of environmental audits. This laid down broad guidelines to enable India’s auditors to examine whether the auditee institutions gave due regard to the efforts of promulgating sustainability development and environmental concerns, where warranted.
• Thus, in India, the Environmental audit is conducted within the broad framework of Compliance Audit and Performance Audit at the central level by the Office of Principal Director of Audit (Scientific Departments) and by the state Accountant Generals (Audit) at the state level. Over the years, more and more states have taken up environmental audits. This compliance as well as performance audits have been printed in the respective state/ central audit reports and presented to Legislature/Parliament. All these reports deal with the environmental themes of water issues, air pollution, waste, biodiversity and environmental management systems. All the environment audits done at the state level and at the central level since 2001 are collated in the CAG report on environmental audit.

Gender Inequality Index

• Gender inequality remains a major barrier to human development. Girls and women have made major strides since 1990, but they have not yet gained gender equity.
• The disadvantages facing women and girls are a major source of inequality. All too often, women and girls are discriminated against in health, education, political representation, labour market, etc.—with negative consequences for development of their capabilities and their freedom of choice.
• The GII is an inequality index. It measures gender inequalities in three important aspects of human development—reproductive health, measured by maternal mortality ratio and adolescent birth rates; empowerment, measured by proportion of parliamentary seats occupied by females and proportion of adult females and males aged 25 years and older with at least some secondary education; and economic status, expressed as labour market participation and measured by labour force participation rate of female and male populations aged 15 years and older.
• The GII is built on the same framework as the IHDI—to better expose differences in the distribution of achievements between women and men. It measures the human development costs of gender inequality. Thus, the higher the GII value, the more disparities between females and males and the more loss to human development.
• The GII sheds new light on the position of women in 159 countries; it yields insights in gender gaps in major areas of human development. The component indicators highlight areas in need of critical policy intervention, and it stimulates proactive thinking and public policy to overcome systematic disadvantages of women.

Gross National Happiness Index

• Gross National Happiness is a term coined by His Majesty the Fourth King of Bhutan, Jigme Singye Wangchuck in the 1970s. The concept implies that sustainable development should take a holistic approach towards notions of progress and give equal importance to non-economic aspects of well-being.
• “How are you?” We ask that question of one another often. But how are we doing – as a country, a society? To answer that question, Bhutan uses its Gross National Happiness (GNH) Index.
• In 2015, a total of 91.2% of Bhutanese were narrowly, extensively, or deeply happy. 43.4% were extensively or deeply happy. The aim is for all Bhutanese to be extensively or deeply happy. Bhutan is closer to achieving that aim in 2015 than it was in 2010.
• GNH is a much richer objective than GDP or economic growth. In GNH, material well-being is important, but it is also important to enjoy sufficient well-being in things like community, culture, governance, knowledge and wisdom, health, spirituality and psychological welfare, a balanced use of time, and harmony with the environment.
• The four pillars of GNH:

• The Nine Domains of GNH

Criticism of GNH

• From an economic perspective, critics state that because GNH depends on a series of Subjective judgments about well-being, governments may be able to define GNH in a way that suits their interests
• Other critics say that international comparison of well-being will be difficult in this model; proponents maintain that each country can define its own measure of GNH as it chooses and that comparisons over time between nations will have validity. GDP provides a convenient, international scale.
• Research demonstrates that markers of social and individual well-being are remarkably transcultural: people generally report greater subjective life satisfaction if they have strong and frequent social ties, live in healthy ecosystems, experience good governance, etc. Nevertheless, it remains true that reliance on national measures of GNH would render international comparisons of relative well-being more problematic since there is not and is not likely ever to be a common scale as “portable” as GDP has been with other countries.

Human Development Index

• The Human Development Index (HDI) is a statistical tool used to measure a country’s overall achievement in its social and economic dimensions. The social and economic dimensions of a country are based on the health of people, their level of educational attainment and their standard of living.
• Pakistani economist Mahbub ul Haq created HDI in 1990 which was further used to measure the country’s development by the United Nations Development Program (UNDP). Calculation of the index combines four major indicators: life expectancy for health, expected years of schooling, mean of years of schooling for education and Gross National Income per capita for the standard of living.

Why do we require HDI?

• Firstly, GDP method of calculating progress ignores non-income aspects like education and health thus, for example, Arab countries have high GDP per-capita, but the progress in health and education field is limited in those countries which do not get measured in GDP. Similarly, in countries like Cuba and Sri Lanka GDP per capita is low, but the quality of life is much better than many high GDP per capita countries of the Arab world and Latin America because of high-quality indicators in social sectors. HDI will overcome this problem
• Secondly, GDP per capita ignores income inequality or distribution of wealth in a country for example in countries of Latin America have high GDP per capita but due to skewed income distribution, the masses are excluded from growth process.
• The HDI was created to emphasize that people and their capabilities should be the ultimate criteria for assessing the development of a country, not economic growth alone

Method of calculating HDI

• The Human Development Index (HDI) is a summary measure of average achievement in key dimensions of human development: a long and healthy life, being knowledgeable and have a decent standard of living. The HDI is the geometric mean of normalized indices for each of the three dimensions.

