If you're new here, you may want to subscribe to my RSS feed. Thanks for visiting!

GDP likely expanded faster in Q1 on remittances, election: blares the money headline on Inquirer.

Economy expands 6.9% 1st-quarter GDP growth strongest in 17 years!

07 debt-to-GDP ratio seen at 58.3% Anu yun?

The Philippines is on a roll! Said the one by da Pasig River.

Really?!

I feel like calling my friends in Floodway. I’m sure you know exactly what I’m talking about. You see, my friends were pushed to live in the underworld of Floodway because of our economy, that’s been on a roll, you understand me, right? So, I thought I’d give them the good news that our GDP expanded faster in the 1st quarter of this year, that we are on a roll, that the stock market is breaching everything that it could break, that GDP is almost 7% and then, there’s highway robbery on EDSA and killings are unabated! You wonder, is the rise in GDP automatically kicks the rise in crime in the Philippines?

Well, listen children. Before you can have some appreciation of the GDP, JKF, FVR, EDSA, PSBA and they’re not all the same by the way, and what it means to you and your family, let’s try to learn some macro-economics over here. I promise that this won’t hurt. We’ll make this fast and easy.

My goal, is to turn you my dear readers into Economists so that we won’t be dumb and stupid and jumping tra-la-la whenever we heard our powers-that-be and trumpet that the stock market broke the roof of our house, that we should be happy, yet we sit in our table and bwisit! tinapa na naman!!!

Don’t worry about diplomas. I may not have any political connections whatsoever, but I know a lot of people who prints out nice diplomas in Recto. Name your school of choice! You want PhD after reading this article? We’ll give you one. Don’t worry.

So, here’s Macro Economics 101. *Plakkkkk~ *hataw nang stick sa blakburd*

MACRO-ECONOMICS 101

GROSS DOMESTIC PRODUCT

In very simple terms, children, GDP is just a list of stuff, of everything that we as a nation of brown and exotic people produce.  Assume that our entire economy consists of 20 people and that we are a stone age economy. Each aboridyinis spends every day cultivating, harvesting and storing food which is used to support consumption. The total production of this economy in REAL terms, GROSS DOMESTIC PRODUCT, or GDP is simply the list of stuff produced by the 20 people.

• 20 sacks of rice

• 20 bags of corn

• 20 bottles of lambanog

• 20 sacks of kamote

• 20 boxes of dried fish

GDP is a concept designed to measure economic activity. It’s like like preparing an Income Statement - I mean, this concept is closer to a Profit and Loss Statement (how much you sold, less how much it cost you and your net profit or net loss), instead of the Balance Sheet (how much you own, how much you owe and how much is your net worth). That’s why CAPITAL GAINS are not included coz this is just a swap of papers and not production.

Concept of Specialization

In our example kids, everyone is producing only one item. So now, we have already learned and applied the principle of specialization. Specialization raises everyone’s income (their pile of stuff after trading has occurred). Since none of us can make our own cars, refrigerators, houses etc., we would have none of these if we had to make them ourselves. In poor economies, there is little specialization so citizens have little to sell (e.g. if they have to make everything for themselves, they don’t have much).

Concept of Trading

But you see, Pidro will not eat rice only! And Mareeea will not eat corn only, so TRADING will take place. Each person puts their production in a tricycle (during my time, used to be hauled by a carabao) and pulls it around Ayala at the Philippine Stock Exchange trying to make trades. SINCE EVERY TRADE IS VOLUNTARY, IT IS CLEAR THAT EVERYONE WILL BE BETTER OFF AFTER THEY TRADE. No individual will make a trade to lose money or that they do not perceive as a good trade for themselves, common sense right?

Concept of Market, Relative Prices, Intermediaries, Transaction Costs and Economic Efficiency

There’s an easier way. A MARKET develops - everyone brings what they have to trade to a central location. This would make it a lot easier to trade. This also provides better, lower cost information about RELATIVE PRICES - that is, what the terms of trade are between bread and wine etc. This is what markets do - make it easier to get transactions accomplished.

Supermarkets make it easier [less time and hassle] to buy groceries. They do not produce food.

Retailers etc. are in the business of reducing TRANSACTIONS COSTS and as such are INTERMEDIARIES.

The internet makes the collection of such information very cheap and makes markets work even better [ ebay makes it possible to invite the word to your garage sale, increasing the likelihood that what you have to sell will be sold to a buyer who values it the most is a critical requirement for achieving ECONOMIC EFFICIENCY.

