Actionable insights on equities, fixed-income, macros and personal finance Start 14-Days Free Trial
Actionable investing insights Get Free Trial

Unravelling the GDP Number: The Perils of Arguing About Real GDP Growth

Finance Minister Chidambaram and BJP politician Yashwant Sinha had a public spat recently about GDP growth rates. According to Chidambaram, the statement made by Gujarat chief minister Narendra Modi, that GDP growth during the BJP rule was 8.4%, was plain wrong. In the years that BJP was at the helm, the growth rates were 6.7%, 7.6%, 4.3%, 5.5%, 4.0% and 8.1% respectively, so where was the 8% figure coming from?

Sinha retorted that what was important was what GDP growth they ended with – and when the BJP left the country was growing at 8%, while with the Congress the country is now at 4.8%.

Let’s ignore the political argument for now about who was better. But first, as they accuse each other of fake encounters or terrorism with facts, let us first try and understand what these numbers actually mean.

Is 4.8% bad? America or Western Europe would kill for these growth rates, as would Japan. Is 8.4% good? It doesn’t look like the kind of growth one thinks is great (for instance, would you be overjoyed if your salary was increased by 8.4%? Possibly not.

What does GDP mean?

GDP is the sum of all the value created in a country in a year. Let’s take a simplistic example of a country which has only one factory, which can make 100 apples a year. 100 apples sell for Rs. 1 each, for a sum total of Rs. 100. (This is simplistic, so bear with me). That is the GDP.

Now, the factory can increase the price of the apples to Rs. 1.5 each. That will increase the GDP to Rs. 150, or a 50% increase! Is this good? The answer is no: the same number of apples is being produced, just that they are being sold for a higher price. The higher price is, effectively, inflation.

The “nominal” growth therefore is 50%. So if you subtract inflation of 50% (since the apples went from Rs. 1 to Rs. 1.5) from the GDP Nominal growth, you get 0% “real” growth. In effect, we’ve not produced any more apples, so we don’t have any growth.

Take another scenario. Let’s assume that the factory was expanded to produce 120 apples, whose price goes from Rs. 1 to Rs. 1.1 each. This means the total sales were Rs. 1.1 x 120 = Rs. 132.

GDP grew nominally from Rs. 100 to Rs. 132 (a growth of 32%). But since inflation was 10%, the actual growth is lower, since we only produced 20 more apples (100 to 120), we can only have seen 20% “real” growth. We have taken the nominal growth of 32% and deflated it by the impact of inflation to get a real growth of 20%.

Effectively, the GDP growth number that is bandied about is growth net of inflation; so even if the economy grew by more than 10% a year in nominal terms, in both UPA and BJP regimes, a good portion of this growth was inflation, which has to be “removed” from the GDP number.

Put another way: Would you be happy if your salary was increased 8.4%? If inflation is 10%, your expenses will grow at a high rate than your income, which is untenable. But if you got a 15% increase, then you can say your “real” growth is 5% – since that’s the number you make that is higher than inflation.

It’s all fine when you have just one factory. But it’s next to impossible to accurately estimate GDP when you have a billion people and a land mass the size of India. When you pay an auto rickshaw driver, that payment should be part of GDP, but no one’s counting. When you paid a much higher amount to your neighbourhood vegetable cart vendor than the price in the wholesale market, no one accounted for that inflation.

GDP is fiendishly difficult to accurately know, so there are only different ways to estimate it. The Ministry of Statistics and Program Implementation (MOSPI) has a manual on how they calculate it for India.

MOSPI gathers data for many sectors – Agriculture, Mining, Manufacturing, Trade, and Transport, Banking and so on. This data is accumulated from various sources, and much of this calculation has a large room for error.

For instance, for agriculture, data is gathered for total area cultivated. Only about 85% of this has any degree of accuracy. MOSPI then estimates total value of output from wholesale mandi prices during peak marketing seasons of each commodity. Why should we use mandi prices only for peak marketing seasons (when prices will be low), when some farmers might warehouse and store products for other times? Input information is estimated from sales quantity and wholesale prices of fertilizers, but there again, farmers pay very different prices from what is indicated in the wholesale price index.

This inaccuracy, like the butterfly effect, can be small errors in individual data that, when aggregated will compound into a large number, even hundreds of thousands of crores. That 8.4% could well be 7.5% or 9.5% if you worked figures around.

And then, there is the complication in how you calculate “real” growth. Currently all numbers are quoted in terms of 2004 rupees – that is, assuming we are in 2004 with today’s production, how much more value are we creating today?

The calculation involves deflating the “nominal” number. For agriculture, they deflate both input and output prices. Input prices of fertilizers, for instance, are deflated using the wholesale prices (through the wholesale price index, or WPI) for fertilizers.

Let us assume we sold Rs. 15,000 worth today fertilizer versus Rs. 10,000 worth in 2004. The price in 2004 was 100, and today it’s 120. The nominal increase in sales is 50% (10,000 to 15,000). But the “real” increase, if we attempt to deflate for prices, is 25%

Note: The math is: Compare (10,000 / 100) and (15,000 / 120), which is (100) and (125).

Using the WPI in prices is one mechanism. Others used by the MOSPI for deflating GDP to a real number are “yield per hectare” calculations for agriculture, differences in the Index of Industrial Production (IIP) for manufacturing, Employment data from NSS rounds, CPI numbers (there are four different CPI indexes) and so on.

The degree of inaccuracy in each of these elements is high. Arguing about whether 4.8% or 8.4% means little when, if you were to use a slightly different method, you get a very different answer.

