Measuring Real GDP and Changes in the Terms of Trade across space and time. WANG Yan, DUFE Presented at BNU
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1 Measuring Real GDP and Changes in the Terms of Trade across space and time WANG Yan, DUFE Presented at BNU
2 Main Contents 1. Introduction 2. Literature Review 3. Measurement Framework 4. Conclusion
3 1. Introduction
4 Backgroud Larger international transactions and sharp changes in relative prices have great effect on the estimates of national income and product. These estimates have been more sensitive to the choice of concepts and methodologies since 1970 s (Denison, 1981). The economic performance of Switzerland over the long run is paradoxical. In most international comparisons, Switzerland is found to have a growth rate that is significantly lower than that of other industrialized nations. However, in terms of average living standards, Switzerland always ranks among the top nations. Why did this happen?
5 An example Production (Rice) Consumption (Rice) Export (Rice) Import (Oil) Period 1 Period 2 Price Quantity Price Quantity Price Quantity Price Quantity Price Quantity Price Quantity Price Quantity Price Quantity The quantity of production for the two periods remains the same. However, the quantity of consumption has increased in period 2 due to the decrease in import price.
6 Terms of trade If we define the terms of trade as the ratio of export price to import price, an improvement in the terms of trade essentially means that the country gets more for less. This phenomenon is similar to a technological progress (Diewert and Morrison, 1986). Contrary to a technological progress, however, a change in the terms of trade is treated by the national accounts as a price phenomenon, rather than as a real effect. Consequently, the beneficial effect of an improvement in the terms of trade is not taken into account by real GDP (Kohli, 2004).
7 2. Literature Review
8 National practice Since 1981, the U.S. Bureau of Economic Analysis publishes series of what has become known as Command-Basis GNP. Command-Basis GNP (GDP) is a measure of real GNP (GDP) that tries to take into account the effects of changes in the terms of trade on the purchasing power of a nation. BEA use import price index to deflate the trade account. Canada and Swiss National Bank use Gross Domestic Final Expenditure (GDFE) to deflate the trade account.
9 The SNA approach SNA (1993) first introduce the concept of real GDP based on production approach and expenditure approach to take into account the terms of trade. According to SNA, the production approach measures the real GDP in a way to measure an economy s production capability and its production possibility frontier; The expenditure approach measures the real GDP in a way to measure an economy s real purchasing power and living standard (SNA, 1993).
10 The SNA approach The latest SNA(2008) confirms the importance of these two approaches: GDP C I G X M o t t t t t t x m Pt Pt Pt GDP C I G X M e t t t t t t * Pt Pt
11 How to select P* As SNA (2008) stated, there is no consensus on the choice of P*. Kohli (2004) suggested that domestic price should be used to deflate the trade account, which enable us to use a superlative index formula to capture the exact contribution of real forces including terms of trade. Reinsdorf (2006) indicated that marginal income arising from trading gains is spent in the same way as average income, so it is appropriate to use GDFE to eliminate a trade imbalance.
12 Literature on measuring the terms of trade There are two main approaches to measuring the Real GDP on output-side and expenditure-side and the terms of trade. 1. Focusing on temporal changes in the terms of trade from the perspective of national accounts. In the pioneer work by Diewert and Morrison (1986), production theory and translog GDP methodology are employed to measure the changes in the terms of trade. The measurement work can be reduced to Tornqvist index. Based on this framework, many authors have attempted to measure the terms of trade for one country over years (Morrison and Diewert, 1990; Kohli, 2003, 2004, 2006, 2007; Diewert, 2008; Reinsdorf, 2010; Diewert and Yu, 2012)
13 Literature on measuring the terms of trade 2. Extending to investigate the changes in the terms of trade across time and space from the perspective of international comparison. Feenstra et al. (2007), the traditional Gary-Khamis system has been modified to include differences in the terms of trade between countries, which enable us to measure the real GDP from both the expenditure-side and the output-side. Penn World Table incorporates these technics to provide RGDPe and RGDPo started from version 8.0 (Feenstra et al, 2015).
14 Comments It is difficult to measure the total effect made by the international trade and the consequent price movement on production and consumption based only on an economy s national accounting data. Latest version of PWT uses two sets of indexes called CGDP and RGDP to measure the real GDP on output-side and expenditur-side, but there are still questions to ask: (1) The implicit PPP based on Fisher quantity index may not be transitive. (2) We can t decompose the Fisher quantity index into meaningful parts to directly measure the effect of terms of trade.
15 Questions Can we measure the real GDP on the output-side and expenditure-side across space and time in a more consistent way? Can we measure the contribution of terms of trade to the real GDP growth across space and time in a more consistent way?
16 Our work Based on production theory and translog GDP methodology introduced by Diewert and Morrison (1986), Inklaar and Diewert (2016) proposed a new method for simultaneously comparing real value added and input quantity, which can be used to compare industry productivity across countries and over time. We further extend Inklaar and Diewert (2016) s framework to simultaneously calculate real GDP on expenditure-side and output-side and isolate the effect of terms of trade on real GDP.
