21 September, 2020

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Of What Use Is Per Capita Nominal GDP Which Includes Inflation

By RMB Senanayake –

RMB Senanayake

Mr Chandra Jayarane has urged professional economists to respond to an statement by S.B Dissanayake in the Sunday Observer that in 10 years the per capita income under President M.R would top US$ 10,000. Here is what he said “this story noted below appearing in the Front Page of the Sunday Observer today, meant to fool us and all along with all the  citizens of Sri Lanka and make us Venerate with “Sadu Sadhu” and hands above our heads, the Development Strategy that unfolds in the horizon”

Economists have pointed out that the per capita money income includes inflation and when converted at a prevailing over-valued nominal rate of exchange instead of at the purchasing power parity rate of exchange represents nothing. It is not a measure of the standard of living. Imagine the Government borrows Rs 200 million from the Central Bank and gives Rs 1 million to each person. Then the nominal GDP per capita will increase to Rs 1 million plus and if we convert this nominal GDP per capita at the current exchange rate of Rs 125 to the US$ the GDP per capita would be US$ 10,000 now and doesn’t have to wait for 10 years as stated by Mr. S.B Dissanayake. This gift of Rs 1million to each person in the population doesn’t mean that the amount of goods & services has gone up.  In fact it may not have gone up at all although per capita nominal GDP has gone to Rs 1 million plus. Does this measure an improvement in the standard of living of the people? Not at all since people need goods not money and money is wanted only for the purpose of buying goods & services. So it is erroneous to measure thestandard of living by the nominal GDP per capita. What is wanted is to increase the “quantity of goods & services”But the quantity of goods cannot be added together because they are measured in different units- in pounds, gallons etc. How do you add up such different units? They can’t and hence economists use their money value to add up. But the money value varies with the prices and hence we have to measure them at a previous  price level to see if there is an actual increase in quantity and not a mere increase in prices. So economists do such calculation of the sum of goods & sevices at a previous year’s price level called the base year. This summation provides a measure of the quantity of goods & services and is called the real GDP. If it has gone up then the standard of living may be said to have improved ( GDP per capita is not however a good measure of the standard of living but it is commonly used so)  .

GDP Per Capita Real income is the relevant measure but even that is not a measure of personal incomes but of economic activity.

In my opinion there is a total misunderstanding of development theory by the authorities. There is a short term theory of economic growth and a long term theory which are different. If we want to talk about ten years then what is relevant is the long term growth and not an extrapolation of the short term growth theory. What determines the long term growth rate are the real variables.

Generally, economists attribute the ups and downs in the short term to fluctuations in Aggregate Demand with no changes in Aggregate Supply.  The theory of long run growth is different and is based on real variables like the amount of labor and human capital, the stock of physical capital in the form of machinery & equipment, buildings, infrastructure of roads, power plants , the availability of land & natural resources  and entrepreneurship;  while the short run growth is based on nominal variables like the rate of inflation, the rate of interest and the exchange rate. These real factors of production determine what economists call the ‘potential output” which involves the full employment of all f actors of production particularly labor. Our unemployment rate is 3-4% and would constitute full employment since economists consider what is called the natural rate of unemployment is about this level since  workers are all the time leaving one job for another and  this level of unemployment is the minimum required for labor  mobility to respond to wage incentives. As regards the other factors of production like capital ( machinery & equipment, tools etc ) or entrepreneurship, these cannot be increased in the short run. So they are already fully employed. So when an increase in Aggregate Demand due to say higher government expenditure takes place and the actual price level is higher than the expected price level,  the response of the producers is to run down their stocks  causing the GDP to increase . So the GDP fluctuates according to the inventory cycle if the actual price level in the economy is higher than the price level expected by the producers. We are still an agricultural economy and any fluctuation in GDP in response to higher aggregate demand is not possible for it depends on the weather. So any increase in Aggregate Demand produces a higher price level along with a higher nominal GDP. It may also produce more imports and cause a current account deficit.

The topic of economic growth is concerned with the long-run trend in production due to structural causes such as technological growth and factor accumulation. The short term cycle moves up and down, creating fluctuations around the long-run trend in economic growth

 

In the short run the changes in GDP are primarily caused by changes in Aggregate Demand. Economists draw Aggregate Supply and Aggregate Demand curves .The Aggregate Demand curve is like the normal demand curve for a single product sloping downwards in relation ot price level- higher  the price level lower the Aggregate Demand. But the curve can shift to the right meaning that at each price level the amount demanded will be more than earlier.