(a)Life Expectancy Index assessment

• The minimum value for life expectancy is fixed at 20 years in the new calculation. The maximum value for life index is kept at 83.2 years. 
• Formula to calculate Life Expectancy Index (LEI) = Life Expectancy of a country -20/ 83.2-20

 (b) Education Index assessment
Education Index (EI) assessment is composite of two indices. They are 
1. Mean Years of Schooling Index (MYSI)
2. Expected Years of Schooling Index (EYSI)

• Formula to calculate Mean Years of Schooling Index (MYSI) = Mean years of schooling – 0/ 13.2 – 0
• Formula to calculate Expected Years of Schooling Index (EYSI) = Expected Years of Schooling – 0/ 20.6 – 0

   (C)  Income Index assessment

• To calculate this index, goal posts are set as per observations during 1980 – 2010 in various countries. Gross National Income per capita is taken as a measure to calculate new Income Index in new HDI. Minimum income is set as $163, and maximum income is set as $108,211.
• Formula to calculate Income Index = Log (Country’s GNIpc) – Log ($163) / Log ($108,211) – Log ($163)

How to calculate Human Development Index as per new method?
Formula to calculate Human Development Index (HDI) = (Life Expectancy Index X Education Index X Income Index) 1/3
New Human Development Index (HDI) is geometric mean of Life Expectancy Index (LEI), Education Index (EI) and Income Index (II).

After this calculation total value will be between 0 and 1. As per the values gained, countries will be placed in the list of the division of countries. They are divided into very high human development, high human development, medium high human development and low high human development countries

Global Trends in HDI

• The Scandinavian countries which include Norway, Sweden, Denmark etc. are world leaders in HDI since most of them occupy positions within top 10 in HDI list and Norway always tops the list. According to 2015 HDI rankings, Norway is top ranked country. The reasons why these countries are performing so well In HDI are manifold. These countries have high per capita income, along with this positive state interference in education and health along with a well-developed social security system ensure that these countries maintain their dominance in HDI ranking.
• Among India’s neighbours, Bhutan and Bangladesh  figure in Medium development category. Pakistan (ranked 146) and Nepal (145) are in the ‘low development’ category, while Sri Lanka (73) is in the ‘high development’ category.
• The five countries that made up the bottom of the list were Niger (0.348), Central African Republic (0.350), Eritrea (0.391), Chad (0.392) and Burundi (0.400).

Strength of HDI index

• There is widespread use of HDI to compare development levels, and it does reveal clear global patterns.
• Does not solely concentrate on economic Growth, and takes into consideration that there are other, more social, ways to measure progress.
• Increase in education and health shows an improvement in countries progress index.

Weaknesses of HDI index

• The fact that the HDI uses GDP per capita in its calculations opens many criticisms. Here are some of them.
• GDP per capita does not give an indication of the income distribution. Issues about Rich and poor divide etc
• GDP does not show how the income is spent by the government. Some countries spend more on military than on health care
• The range of variables included by the HDI is too narrow and does not include much-needed factors such as the % of people living on under 1$ a day
• Out of the three main constituents of the HDI, some factors are more important than others. The HDI is flawed for this reason as the score of the three is averaged out.
• When knowledge is measured it only takes into account what children learn at school not in the family. And so maybe knowledge statistics may be distorted if the family play more of a role in education in the home.
• Longevity can also be distorted as the life expectancy of a person does not consider how healthy the life was led. i.e. A person aged 90 years old but has suffered serious illness in the last 30 years of their life would have a higher HDI value compared to a 70-year-old who has led a very healthy life.
• Countries like are countries with booming economic growth. And also, it has well-developed health and education sector. There is no religious freedom, there’s censorship on the internet, and the state is everywhere.
• Data from some developing countries may not be very reliable and may be difficult to confirm.
• The measures chosen may seem very arbitrary to some because there are another way of measuring relative qualities in health and education
• No indication in the education index about access to education for all groups in society.

The HDI and India

• India’s human development index (HDI) ranking for 2015 puts Asia’s third largest economy among a group of countries classed as “medium” in the list, as opposed to “low” in the 1990s, thanks to factors such as an increase in life expectancy and mean years of schooling in the past 25 years.
• But the bad news from the report released on Tuesday in Stockholm is that regional disparities in education, health and living standards within India—or inequality in human development—shave off 27% from India’s HDI score.
• As it stands, India is ranked 131 out of 188 countries in a list that is topped by Norway.

• India’s HDI value for 2015 is 0.624—which puts the country in the medium human development category but behind fellow South Asian countries like Sri Lanka and the Maldives.
• India’s 2015 score is up from 0.428 in 1990, i.e. an increase of 45.8% between 1990-2015.
• India’s improved HDI value is second among BRICS countries, with China recording the highest improvement—48%.
• Between 1990 and 2015, India’s life expectancy at birth increased by 10.4 years, mean years of schooling increased by 3.3 years and expected years of schooling increased by 4.1 years,” the report said, adding that India’s Gross National Income, or GNI, per capita, increased by about 223.4% during the same period.
• In South Asia, countries that are close to India in HDI rank with a comparable population size are Bangladesh and Pakistan, which are ranked 139 and 147, respectively.
• The HDI report also showed that almost 1.5 billion people in developing countries live in multi-dimensional poverty. Of this, 54%, or 800 million people, are in South Asia while 34% are in Sub-Saharan Africa.