ICAI Notes 5.3 - National Income in India | Business Economics for CA Foundation PDF Download

Learning Objectives

• know the meaning of National income.
• understand the various concepts related to National income.
• understand how National income can be approached from three different ways.
• know how National income and per capita income are growing in India. 

INTRODUCTION 

National income is the money value of all the final goods and services produced by a country during a period of one year. National income consists of a collection of different types of goods and services of different types. Since these goods are measured in different physical units it is not possible to add them together. Thus we cannot state national income is so many millions of metres of cloth, so many million litres of milk, etc. Therefore, there is no way except to reduce them to a common measure. This common measure is money. The value of all goods and services produced is measured in money. For example, if the value of a metre of cloth is Rs. 20 and the total cloth produced is 100 metres, then the money value of cloth is Rs. 2000. In this way we can find out the value of other goods and services and the total value of all the goods and services produced during one year. This gives us a single measure of the final goods and services produced by the country in that year which is nothing but the value of national income or national product.

3.0 BASIC CONCEPTS IN NATIONAL INCOME AND OUTPUT

(1) Gross Domestic Product (GDP) : Gross domestic product is the money value of all final goods and services produced in the domestic territory of a country during an accounting year. The concept of domestic territory has a special meaning in national income accounting. Domestic territory is defined to include the following:

(i) Territory lying within the political frontiers, including territorial waters of the country.

(ii) Ships and aircrafts operated by the residents of the country between two or more countries.

(iii) Fishing vessels, oil and natural gas rigs, and floating platforms operated by the residents of the country in the international waters or engaged in extraction in areas in which the country has exclusive rights of exploitation.

(iv) Embassies, consulates and military establishments of the country located abroad.

(2) GDP at Constant Prices and at Current Prices : GDP can be estimated at current prices and at constant prices. If the domestic product is estimated on the basis of the prevailing prices it is called gross domestic product at current prices. Thus when we say that GDP of India at current prices in 2007-08 is Rs. 43,20,892 crores, we are measuring GDP on the basis of the prices prevailing in 2003-04. On the other hand, if GDP is measured on the basis of some fixed prices, that is prices prevailing at a point of time or in some base year it is known as GDP at constant prices or real gross domestic product. Thus when we say that GDP in 2007-08 is Rs. 31,29,717 crores at 1999-00 prices, we are measuring GDP on the basis of the prices prevailing in 1999-2000.

(3) GDP at Factor Cost and GDP at Market Price : The contribution of each producing unit to the current flow of goods and services is known as the net value added. GDP at factor cost is estimated as the sum of net value added by the different producing units and the consumption of fixed capital. Since the net value added gets distributed as income to the owners of factors of production, we can also estimate GDP as the sum of domestic factor incomes and consumption of fixed capital. Conceptually, the value of GDP whether estimated at market price or factor cost must be identical. This is because the final value of goods and services (i.e. market price) must be equal to the cost involved in their production (factor cost). However, the market value of goods and services is not the same as the earnings of the factors of production. GDP at market price includes indirect taxes and excludes the subsidies given by the government. Therefore, in order to arrive at GDP at factor income we must subtract indirect taxes from and add subsidies to GDP at market price.

In brief    GDP_F.C = GDP_M.P. - IT + S.
             Where IT = Indirect Taxes
             S = Subsidies

(4) Net Domestic Product : While calculating GDP no provision is made for depreciation allowance (also called capital consumption allowance). In such a situation gross domestic product will not reveal complete flow of goods and services through various sectors. It is a matter of common knowledge that capital goods like machines, equipment, tools, buildings, tractors etc., get depreciated during the process of production. After some time these capital goods need replacement. A part of capital is therefore, set aside in the form of depreciation allowance. When depreciation allowance is subtracted from gross domestic product we get net domestic product.

In brief NDP = GDP - depreciation

(5) Gross National Product (GNP) : It has already been seen that whatever is produced within the domestic territory of a country in a year is its gross domestic product. It, however, includes, the contribution made by non-resident producers by way of wages, rent, interest and profits. The non-residents work in the domestic territory of some other country and earn factor incomes. For example, Indian residents go abroad to work. Indian banks are functioning abroad. Indians own property in foreign countries. The income of all these people is the factor income earned from abroad. In other words, it is factor income earned from abroad by the residents of India by rendering factor services abroad. Similarly, factor services are rendered by non- residents within the domestic territory of India. Net factor income from abroad is the difference between the income received from abroad for rendering factor services and the income paid for the factor services rendered by non-residents in the domestic territory of a country.