                                                                                                                                                                                                                                  

Short run economic growth theory explains both GDP increase as well as Price level changes and changes in the current account of the Balance of Payments. In the short term what the authorities have to do is to manage Aggregate Demand to control inflation and ensure there is no balance of Payments crisis. So the growth rate projected by the Central Bank of 7.5% is possible but is it desirable for it risks a larger current account deficit which if there are not adequate foreign capital inflows could cause a serious balance of Payments crisis.

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Latest comments

  • 0
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    This dude deserves the Noble Prize for Economics.

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      K.A Sumanasekera

      “This dude deserves the Noble Prize for Economics.”

      You may be right.

      Please ask the clan chief to create an award system based on Noble Prize and award the dude one.

      Can you assure me that Dr Mervyn Silva PhD would not be nominated for Economics, Literature, Physics, etc in the same and subsequent years?

    • 0
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      Dear Mr. RMB Senanayake and K.A Sumanasekera

      Your example at the beginning is dead wrong and stupid. Increasing in salaries or government transfer of funds to public can not increase GDP per-capita in USD as both the acts shoot the inflation and thus the exchange rates (inflation and the exchange rate are highly co-related) resulting no change in GDP in USD unless the USD dropped due to US economy fluctuations at that time.

      But there is nothing wrong using the year on year GDP growth rate which is given in real values (inflation removed) or nominal GDP given in USD as a comparison measure over time and over different economies as the real GDP growth, particularly when it is beyond 5% is highly correlated to peoples well-being and the USD, though it is also falling, is used as the absolute value in most western economic indicators.

      So there is nothing wrong targeting USD 10,000 GDP per-capita in 10 years as it is simple and understandable to anybody and your text too suggest that SB’s target is logical and achievable. This replies to Mr. C. Jayaratne’s claim that it would never achieved (please read my reply to Mr Jayaratne’s text). Resent nominal GDP growth rates too proves that it is easily achieved and therefore SB’s target is a logical one that the country should work on and motivate the people on.

      Please cheer the SB’s empirical goal if you are a true Sri Lankan as a country needs clear and simple goals and dedicated people who work towards achieving them.

      However you deserve the Noble price as it is awarded to those who work on or say something that satisfies the west or to those who undermine the local economies those are not in favor of the western (London, Paris, New york) economies.

  • 0
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    Good explanation of the real situation as against figures quoted by the CB and Govt to justify policies. Real situation is that most people are indebted and unable to make ends meet.

    Govt says GDP is USD 3000 per capita. Does every on in this country earn average Rs 32,500 a month including husband, wife and children? Sheer trickery by our politicians to deceive the people. On the other hand GDP is the level of economic activity and much of this money is flowing into someones pockets. Guess who?

  • 0
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    Regardless of economists’ and governments’ statements, ordinary people must compare their periodic incomes and the prices paid for consumer goods and services over a period of say, ten years (ie 2003 to 2012) and conclude whether their lot has improved or not.

    By the same token, ordinary people must compare the state of hospital care, equipment, facilities, availability of medicines, good doctor services, comfortable beds and clean toilets over a period of the same ten years and conclude if their lot has improved or deteriorated.

    Ordinary parents of school children must compare the quality of teaching and learning facilitated in the schools, the availability of good trained teachers and equipped classrooms, the vocational prospects after secondary and tertiary study over that same period and make conclusions as to whether it has improved or regressed.

    Ordinary people must consider their urban road environments and reflect over the past ten years and conclude if traffic congestion, road rules, driver care and ethics, courtesies etc have improved or fallen in the last ten years.

    Then, if they generally see improvements to their lives, they will conclude that the country has ‘developed’.

    • 0
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      If we consider the scenario painted by SBD as illustrating a healthy credit balance in favour of Sri Lanka in 2023, and compare with your comment, which is full of debits and gaps, then the projected balance sheet in 2023 indicates a loss. In such an eventuality, what is the use of talking only about a figure? In the background the per capita debt burden in 2023 could be closer to US $ 10,000.00 and that would leave us with a negative performance report.