Concept of Money

We know this one already. Makes our lives easier. Let’s start with 100 Stones. Our currency is $tones. Skip to the next chapter please!

Ghandee! What are you reading?! I said, skip to the next chapter! #$%^~! *plak!

Concept of Real Income

If lambanog sells for 2 Stones per bottle and kamote for 10 Stones a dozen, the “BARTER” price of kamote is clearly 5 bottles of lambanog. But to buy kamote, you need not bring 5 bottles of lambanog, just 10 Stones (which you earn by selling whatever it is that you produce). For simplicity, assume that the price of each unit of output is 5 Stones. Thus, real income of 20 units @ 5 Stones = 100 Stones of income.

The Concept of GDP

Since we consume all we make in this economy, all 100 Stones will be spent to buy food and goods. Instead of listing all of the food produced [and consumed], we can simply describe the output of the economy in terms of Stones. Since everyone spends all of their Stones in a year, then we can say that the GDP of this economy is 2,000 Stones [20 people x 100 Stones].

Notice that THE VALUE OF YOU PRODUCE IS EXACTLY EQUAL TO YOUR INCOME. Although everyone has the same income in this example, undoubtedly some members of the group will be better farmers than others, or will have settled on better land, or produce output that is more highly prized and thus fetches a better price. This would produce different incomes rather than identical incomes in the real world.

The Concept of Inflation

INFLATION happens where there is an increase in the average price level for a given set of goods and services. Suppose all 20 people discovered 100 new stones in their back yards. What happens next? Everyone would rush out and spend their stones at SM. This would make GDP 4,000 Stones twice the previous level. But was there new food available for purchase? NO! The same amount of food was brought to the market. But, the price of everything doubled as people bid to get the food. Thus, NOMINAL GDP was 4,000 but REAL GDP was still 2000 stones, using prices established before everyone found more stones (this will be the BASE PERIOD).

“Finding stones” is the same as Central Bank printing more money. Printing more money doesn’t create more goods. In fact, there is a simple relationship that you can count on in the long haul if money grows faster than real output, prices will rise (inflation):

% change in Money = % change in Price level + % change in Q (real output)

The Concept of Consumption

Let’s go back to our economy with a GDP of 2,000 stones, it is important to note that INCOME is equal to CONSUMPTION. If we have a good weather year and grow more stuff, we eat more and our REAL INCOME is higher. If we have a bad weather year, our real income is lower and we eat less. These kinds of events are called supply shocks.

So, INCOME = OUTPUT. In this example, all of the output is consumed, so INCOME = CONSUMPTION, or Y = C.

Check this out by spending your stones to buy stuff to eat and “buy from yourself” what you keep and don’t sell to others.

Your income = your output = your consumption = 100 stones.

A technical note at this point - if some food was carried over to the next year, this would be INVESTMENT (discussed shortly), which in our actual national income accounts framework includes new buildings and equipment, new homes, and changes in business inventories, in this case, food that was not consumed in the period it was grown, but carried over to future periods.

Consuming it in a later period would result in negative inventory investment , that is, sales in the future period would be from stuff produced in that period and stuff produced in earlier periods. GDP measures current production, so the inventory draw down would be subtracted from total sales to get GDP for the period.

The Concept of Hedging

NOTICE THAT EXCEPT FOR RANDOM WEATHER CHANGES, OUR INCOME IS THE SAME YEAR AFTER YEAR.

The impact of weather on income represents uncertainty for workers in the economy. It is a risk that cannot be eliminated or reduced and it is difficult to attach probabilities to the various weather outcomes. Weather just happens. However, in a sophisticated economy, this uncertainty can be sold to investors who will make money by managing risk and do it better than farmers. The outgrowth of risk aversion is the hedge and its various forms. The farmer is willing to pay to get rid of the risk and sells it to someone who can manage it better (at a lower cost) and make money at it. There are very large markets that trade risk and many financial instruments used to accomplish the sale of risk.

CHECK OUT THE FUTURES PRICES IN THE WALL STREET JOURNAL. HOW DOES THIS MARKET HELP FARMERS TO MAKE DECISIONS?

Remember this! 

THE ONLY WAY REAL INCOME CAN RISE IS IF WE ACTUALLY PRODUCE MORE OUTPUT PER HOUR OF WORK - AN INCREASE IN PRODUCTIVITY.