Gross national product is defined as the sum of the gross domestic product and net factor incomes from abroad. Thus in order to estimate the gross national product of India we have to add net factor income from abroad i.e., income earned by Indian residents abroad minus income earned by non-residents in India to form the gross domestic product of India.

In brief GNP = GDP + NFIA (where NFIA is the net factor income from abroad).

(6) Net National Product (NNP) : It can be derived by subtracting depreciation allowance from GNP. It can also be found out by adding the net factor income from abroad to the net domestic product. If the net factor income from abroad is positive i.e., the inflow of factor income from abroad is more than the outflow, NNP will be more than NDP; conversely, if net factor income from abroad is negative, NNP will be less than NDP and it would be equal to NDP in case the net factor income from abroad is zero.

Symbolically, NNP = NDP + NFIA

(7) NNP at factor cost or National Income : NNP at factor cost is the volume of commodities and services turned out during an accounting year, counted without duplication. It can also be defined as the net value added at factor cost (by the residents) in an economy during an accounting year. In terms of income earned by the factors of production, NNP at factor cost or national income is defined as the sum of domestic factor incomes and net factor income from abroad. If NNP figure is available at market prices we will subtract indirect taxes and add subsidies to the figure to get NNP at factor cost or national income of the economy.

Symbolically, NNP at FC = National Income = FID + NFIA where FID is factor income earned in the domestic territory of a country and NFIA is the net factor income from abroad. There are two more concepts: Personal Income and Personal Disposal Income. Personal income is the sum of all incomes actually received by individuals during a given year. In order to estimate it we subtract from national income the sum total of social security contribution and corporate income taxes and undistributed corporate profits and add personal payments which are incomes received but not currently earned. After the deduction of personal taxes from personal income of the individuals what is left is called personal disposable income which is equal to consumption plus saving.

The following statements mathematically summarise the various concepts discussed above and the relationship among them:

GNP at market price - depreciation = NNP at market price.
GNP at market price - net income from abroad = GDP at market price.
GNP at market price - net indirect taxes = GNP at factor cost.
NNP at market price - net income from abroad = NDP at market price.
NNP at market price - net indirect taxes = NNP at factor cost.
GDP at market price - net indirect taxes = GDP at factor cost.
GNP at factor cost - depreciation = NNP at factor cost.
NDP at market price - net indirect taxes = NDP at factor cost.
GDP at factor cost - depreciation = NDP at factor cost.

3.1 METHODS OF MEASURING NATIONAL INCOME 

Production and sale of goods and services and the generation of income which accompanies these activities are processes that go on continuously. Production gives rise to income; income gives rise to demand for goods and services; and demand in turn gives rises to expenditure; again expenditure leads to further production. The circular flow of production, income and expenditure represents three related phases, namely, production, distribution and disposition. These three phases enable us to look at national income in three ways - as a flow of goods and services, as a flow of incomes or as a flow of expenditure on goods and services. To measure it at each phase, we require different data and methods. If we want to measure it at the phase of production, we have to find out the sum of net values added by all the producing enterprises of the country. If we want to measure it at the phase of income distributed, we have to find out the total income generated in the production of goods and services. Finally, if we want to measure it at the phase of disposition, we have to know the sum of expenditures of the three spending units in the economy, namely, government, consumer households, and producing enterprises.

Corresponding to the three phases, there are three methods of measuring national income.

They are:

(i) Value Added Method (alternatively known as Product Method);

(ii) Income Method; and

(iii) Expenditure Method.

(i) Value Added Method: Value added method measures the contribution of each producing enterprise in the domestic territory of the country. This method involves the following steps:
(a) Identifying the producing enterprise and classifying them into industrial sectors according to their activities. (b) Estimating net value added by each producing enterprise as well as each industrial sector and adding up the net value added by all the sectors.

All the producing enterprises are broadly classified into three main sectors namely: (1) Primary sector which includes agriculture and allied activities; (2) Secondary sector which includes manufacturing units and (3) Tertiary sector which include services like banking, insurance, transport and communications, trade and professions. These sectors are further divided into sub-sectors and each sub-sector is further divided into commodity group or service-group.

