Monday, October 29, 2012

Some quirks of national income accounting

In 2011 real GDP was 6.8% lower than the peak recorded in 2007.  In 2010 prices, real GDP was €170.4 billion in 2007 and was down to €158.7 billion in 2011.  With net exports making a positive contribution to GDP growth over the period the collapse in the domestic economy is masked in the headline fall in GDP.

Domestic Components of GDP

Sometimes when trying to find patterns in the data one discovers some of the ‘quirks’ of national income accounting.  This graphs shows subcategories from the ‘Consumption’ and ‘Investment’ components above which contributed to the rise and fall of GDP over the past decade.

Selected Components

Neither are major components of GDP.  In 2007, their total made up just 5% of GDP but by 2011 they provided just 3.2%, indicating a faster fall than for the overall GDP number over the period.  Here is a chart of them in nominal terms where the collapse in the ‘investment’ category is even more accentuated.

Selected Components Nomninal

The component of consumption is ‘expenditure outside the state’ and is spending by Irish residents on goods and services that takes place outside of Ireland.  This is a contribution to GDP as consumption is defined as:

Final consumption expenditure consists of expenditure incurred by resident institutional units on goods or services that are used for the direct satisfaction of individual needs or wants or the collective needs of members of the community. Final consumption expenditure may take place on the domestic territory or abroad.

Since 2008, real expenditure outside the state by Irish residents has fallen 32%.  Spending less money abroad may mean more money available for expenditure in Ireland.  The drop in household income means this substitution is not happened and consumption expenditure by Irish residents in the state is also falling. 

Still, it is somewhat noteworthy that the drop in something which would expect to harm other economies (where the spending was happening such as places like this) is actually recorded as part of the drop in Irish GDP.  Opposed to that, it can be said that less spending (regardless of where it happens) means less consumption of goods and services which means less satisfaction and well-being for people.

The fall in the subcategory of investment included in the graph has been even more dramatic and since 2006 in real terms is down 86%.  The ‘costs associated with the transfer of land and buildings’ include conveyance and other professional costs of property transaction as well as estate agents’ fees.  However, the biggest item in this was Stamp Duty.  The definition of gross fixed capital formation says:

3.111 . For both fixed assets and non-produced non-financial assets, the costs of ownership transfer incurred by their new owner consist of:

a) charges incurred in taking delivery of the asset (new or existing asset) at the required location and time, such as transport charges, installation charges, erection charges, etc.;

b) professional charges or commissions incurred, such as fees paid to surveyors, engineers, lawyers, valuers, etc., and commissions paid to estate agents, auctioneers, etc.;

c) taxes payable by the new owner on the transfer of ownership of the asset.

In 2006, the ‘costs associated with the transfer of land and buildings’ was €4.5 billion in nominal terms.  The amount of Stamp Duty collected from land and property in the same year was €3 billion.  Unsurprisingly, this has collapsed since and in 2010 just €0.2 billion of Stamp Duty was collected from land and property transactions, a drop of more than 90%. In 2011 the ‘costs associated with the transfer of land and buildings’ contributed less than €0.4 billion to GDP.

Perhaps surprisingly, Stamp Duty from all property transactions is included in GDP.  In general, second-hand house sales do not contribute to GDP as the purchase of the asset by the buyer is offset by the sale of the asset by the vendor.  Sales of new houses do add GDP as there is a net addition to the capital stock and the collapse in purchases of new homes by the household sector accounts for much of the 55% drop in real investment seen over the past four years.  However, Stamp Duty and related transaction costs from all property transactions are included in GDP.

Since 2007, real GDP has fallen about €12 billion in 2010 prices.   Using the same prices, real total domestic demand has fallen by about €33 billion (driven by the collapse in investment with smaller falls in final consumption expenditure and net government expenditure on goods and services).  

From the above charts we have seen that around €3.5 billion of this real drop (equivalent to 30% of the fall in GDP and 10% of the drop in total domestic demand) is due to Irish residents spending less money on consumption outside of Ireland and the virtual collapse in Stamp Duty liabilities from land and property transactions.


  1. GDP was 190 bn euro in 2007, though, wasn't it? (In 2007 terms). The value of the euro (purchasing power) has not increased by then.

    Lies, damn lies and 2010 prices?

    1. Hi yoganmahew,

      The base year for the prices doesn't really matter. The exercise was to show the real changes. If 2007 prices were used the euro amount of the decline in the investment sub-component would be even greater as it would reflect both the huge falls in activity and house prices since then.

      The 2010 prices would account for a lot of the price drop but using those the 2007 level would be lower so the real drop is still the same. 2007 euros are different to 2010 euros but with the real change it doesn't really matter which one is used.

  2. I understand that, sort of. Except the value of the euro didn't change. Local inflation changed, but that is not relevant to the purchasing power of the currency. Using Irish deflation (largely based on interest rates dropping...) does not give an accurate picture of the decline in the size of the economy.

    Let's put it in pint of beer perspective. If a pint cost me a fiver in 2007, but then we have price deflation of 20% and a pint now costs still a fiver, are you telling me that my memory (and accounts) are wrong and that a pint only cost four euro in 2007?

    The point is important, I think, because we have a false picture of both the level of bubble output and the loss of that output if we use a local GDP inflator within a common currency.

    As I say, GDP was 190 bn in 2007 in 2007 euros. Saying now that it was 170 bn euro is effectively saying that a 2010 euro has 10% more purchasing power than a 2007 one. The hole in my pocket tells me that isn't the case :)

    I guess what I'm arguing with is the use of the word 'real'. While I understand it has an economics meaning, that meaning is not 'real'...