If I were to use the Consumer Price Indexes as an inflation estimate and then look at the GDP numbers, I could easily arrive at this conclusion: In June 2013, we grew “nominally” by 8.14% over Jun 2013. But inflation (consumer prices) was over 9%. So we have negative “real” growth – which means we are in a recession. (Officially, “real” growth is 4.4% though).

And then, even if we wanted to score political points about GDP growth, it would be silly to not consider international events. In 2000 and 2001, the dot-com bust and the terrorist attack in the US caused a recession in the west, but their response of easy liquidity kept money cheap and flowing into emerging economies like India, until 2008 when the dam burst. From then on, money has become even cheaper, and now just the fear that the tap will be shut caused our beloved rupee, and our economy, to hurt severely.

It’s not easy to attribute GDP growth rates to governments and policies. Roads built 10 years ago might only contribute to GDP today. Removing a diesel subsidy will hurt everyone in the short term, but will win laurels after the five year term a government gets. The lack of government control might actually spur an industry (like IT) than others where there are too many licensing issues. In fact, it’s more likely we grow well in spite of our governments, than because of them.

  • Bull Bhai says:

    Deepak , Good post. But 32% growth Minus 10% inflation is equal to 22%.
    32% – 10% = 22%. Plzz correct me if any mistake.

  • Leo says:

    exactly bull bhai the inflation rate is 20% . so there is no growth at all..
    THE time things were growing with low debt was from 1998 2004 …surprising isnt it
    Now from 2004 to 2013 whatever is happening on borrowed money which cant be paid back when rates rise…9+% in india due to external factors …things go kaboom
    Last 60 years population has just trippled but if u consider money supply it is huge…it is exponential from 2004 to 2013…
    indian bernanke = MMS and lungi…when u have debt growth faster than real growth ..It always leads to DEFLATIONARY shock.If not only places to hide is LAnd to grow food + gold.Coz politicians never listen

  • You will find this article on the subject of GDP interesting (click on the link above): Three myths about GDP growth –

  • Ramamurthy says:

    Thanks a lot for this post. I thought that these GDP growth rates published by the Govt were all inflation adjusted.Am I wrong?
    You say and I agree that the official figures can be disputed.But in your opinion what is the ideal way it can be calculated?Frankly I have no answer and hence I am asking you please.The whole thing is so complicated and correct data base can not be obtained particularly from non organised sector.What the Govt should do I think is to make the point very clear that the figures are not accurate.Govt never does this. What makes it funny is the figures are given in decimals just to decieve the public that what Govt says is very accurate.

  • Rama Karupaiah says:

    Are you saying that govt. policy has no impact on growth of a country? So India has been growing on auto mode? Now consider the years to 1991. India was infamous for its Hindu rate of growth and I remember article after article by foreigners explaining that it is religion which is responsible for the fatalistic approach of Indians and that is why the country is stuck with low growth rates!
    I take issue with specious arguments such as these. In fact economic history should be a compulsory subject in school; provided history is not written by leftists. Look up wikipedia and other sources and it dawns upon one that the Indian subcontinent was a dominant force in the world economy right up till the 1500s! You can argue that India as a country did not exist; yes but many other countries did not exist as such at that time. Furthermore trade was vigorous in many parts of the sub continent. So entrepreneurship was flourishing, agriculture was flourishing (please read the Beautiful Tree by Dharampal), trade was flourishing… So Indians did not lack in initiative, enterprise.
    So what happened.. policies (deliberate during the British period which favoured british industrialisation over indian and in the period after independence, a grossly mistaken leaning towards fabian, socialist policies promoted by an incompetent Nehru). Remember you can never legislate prosperity; you can only nurture it.
    So yes govt. policy has a large role to play in economic development. Lets not kid ourselves over gdp and definition thereof. And the Congress which has been in control of India for most of the period after independence has failed miserably.

    • How do you take my post and decide I mean “Government has no impact on growth of a country”? My argument is that it is overrated, especially in an open “flat” world. In the context of the last decade or so, it is vastly overrated – we grew more because the world was awash with liquidity than because of our policies.
      Agreed though that bad policies can destroy a country. I will argue that usually a bad policy is considered a good one in the short term. Like the policy of the Germans to print money to pay debt, before hyperinflation set in..

      • Leo says:

        i think we will get into a very bad scenario in coming days… and barter system might come…coz what is happening is all govts are printing Including our PM MMS who is an IMF guy and is the biggest curse on our nation.
        when u punt and devalue currency it blows up sometime .The stock mkt is just made up for some reason .MARKET = money supply .if u see GDP has tanked with money supply and debt on our nation doubling in the last 5 years.
        This will all end very badly .So it is policy which is making things worse .I agree when u have fool governing us and knows only one thing which is printing and GDP.
        Think of the lady janet yellen she once said if u deposit 100 bucks in a bank year ur return shoudl be 90 rs… that -10% interest rate. Totally nuts.If in 1932 they actually devalued all currencies against gold. Govt does impact growth. i agree but if govt is foolish what can u do.Free laptops tablets wtf who is going to pay for this.endless crappy currency is it ?
        Very sad state

  • rodin says:

    How come GDP grows w.o. govt action?Afterall it is the govt that has to decide to build a road or a powerplant or give free loans to farmers and the cotterie so that they may spend and spur consumption and GDP growth. Also dont forget that even when the road is being constructed, GDP increases by the very act govt expenditure and the immediate multiplier effect on demand and consumption!