For calculating the net product of the industrial sector we need to know about gross output of the sector, the raw materials and intermediate goods and services used by the sector and the amount of depreciation. For an individual unit, we subtract from the value of its gross output, the value of the raw material and intermediate goods and services used by it and, from this, we subtract the amount of depreciation to get net product or value added by each unit. Adding value-added by all the units in one sub-sector, we get value-added by the sub-sector. Again adding value-added or net products of all the sub-sectors of a sector we get value-added or net product of that sector. For the economy as a whole, we add net products contributed by each sector to get Net Domestic Product. If the information regarding the final output and intermediate goods is available in terms of market prices we can easily convert it in terms of factor costs by subtracting (or adding as the case may be) net indirect taxes to it. If we add or subtract net income from abroad we get Net National Product at factor cost which is nothing but National Income.

Care should be taken to include the value of the following items :
(a) Own account production of fixed assets by government, enterprises and households.
(b) Production for self-consumption.
(c) Imputed rent of owner occupied houses.

Care should also be taken not to include sale of second-hand machines because they were counted as a part of production in the year in which they were produced. However, brokerage and commission earned by the dealers of second-hand goods are a part of production and hence included while calculating total value-added. There is a difference of opinion among the national income accountants regarding raw materials, intermediate goods and depreciation. For example, a question arises whether government services are final (because they add to satisfaction) or intermediate (because they are essential for economic activity). In India, we treat them as final services but in Soviet Union (now called Commonwealth of Independent States) these are treated as intermediate services. Similarly, it is very difficult to ascertain the actual amount of depreciation because a fall in the value of capital stock depends upon many factors which are difficult to measure.

Moreover, large areas of production activities are excluded for varying reasons. Their net products cannot be valued either because there is no acceptable way of valuing them (which is true in the case of services of housewives or self-services in homes or services of friends) or because of the difficulty of securing data of the subsistence producing units particularly in underdeveloped countries.

The product method thus gives information about the industrial origins of national income. Additionally, net income from abroad should also be included or subtracted to get a true picture of national income.

(ii) Income Method : Different factors of production pool their services for carrying out production activities. These factors of production, in return, are paid for their services in the form of factor incomes. Thus labour gets wages, land gets rent, capital gets interest and entrepreneur gets profits. In other words, whatever is produced by a producing unit is distributed among the factors of production for their services and aggregate of factor incomes of all the factors of production of all the producing units form the subject matter of calculation of national income by income method.

Only incomes earned by owners of primary factors of production are included in national income. Transfer incomes are excluded from national income. Thus, while wages of labourers will be included, pensions of retired workers will be excluded from national income. Labour income includes, apart from wages and salaries, bonus, commission, employers' contribution to provident fund and compensations in kind. Non-labour income includes dividends, undistributed profits of corporations before taxes, interest, rent, royalties and profits of unincorporated enterprises and of government enterprises.

However, normally, it is difficult to separate labour income from capital income because in many instances people provide both labour and capital services. Such is the case with selfemployed people like lawyers, engineers, traders, proprietors etc. In economies where subsistence production and small commodity production is dominant most of the incomes of people would be of mixed type. In sectors such as agriculture, trade, transport etc. in underdeveloped countries (including India), it is difficult to differentiate between labour element and capital element of incomes of the people. In order to overcome this difficulty a new category of incomes, called mixed income is introduced which includes all those incomes which are difficult to separate. Care has to be taken to see that transfer incomes do not get included in national income. In this context it is worthwhile to note that personal income which is income of household sector should not be confused with national income. While personal income includes transfer payments, national income does not. Similarly, illegal incomes, windfall gains, death duties, gift tax and sale proceeds of second-hand goods are not included while calculating national income.

Net income from abroad need not be added separately since the incomes received by people include net foreign incomes as well. But if national income is calculated not from incomes received by the people but from data regarding incomes paid out by producers then net income from abroad would have to be added separately because incomes paid by producers would total to domestic income. To arrive at national income, net income from abroad should be added to domestic income.

(iii) Expenditure Method: The various sectors - household sector, business sector and government sector either spend their incomes on consumer goods and services or save a part of their incomes or we can say that they spend a part of their incomes on non-consumption goods (or capital goods).

Total expenditure in an economy consists of expenditure on financial assets, on goods produced in preceding periods, on raw materials and intermediate goods and services and on final goods and services produced in the current period.

Expenditure on financial assets which are produced and owned within the country is excluded but expenditure on financial assets of foreign countries is included in national expenditure. However, only the net expenditure i.e., the difference between expenditure on foreign financial assets by residents and expenditure on the country's financial assets by non-residents or foreigners is incorporated. This difference is also called net foreign investment. Goods produced in preceding years are also excluded from national income because they have been accounted for in the national incomes of the periods when they were produced. Similarly, expenditure on raw materials and intermediate goods and services are excluded because otherwise there would be double counting of some of the items included in the national income. Government expenditure on pensions, scholarships, unemployment allowance etc. should be excluded because these are transfer payments.