    1. Hi yoganmahew,

      Real is essentially just the level of activity. It is not reflective of price changes or the purchasing power of the currency. It is simply a measure of the level of economic activity.

      As with all GDP figures it is best to focus on the relative or percentage changes rather than the numbers themselves.

      Nominal GDP for 2007 is €190 billion and using 2010 prices the level of activity this represented would be equivalent to €170 billion. If the 2007 economy existed with 2010 prices it would generate €170 billion of activity.

      For example, assume that in 2007 the household sector was buying new houses at an average price of, say, €280,000. Assume further than the 2010 price for the equivalent new house was €160,000.

      In 2007, 1,000 new house purchases would have added €280 million to GDP. In 2010, 1,000 new house purchases would have added €160 million to GDP. But in both years the level of activity is the same; there has been no real change.

      To work out the real change we apply the same prices to both years. So we can either say that 2010 GDP is €280 billion in 2007 prices and compare that to the €280 billion from 2007, or we can say that 2007 GDP is €160 billion in 2010 prices and compare that to the €160 billion from 2010.

      The number itself means little but what we want is something that shows that the real change in the above example is zero; in both years 1,000 houses were sold.

  3. I was about to say 'fair enough', but I'm not sure that I agree with the explanation - rather, I can agree with it, but I do not think it is an accurate method to use an Irish deflator. A eurozone wide HICP deflator should be used.

    The euro is not more valuable now than it was in 2007. Any smaller previous year number after 'real' adjustments says that it is. So if you go from GDP of 190 bn to 170 bn after adjusting for inflation, you are saying there has been, effectively 10% deflation right? (I'm not gone on some wild tangent here, am I?).

    What I mean is that we can't continue to exist in isolation. The euro is trans-national, so to use national inflation indicators to determine the change in euro value is a mistake. GDP of 190bn in 2007 was an absolute value. There was some inflation (eurozone-wide) between 2007 and 2010, but let's assume there was none. GDP of 156bn in 2010 would give a decline from 2007 of 34bn euro or 17% from 2007.

    Realtivising using Irish inflation figures gives a false sense of the loss of output. I've looked (not recently, I'll admit), but there is no data series that runs by eurozone HICP.

    1. Hi yoganmahew,

      If you are looking for a measure of the loss of output then price effects have to be factored in. Just as in periods of expansion the impact of price increases must be accounted for to get a measure of the actual increase in output the same must be done in periods of contraction.

      When calculating real GDP the CSO do not use an explicit deflator. The examples used above show the effect of what is done (the same prices are applied in each period) but that is not how the CSO do it in practice. They actually create a series without the price effects so that they don't have to deflate/inflate for them.

      The constant price series produced by the CSO is a "chain-linked volume" series. The CSO don't use CPI or HICP or any other index. They work out the volume in each year so the real series is based on actual changes in output. The series is then referenced to a base year which is currently 2010.

      In the national accounts you will that all GDP for 2010 (real and nominal) are the same. The real figures for other years are based on the change in output volume relative to 2010.

      So, the CSO estimate the 2010 GDP was €156.5 billion. They separately estimate that the volume of output in 2007 was 8.9% higher than that seen in 2010. This is really all we need to know. There has been a loss of output between 2007 and 2010 and the CSO tell us how large this has been.

      However, this is added to by giving a "real" GDP figure for each year. So in 2010 GDP was €156.5. For 2007 the CSO estimate that volume was 8.9% higher and calculate 156.5 x 1.089 = €170.4 billion.

      This is where the €170 billion comes from. Each of the components of GDP (C,I,G,X & M) are separately and independently chain-linked in a similar fashion. Getting price changes to use as a deflator is hard so the CSO avoid doing so. An implicit deflator can be estimated from the difference between the real and nominal figures but this is an outcome from the chain-linking rather than an input into the calculation.

      I think we're getting a little too deep into the 'quirks' of national income accounting!

  4. Thank you for your patience Seamus!

    I will put it down to another quirk. I am left somewhat bemused that when I was in 2008, I was told that GDP in 2007 was 190 bn. Now it appears it was really only 170 bn ;)

    1. Nominal GDP for 2007 will always be around €190 billion.

      If you really want to be anchored to this figure we can use 2007 as the reference year. Thus, with the 8.2% drop in output to 2010 this would mean that the 2010 real GDP figure is €173 billion!

      You can say the volume of output in 2010 was 8.2% lower than the output from 2007:

      188.7 x (1 - 0.082) = 173.4

      Or you can that the volume of output in 2007 was 8.9% higher than the output from 2010

      156.5 x (1 + 0.089) = 170.4

      It doesn't matter which we say, the resulting change in output is the same.

      With 2007 as the reference year we have:

      2007: 188.9
      2010: 173.4

      With 2010 as the reference year we have:

      2007: 170.4
      2010: 156.5

      It doesn't matter what figure are used the drop between the two is 8.2% in both cases. Calculate it. With real GDP focus on the change not the size of the numbers.

  5. Ah, so the drop is 8.2%? Which means that 2010 GDP was 173.4bn?

    Okay, now I'm even more confused! You see, I should stick to programming. It doesn't involve any maths...

    I think/hope my confusion comes from using relative numbers (the percentage change) rather than absolutes and calculating the relative change as required.

  6. Seamus

    Do you know how the investment component of Irish GDP at 10.3% (16.4/158.7) of GDP in 2011, compares with other European countries.
    [Notwithstanding that our GDP/GNP relativity is quite different from these countries].

    1. Hi Joseph,

      This very issue was covered here.

      You can also watch/listen to a presentation I gave on the topic here. The first half deals with Ireland and the EU comparisons have about three and a half minutes beginning from 10:10. This link goes straight to the relevant section of the recording.