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Understanding key macroeconomic statistics … Gross Domestic Product and Rebasing   
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Understanding key macroeconomic statistics … Gross Domestic Product and Rebasing

Posted : April 27, 2016

I have read with keen interest a few misconceptions about key macroeconomic statistics for Ghana, especially those related to Gross Domestic Product and inflation. To an economist these may seem straightforward, but not every policymaker is an economist so this article is aimed at explaining the rationale and methodology for calculating these key macroeconomic statistics -- which I believe every policymaker should understand if they are to discharge their duties effectively.


First off, at a basic level gross domestic product - GDP - refers to the total value of all final goods and services produced in a country or specific geographical area over a specific period. Normally, this is done by adding up the total value of final produced goods and services. But this is not the only way. Since GDP is thought of as equal to the total value of final goods and services produced in an economy for a specific period, then it can also be calculated as being equal to the flow of funds (money) received by local (Ghanaian in this instance) firms from sales in goods and services markets.


Now this total flow of funds into the goods and services market is equal to the aggregate spend on domestically produced goods and services -- i.e. the sum of consumer spending, government spending on goods and services, business investment spending and net imports/exports. Thus, GDP can be calculated as the aggregate spend on domestically produced final goods and services in the Ghanaian economy.


In addition, aggregate income is another way of calculating GDP in an economy. Specifically, households own firms and the factors of production -- i.e. capital, land -- thus firms pay income to households in the form of rent, wages, interest and profit.  This means a sum of the income earned by households from firms and the factors of production constitute GDP. The three methods mentioned provide the same estimate of gross domestic product.


At this juncture it is noteworthy that we often make comparisons between Ghana’s GDP in two periods, with interesting offerings on percentage increments in the size of GDP during these periods. There is nothing wrong with this, but there are a few things to understand about these percentages that I will explain now.


Part of the increases in gross domestic product over time is due to increments in the price of goods and services rather than increments in real economic output.  When this change in prices has been accounted for, then we have what is called real GDP. For example, Ghana’s GDP was just over 18% in nominal terms in 2014; but prices had increased by at least 16% in the same year, implying that in real terms Ghana’s GDP had grown by a paltry 2% in 2014[1]. Thus, a GDP number that has not been accounted for by price increments in the economy is referred to as nominal GDP.  In fact, it would be misleading to say Ghana’s economy grew by 18% in 2014 when prices of goods and services increased by 16%; therefore it is right to say that the cedi value of Ghana’s economy increased by 18% in 2014.  And that is an ineffective way to track the economy over time.


Now let us assume a simplified two-good Ghanaian economy as shown in the table below – the figures used in the table below are arbitrary. Nominal GDP for year-1 is (3,000million x GH?0.50) + (2,500million x GH?1.10) = GH? 4,250million while that of year-2 is (3,300million x GH?0.70) + (2,700million x GH?1.50) = GH?6,360million.

 


Goods
 

Year-1
 

Year-2
 

 

Quantity of coconuts (millions)
 

3,000
 

3,300
 

 

Price of coconut
 

GH?0.50
 

GH?0.70
 

 

Quantity of mangoes (millions)
 

2500
 

2700
 

 

Price of mangoes
 

GH?1.10
 

GH?1.50
 

 

nominal GDP millions of Ghana cedis
 

GH?4,250
 

GH?6,360
 

 

Real GDP millions of year 1 Ghana cedis
 

GH?4,250
 

GH?4,620
 

 

Now we realise that nominal GDP and real GDP for year-1 is the same. This is because year-1 is the base year, and in the base year nominal GDP is always equal to real GDP. That said, year-2 has a different and reduced real GDP -- meaning that GDP in year-2 has been calculated assuming that prices in Ghana’s hypothetical two-good economy did not increase and stayed the same as in year-1; i.e. real GDP in year-2 = (3,300million x GH?0.50) + (2,700million x GH?1.10) = GH?4,620million.


Indeed, year-2 can be made the base year; which means the value of goods produced in both year-1 and -2 are calculated using year-2 prices, which gives a real GDP value of GH?5,850million for year-1 and GH?6,360million for year 2. Similarly, we find that nominal GDP and real GDP are the same for year-2 because it’s the base year; but year-1 has a higher real GDP than nominal GDP because it has been calculated using year-2 prices which are higher.


Changing the base year from year-1 to year-2 is what’s normally referred to as rebasing. Indeed, we find that after rebasing gross domestic product to year-2 prices, there is a 37.65% increase in real GDP for year-1. Moreover, to track the change in real GDP over a period of time, the average of two base years can be calculated and then used in estimating real GDP (as shown above) -- and this is known as chain-linking, which is an effective way to track the economy over time.


It is important to note that there is no laid-down rule as to the choice of a base year, and so in our simplified two-good Ghanaian economy any of the base years is equally valid, and the resultant real GDP can be used for economic policy prescription and analyses.

However, in an economy like Ghana’s with high and persistent inflation (19.1% in first-quarter 2016), rebasing GDP figures to 2016 prices can produce some ‘wonderful’ real GDP figures which would be unequivocally misleading.


This is one reason it is of no benefit for policymakers to debate base years, as these are arbitrary and normally used to produce large real GDP figures that only show the size of an economy has increased without necessarily having any real impact on the ‘common man’. In addition, a rebased GDP figure that is normally higher does not mean the productive capacities of the economy have increased -- i.e. the economy’s production possibilities frontier. Chain-linked GDP figures provide a better picture as these track changes in real GDP over time.


What economic policymakers should focus on is inflation, which affects many Ghanaians. This is because the mass of Ghanaians is still classified as poor and therefore likely to have all or most of their assets in cash – the value which is eroded by inflation. Moreover, the high rate of persistent inflation means the cost of living is increasingly rising while the standard of living falls. In such economic circumstances, debates about gross domestic product rebasing would be ‘reinventing the wheel’ and have no positive impact on economic welfare, which is the ultimate aim of economic policymaking.


These figures are based on IMF and The World Bank data which would have been supplied by Ghana Statistical Service.

 

Source: Kwabena Meneabe Ackon | thebftonline | Ghana

 

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