  • 0
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    SBD is totally clueless even about rudimentary arithmetics. How he graduated, even from the University he did, is baffling. We remember
    how he actually believed the more Rupees you received for the US$
    the stronger the SLRs is. That is what he told an audience of Samurdhi
    receipients, the folks whose allocations made him a multi-millionaire, when he tried to impress upon them of the good work men like him did as Ministers of the Govt in power then. And, the man, I believe, was once a Minister of sorts involved with the Finance Ministry.

    Senguttuvan

  • 0
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    Sumane,

    RMBS is a former Senior Secy/Finance, Chairman of leading Corporations and after leaving the CCS/CAS lead leading private sector bodies. He was also invited to be on the board of a private bank. It was an educative and useful exercise to be a member of Committees in which
    he was brought in. Patriotic, highly read, earthly simple and totally devoid of air the man is highly religious and a passionate social activist who has fought for all of us. By any measure – a model citizen to any society.

    Senguttuvan

    • 0
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      I suggest that when someone contributes an article based on the person’s professional judgement and experience and if someone else wants to challenge the content it should be done with facts and figures. RMBS is not SBD and RMBS has, with analysis, penned his comment in a civilized manner. Anyone challenging the content of RMBS’s article should pen his/her thoughts with facts and figures and also with more questions if necessary. It would lead to a readable dialogue.

      • 0
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        The Professional:

        “Anyone challenging the content of RMBS’s article should pen his/her thoughts with facts and figures “

        I hate to agree with you.

        However according to Sri Lankan traditions a rebuttal means: “play the man if you can’t play the ball”.

        You are expecting too much from stupid commentators. Please be realistic demanding facts and figures is like enforcing curfew in this forum 24/7/52. You will see none of the current commentator parting their wisdom in this forum, including yourself.

  • 0
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    I wonder whether the “genius” who pronounced that in ten years the GDP would be US$10,000 knows the meaning of GDP. There is another “genius” in the cabinet who said that a family can live on Rs6000 for a month.Then you get the lackeys who say in Parliament “the hell with the Judiciary. These are the people we get in our Parliament who call themselves super judges.We have to blame ourselves for this predictment. God save Sri Lanka

  • 0
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    I wonder whether the “genius” who pronounced that in ten years the GDP would be US$10,000 knows the meaning of GDP. There is another “genius” in the cabinet who said that a family can live on Rs6000 for a month.Then you get the lackeys who say in Parliament “the hell with the Judiciary. These are the people we get in our Parliament who call themselves super judges.We have to blame ourselves for this predictment. God save Sri Lanka

  • 0
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    For the layman, a simpler explanation is adequate; it conveys the essence in a nutshell. If NOMINAL GDP goes up by 7%, and say inflation is 9.5%, then the actual output of the economy, measured in goods and services, has DECLINED by 2.5%. If nominal GDP rises 7% but inflation is 5%, then real GDP has risen 2%, and so on. (Nominal means money of the day or the moment).

    There are differnet measures of inflation (Headline, Core, etc) but usually they are not very different numerically, and not necessary for the layman. Simply stated, inflation is the fall in the value of money. If my pay goes up 10%, but the cost of living rises 12%, I am 2% WORSE off; that’s a rough analogy.

    To compare with the past it is possible to refer everything to a base year. For example if inflation was 6% for each of the last five years and GDP in today’s money is Rs 5 trillion, then in five-years-ago-money it is only worth 5 trillion divided by 1.06 five times over; that is Rs 3.736 trillion

    SB of course is an outright conman for concealing the negative effect of inflation which is currently over 9% – the nominal GDP growth rate in 2012 was about 6.2%.

  • 0
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    hi man do not make this kind of rubbish statements and you think you know economic?

  • 0
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    [Edited out]

    Fool GDP per capita depends on technology progress, factor productivity, capital formation (Investment ratio)….many 100 things.You do not have anything to go to 5000.00 US $ level even for next fifty year. You seems like educated low level joker professors appointments based low quality Sri Lankan Universties.

    Part of this comment was removed by a moderator because it didn’t abide by our Comment policy.For more detail see our Comment policy
    https://www.colombotelegraph.com/index.php/comments-policy-2/

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