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Economy

What is GDP growth and how it affects us?

Let’s start with the GDP

Indias growth rate of real GDP per capita(1950...

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GDP or Gross Domestic Product is the value of economic output of a country. For beginners, here’s a simple example. Take a family of 6 brothers, A, B, C, D, E and F. Here’s what each of them does for a living:

A: Furniture maker. His full year sale is Rs 5 lakh
B: Makes and sells steel utensils. His full year sale is Rs 3 lakh
C: Operates a tiffin service. His full year sale is Rs 2 lakh
D: Manufactures steel sheets. His full year sale is Rs 1 lakh. Out of this Rs 1 lakh, he has sold steel sheets for Rs 25000 to B.
E: Produces and sells rice. His full year sale is Rs 50,000. Out of this Rs 50.000 he has sold rice for Rs 20000 to C.
F: A teacher who earns Rs 1 lakh per year.

(Sale value in all these cases includes cost of raw materials, labour plus owner’s profits.)

Let’s calculate their total GDP.
Step 1: Calculate total sales. This works out to Rs 12.5 lakh.
Step 2: Calculate overlapping sales, called intermediate consumption, that is, sale of one person that becomes raw material for another person. This works out to Rs 45,000.
Step 3: Reduce the total sales by intermediate consumption to eliminate double counting (for instance, the sale value of B includes the cost of steel sheets purchased from D). This works out to Rs 12.05 lakh.

The GDP for this family of 6 brothers is Rs 12.05 lakh. Now instead of 6 brothers, when this exercise is done for the entire country, we arrive at the GDP of a country.

The rate of growth of GDP reflects the pace of the economy. For instance, a slowdown in the US economy has led to the GDP of the US growing at a snail’s pace of 1-2% in the last several years, sometimes slipping into the negative territory. By contrast, India clocked a GDP growth of 7-8% in the past few years. And the Govt is projecting it will clock 7.2% in 2012-13.

While 7.2% sounds great, especially in this weak global environment, especially when compared to 1-2% growth rates elsewhere, it really does not translate into too much for India’s standard of living. Not at least in the near future. And this is where GDP per capita and Gross National Income (GNI) per capita comes into play.

GDP per capita and Income per capita

GDP per capita is nothing but GDP per person; the country’s GDP divided by the total population. In our example, it would be Rs 12.05 lakh divided by the total number of people including the workers who work at each of the 6 brothers’ factories. Because the GDP is divided by the total number of workers, the GDP per capita very closely reflects the ‘average’ revenue per person in the economy. As GDP grows it is assumed that everyone in the chain will benefit and the growth will have a trickledown effect on the population, thus improving standard of living. If you earn more, you are able to pay more for your domestic help, thus improving their standard of living. Of course, the growth must be more than inflation.

I must go over a few more explanations before I get to the key point. So do bear with me. Gross National Income, GNI, is slightly different from the GDP. While the GDP measures only the production and services within a country, GNI also includes net income earned from other countries. Per capital GNI or per capita income is the GNI divided by the population.

Now, according to the Government, India’s per capita income has crossed Rs 50,000 for the first time in 2010-2011. It is at Rs 53,000 or around USD 1,000. This is at current prices or market prices. The same works out to USD 790 at constant prices, that is, after factoring inflation.

Statistics mean nothing in absolute terms. So let’s get to some serious global comparison. According to this HSBC report, in 2010, here is how these countries ranked in terms of GDP:
#1 US
#3 China
#8 India

In the same year, this is how per per capita incomes looked:
US: $36,354
China: $2,396
India: $790

Okay so that was when India was rank 8. Let us look into the future. The report projects the top economies by 2050.

Accordingly, in 2050, this is how the countries will rank:

#1 China: GDP at USD 24.6 trillion
#2 USA: GDP at USD 22.3 trillion
#3 India: GDP at USD 8.1 trillion

And here are the projections of per capita income in 2050:
China: USD 17,372
US: USD 55,134
India: USD 5,060

In terms of income per capita, among the countries that will be the top 30 biggest economies in 2050, India ranked last in 2010 and will also rank last in 2050. China ranked at 27 in 2010 but will jump to rank 20 by 2050. The report also projects that India’s population will beat China’s by 2050.

Making sense
So why is India’s per capita income so dismally low?

– Because our GDP is just not big enough for the large population base
By the time the huge GDP trickles down, there is not much left. For almost the same population, look at China’s GDP in 2050. The US has the highest GDP in absolute terms but also has a lower population as compared to China and India. China is ranked next to the US in terms of absolute GDP but the large population drags down the GDP to much below the US. But because the GDP itself is large, per capita GDP is better than India’s.

 Because our GDP is not growing fast enough
HSBC in its report has projected India’s average growth rate for the next 4 decades to be in the range of 5-6% (average growth between 2000 and 2009 was 5.5%). That growth rate looks good when developed countries are growing at just 1-2%. But it is obviously not enough for our population base. The country needs to be far more aggressive for any kind of growth to even make a difference to average income levels quickly. A 7-8% maybe alright for now but India has to maintain it and that too consistently if it has to beat HSBC’s assumption of 5-6% average over the next 4 decades. Just because we are better off at 7% as compared to 3-4% in the past, it does not make us good. We need to look at the future and not the past.

So what exactly should we expect from our Govt?
Well, we know the Govt needs to focus on health, education, infrastructure etc. But apart from doing social good, these things are going to have a bearing on our economics. Here’s how:
– For GDP and GNI to grow at ambitious multiples, it is not enough for the rich alone to get richer. The entire population must see improved incomes. For that to happen, health and education levels of the people has to be improved; the environment for agriculture as well as business needs to be aggresively improved; India needs a big thrust. The US got that thrust in the 1920s through rapid growth in industry and infrastructure. The Government has to do a lot more than just harp on 7% growth rates. It has to act, fast and in one direction.
– Inflation continues to remain high; over a period of time this will erode real incomes even more. A lot of the recent inflation has been from food inflation. The Govt needs to match demand and supply by increasing productivity in agriculture.
– And above all there is corruption and black money. How does black money impact GDP? Well, the Government calculates GDP only on the basis of declared figures. Undeclared revenues, black money, do not get counted in the GDP. Bringing all that money into the system will increase GDP; make funds available for reinvestment; will enable higher tax collection and give more money in the hands of the Govt for developmental spending. Honest Govt spending.

Of course, a lot of the data from HSBC is based on several assumptions and arithmetics. Nobody knows the future. India’s population may not rise at that pace. Even if China grows aggressively, it might face a slow down because of the one-child policy. There is also the problem of the other extreme that the US faces. While the going was good the US created a great standard of living. Now when the economy is moving slowly, people are finding it difficult to maintain the standard of living but at the same time its tough to lower it.

Hope this helps you in understanding all these numbers and what they mean for you and me. Because these are not just lessons in textbooks. These are among the many things we should know before we go out to vote.
Till next time, Money Happy Returns.

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Discussion

2 thoughts on “What is GDP growth and how it affects us?

  1. Very well explained.

    Posted by risingbharat | February 29, 2012, 11:26 am
  2. Pretty basic stuff, would probably serve its purpose well of educating economic illiterates. My country (Indonesia) faces similar problems to India pertaining to economic progress and most importantly, corruption. Our two people’s definitely needs to get our own houses in order soon, or the structural weaknesses that permeates through the system will continue to weaken us and make us susceptible to a future of subservience (Indonesia was colonized by the Dutch for 350 years, not really proud of such a magnificent failure) to other nations.

    Posted by RonnieNolan | February 29, 2012, 11:05 am

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