17 3. Measurement Framework
18 Production theory The bulk of trade consists of raw materials and intermediate goods, and even so-called finished imports are typically not ready to meet final demand. They must still go through a number of changes in the importing country, such as unloading, transporting, financing, insuring, repackaging, wholesaling, and retailing. During this process, they are combined with domestic factor services, so that a significant proportion of their final price tag is generally accounted for by domestic activities.
19 Translog GDP methodology Given a vector of output prices P and a vector of available primary inputs x, GDP function can be defined as: Real income generated can be measured by using real output price vector p: D X M t P P P Y p (,, ) t g ( p, x) * * * P P P Diewert (2008) indicated that if the GDP function has the following translog form, we can decompose the change in real income into meaningful parts by index number. Ing p x a a p a p p t 0 i i ij i j (, ) t t ln t (1/ 2) ln t ln i i j t b ln x (1/ 2) b ln x ln x c ln p ln x n n n m in i n n t t n m nm t t i n t t i, j ( D, X, M ) t t D X M g ( P, x) max P y ( y, x) belong to S P ( P, P, P ) y t g ( p, x)
20 Decomposition method by Diewert (2008) Diewert (2008) showed that when using production theory and translog GDP methodology, the change in real income can be decomposed into: Y Y [ Z / Z ] D X M t t1 t t t t t1 Real income growth domestic price contribution factor Terms of trade contribution factor real output growth 1. domestic real price contribution factor 2. terms of trade contribution factor 3. real output growth Diewert (2008) further pointed out that if we use GDFE as deflator to calculate real income, the first component can be eliminated from the decomposition.
21 PPPs for output-side Following Inklaar and Diewert (2016), the aggregate price of real value added in country k in period t relative to the aggregate price of real value added in country j in period s can be measured by Törnqvist Theil output price index: 1 i i i i P / exp kt js (s js s kt )ln( pkt p js ),i D, X, M i 2 Where the value added output shares i i vkt s kt, i D, X, M v kt v v + v v D X M kt kt kt kt s i kt defined as:
22 PPPs for output-side To get a base invariant PPPs, we follow the CCD strategy to get the transitive PPPs: 1 K T KT Pkt * Pkt / js j1 s1 By rearrangement, we can get a much simple form: ln P ln P kt* kt** 1 D D 1 X X 1 M M ln Pkt ** ( s.. D skt )ln( pkt p.. D ) ( s.. X skt )ln( pkt p.. X ) ( s.. M skt )ln( pkt p.. M ) Set first country and period 1 as base: P P P P P kt kt* 11* kt** 11**
23 PPPs for expenditure-side The aggregate price of domestic absorption in country k in period t relative to the aggregate price of domestic absorption in country j in period s can be measured by the following price index: D D pkt Pkt/ js D p js To get a base invariant PPPs, we follow the CCD strategy to get the transitive PPPs: 1 K T KT D D Pkt * Pkt / js j1 s1 By rearrangement, we can get a much simple form: ln P ln P ln P D D kt* kt*.. D Set the first country and period 1 as base: D D D P P P kt kt* 11*
24 Terms of trade contribution factor Diewert (2008) show that terms of trade contribution factor can be defined as follows: P 1 p p 1 p p exp (s s )ln( ) (s s )ln( ) X D M D XM X X kt kt M M kt kt kt / js js kt X D js kt M D 2 p js p js 2 p js p js To get a base invariant PPPs, we follow the CCD strategy to get the transitive PPPs: P 1 K T KT XM XM kt* Pkt / js j1 s1
25 Terms of trade contribution factor By rearrangement, we can get a much simple form: ln P ln P XM XM kt* kt** XM 1 X X 1 X D ln Pkt ** ( s.. X skt )ln( pkt p.. X ) ( s.. X skt )ln( pkt p.. D ) M M 1 M D ( s.. M skt )ln( pkt p.. M ) ( s.. M skt )ln( pkt p.. D ) 2 2 Set the first country and period 1 as base: P P P P P XM XM XM XM XM kt kt* 11* 11** 11** We can show that the following equation holds: D P P * P XM kt kt kt
26 Decomposition Real GDP on output-side : Y kt v P Real GDP on expenditure-side: Z kt Using kt kt v P kt D kt Z Y P D P P * P * XM kt kt kt XM kt kt kt, we can get: Year-on-year decomposition: Z Y P Z Y P XM kt kt kt * XM k ( t1) k ( t1) k ( t1)
27 4. Conclusion
28 Conclusion Based on production theory and translog GDP methodology introduced by Diewert and Morrison (1986), we further extend Inklaar and Diewert (2016) s framework to simultaneously calculate real GDP on expenditure-side and output-side and isolate the effect of terms of trade on real GDP. Empirical research should be done in next step: PPPs data for domestic consumption, export and import. The estimates for real GDP can be compared with PWT, WDI, UQICD et al. The estimates for terms of trade contribution factor can be compared with the existing works based on time demension.
29 Thanks
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