Thus, only expenditure on final goods and services produced in the period for which national income is to be measured and net foreign investment are included in the expenditure method of calculating national income.

Expenditure on final goods and services is broadly classified into expenditure on consumer goods and service (also called consumption expenditure) and expenditure on capital goods (also called investment expenditure). Consumption expenditure is classified into private consumption expenditure of the household sector and government consumption expenditure; and investment expenditure is classified into private investment expenditure by business sector and investment expenditure by government. To the total domestic investment we add net foreign investment in order to arrive at national investment. Thus, the aggregates resulting from the expenditure method measured at market prices are as follows:

Gross national expenditure = Consumption expenditure + net domestic investment + net foreign investment + replacement expenditure (i.e., expenditure on replacement investment).

Net national expenditure = Consumption expenditure + net domestic investment + net foreign investment. Net domestic expenditure = Consumption expenditure + net domestic investment.

All the three methods mentioned above should ideally lead to the same figure of national income and therefore national income of a country should be measured by these methods separately to get a three dimensional view of the economy. This helps the government to analyse the level of production and economic welfare in the economy, to analyse stability and growth of the economy and to formulate appropriate economic policies of the government. Moreover, each method provides a check on the accuracy of the other methods. However, it is easier said than done. Because of lack of proper and reliable data it is very difficult to estimate national income by each method separately. This is especially so in underdeveloped economies.

As a matter of fact, countries like India are unable to estimate their national income wholly by one method. The contributions of different sectors to the total national income are estimated by different methods. Thus, in agricultural sector net value added is estimated by the production method, in small scale sector net value added is estimated by the income method and in construction sector net value added is estimated by the expenditure method. Income method may be most suitable for developed economies where people properly file their income tax returns. With the growing facility in the use of the commodity flow method of estimating expenditures, an increasing proportion of the national income is being estimated by the expenditure method. Estimation of the national income of a country is not an easy task. Appropriate and completely reliable data for accomplishing this work is not available even in developed countries.

The following problems require particular mention:

(1) Presence of a large non-monetized sector

(2) Lack of appropriate and reliable data

(3) Problem of double counting

(4) Problem of transfer payments

(5) Difficulties in classification of working population

(6) Unreported illegal income

3.2 TRENDS IN INDIA'S NATIONAL INCOME GROWTH AND STRUCTURE

For finding out the impact of economic planning in India a study of trends in national income is necessary. It would be better, therefore, if the trend in national income and changes in the structure of national product are analysed over the five and a half decades of planning.

(i) Trends in NNP : The real national income of India has increased at an annual average rate of 4.4 per cent during the 58 years of economic planning.

There are two distinctive phases of economic growth in India since Independence: 1950- 1980 and 1980-2004. During the period 1950-51 to 1979-80, growth in GDP was 3.5 per cent and during 1980-81 to 2003-04, growth in GDP was 5.6 per cent per annum. If we consider the period between 2004-05 and 2007-08, GDP growth rate substantially increased to 8.9 per cent per annum.

Colonial past, restrictive trade policy, licensing system, inward looking foreign policies, too much stress on public sector and socialistic society, anti-market and anti-competition attitude of the State, and vagaries of nature are some of the reasons for very poor performance of the economy during 1950-80. In fact, since India continued to have an average growth rate of 3.5 per cent, this rate i.e. 3.5 per cent came to be recognized as Hindu rate of growth.

Acceleration in economic growth since 1980 was attributable to several factors. Expansionary macro economic policies, economic reforms including trade liberalization and deregulation of industries especially since 1991, reasonably well established social and legal framework, well developed higher education system, improvement in infrastructural facilities, change in attitude of national leadership, adoption of pro-market policies, well fostered entrepreneurial skills and improvement in science and technology etc. all led to improving the rate of growth of Indian economy.

Restructuring measures by domestic industry, overall reduction in domestic interest rates, improved profitability, a benign investment climate amidst strong global demand and commitment based fiscal policy have led to real GDP growth averaging 9 per cent per annum during 2004-08.

Economic growth decelerated in 2008-09 to 6.7 per cent. The global financial crisis and consequent economic recession in developed economies have been major factors in India’s economic slow down. The deceleration of growth in 2008-09 was spread across almost all the sectors. How a country is performing can be judged in a two ways- by comparing its performance with other countries and by comparing its performance with the targets set by it.

A comparison with a few of the developing countries is shown in the following Table:

Table 8: Real GDP Growth –Select Countries (per cent)

As can be seen in the Table, India’s rate of growth is improving. In fact, India now ranks among the top ten fastest growing countries in the world along with China, Vietnam, South Korea, Malaysia Thailand, Singapore, among others.

Plan-wise study of growth of real income in India, also indicates an encouraging fact that although the annual rate of increase in national income was pretty low during the first three decades of planning, it has lately risen and stood at 5.6 per cent per annum during the eighties, around 5.7 per cent per annum during the nineties and 7 per cent during 2000-06.

During the First Plan, annual average growth rate was 3.7 per cent (at 1970-71 prices), which increased to 4.2 per cent during the Second Plan. However, during the Third Plan, annual average increase in national income slumped down to 2.8 per cent. This was largely the consequence of serious drought in 1965-67, and thus the growth rate got depressed. The depression continued in 1967-68. Only after 1967-68, the situation improved. During the Fourth Plan, the average annual rate of growth of national income was 3.9 per cent. The sharp upsurge in prices during 1972-73 and 1973-74 and the short falls in the production on account of lower utilisation of capacity were the main factors responsible for a lower growth rate during this plan. The Fifth Plan witnessed an annual economic growth rate of 5 per cent. On the whole, the performance during the Fifth Plan was satisfactory. During 1978-79 and 1979-80, the economy suffered a set back and the national income fell by around 5.3 per cent. India's national income increased at a rate of 5.5 per cent during the Sixth plan. Again, the seventh plan period witnessed 3 years of good harvest which resulted in 5.8 per cent annual growth rate.

During the Eighth Plan, India achieved the highest ever annual average growth rate of 6.8 per cent. The spurt in economic reforms and good harvest for almost entire plan could be mainly responsible for such a good performance of the economy. During the Ninth plan, the annual average growth rate dipped to 5.4 per cent. This lower rate of growth against the target of 6.5 per cent has been due to the dismal performance of the Industry.

During the five years of the Tenth Plan (2002-07), the economy registered growth rates of 3.8, 9.0, 7.8, 9 and 9.2 per cent respectively. Against the annual average target growth rate of 8 per cent in the Tenth Plan (2002-07), achieved rate is 7.6 per cent per annum. Encouraged with the good performance in the Tenth Plan, the Approach paper to Eleventh Plan keeps a target of 8.5 per cent per annum growth rate.

(ii) Trends in Per Capita Income : India's per capita net national product i.e., during the last 58 years of planning has increased at a rate of 2.3 per cent per annum. This is modest performance by all means. The rate of increase in per capita net national product was not only conspicuously low but despite 58 years of economic planning, was still unsteady and erratic. The per capita income increased at a modest rate of about 1.8 and 2.0 per cent during First and Second Plans respectively.

As the Third Plan witnessed severe droughts, per capita income grew at almost zero per cent. During the Fourth Plan, the situation improved a little bit and the per capita income grew at a rate of 1.5 per cent per annum. The performance of the economy was satisfactory during the Fifth Plan and the per capita income increase at a rate of 2.7 per cent per annum. However, during 1978-79 and 1979-80, the economy suffered a set back and per capita income fell by around 8.3 per cent during 1979-80 alone. The economy once again witnessed years of good harvests during the sixth and seventh plans and the per capita income recorded a growth of 3.2 and 3.6 per cent per annum respectively during these plans. In the Eighth and Ninth plans, the per capita income witnessed a growth rate of 4.5 and 3.3 per cent per annum respectively. In the Tenth Plan, per capita income growth accelerated to 6.1 per cent per annum.

It is to be noted that during 1950-51 to 1979-80, growth in GDP per capita per annum was 1.4 per cent per annum. It accelerated to 3.6 per cent per annum during 1980-81 to 2004-05.

SUMMARY

We have seen that national income is nothing but money value of all the final goods and services produced by the residents of an economy during a period of time, say one year. National income can be measured by any of the three methods, namely product method, expenditure method and income method. Theoretically we will get identical answers. We have also learned various concepts in national income estimation like GNP at factor price, GNP at market price, GDP, NNP and so on. In actual practice, there are various difficulties (conceptual and statistical) involved in estimating national income. In India, national income is estimated by using a combination of product and income method. India's National income has grown at an annual average rate of around 4.4 per cent per annum since Independence. This rate is low not only compared with other growing economies but also with regards to targets laid down. Of course, however, there have been improvements in the growth rate of National income and per capita income.