The Concept of Savings

Recall that finding more money (stones) did not increase our real income. Let’s say that our Mayor, an innovative member in the village [society] thought of the concept of a tractor. To build the tractor would require one year of his/her work. To do this, the other 19 will have to feed him/her. Thus, society will have to SAVE 100 stones [or, in real terms, not consume 100 stones worth of food themselves] and INVEST this in the idea of the entrepreneur. Thus, each individual will now consume 95 stones worth of food and save 5. This will provide 95 stones worth of food for the inventor and of course the inventor consumes only 95, not the usual 100 stones.

Now, the composition of GDP or what we call NATIONAL ACCOUNTS of this economy look like this:

CONSUMPTION 1,900 STONES “C”
  INVESTMENT 100 STONES “I”
  ____________
  GDP 2,000 STONES “Y”

The National Income Accounts Identity is Y= C+I = C+S, where Y denotes GDP = the total value of final goods and services produced = the value of total income, and S denotes SAVINGS, a concept best described as “non-consumption” [e.g. we don’t worry about where the savings is kept, only that the associated resources are not consumed].

NOTICE THAT THIS MEANS THAT S = I.

SIMPLY, BUT IMPORTANTLY, MEANS THAT ALL RESOURCES NOT CONSUMED ARE AVAILABLE FOR AND WILL BE USED FOR INVESTMENT.

This is accomplished by financial intermediaries (like banks or brokers) that more efficiently bring savers and investors together. The amount of investment that can occur in our economy is limited by the amount of saving that occurs, a very important economic principle.

The Concept of Investment

INVESTMENT (in this framework) is defined as the creation of new productive assets (this would include knowledge, new works of art etc.) and excludes the purchases of all existing assets (e.g. buying stocks is not investing, just swapping stones for pieces of paper called shares).

Thus, the purchase of stocks or bonds, existing houses and buildings, existing machinery etc. is not investment in the context of National Income accounting. These are asset swaps, no new real assets are created. Investment does occur if resources saved are used to create NEW plant, equipment, or inventories [to use in future periods].

When existing assets are purchased (daily on the stock exchanges for example), it is simply an exchange of assets - money for another asset. The economy ends up holding the same asset claims, money and the existing real assets at the end of the day. Only the ownership changes.

But, when the economy makes a tractor, it has additional capital assets to use in future periods. If I buy a used tractor from you, it is just an asset swap nothing changes for the group as a whole. Thus, the concept of investment includes new buildings and equipment, new houses, and additions to business inventories (which can be negative of course).

The Concept of Productivity 

The concept of productivity is a very important concept. Only if output per hour increases will citizens have more income and wealth.  And, to keep productivity rising (output per hour), we must keep investing. The tractor increases output per hour one time to a higher level, but then output and output per hour stalls there until more investment occurs.

Measuring real productivity is difficult, however, since it has a trend and a cyclical component.

For example, suppose we open a new Jolibee, hire two workers, and they serve 10 burgers per hour. Their measured productivity is 5 burgers per hour per worker. Then, more consumers find the restaurant (or the economy grows and more people eat out) and sales grow to 20 burgers per hour. This raises measured productivity, output per hour, from 5 burgers to 10 burgers.

But, are these workers fundamentally any more productive? Obviously not (outside of learning done on the job). It is also obvious that I could pay these workers more as long as sales stay up. But if sales fall, the worker’s wages would have to fall as well.

Then, we find a computer/software system that allows us to serve 20 burgers per hour with only one worker. All orders are taken and sent to the cook on a touch screen, the computer “keeps the books, it makes change. Indeed, the math and writing skills needed are now reduced, making it possible for less qualified workers to get this job done. This is a fundament improvement in productivity, made possible by investment. This worker could permanently be paid a higher wage since the worker is more producitive, whether we sell 10 or 20 burgers per hour.

The Concept of Government 

Now, let’s introduce GOVERNMENT (Ugh!), denoted “G”. Suppose we need a tank to defend our barrio. It takes resources to build a tank [in this simple example, people must take time from farming to build the tank]. If it takes 2 people all year to make the tank, we need to set aside 200 stones to get the job done. Now, the composition of the economy has changed again:

C 1,700 STONES (Consumption)
  I 100 STONES Y = C+I+G = C+S+T (Investment)
  G 200 STONES Where T = taxes and G = government consumption
  GDP 2,000 STONES

The Concept of Taxes

Ok, you all know what TAXES, it simply refers to the amount of income [resources] that the government takes to support its spending. Since S is defined as non-consumption it is clear that taxes taken by themselves raise national savings since private saving, S, = Y-C-T. The issue is what is done with the T collected.

If G=T, the budget is balanced. If G>T (greater than), then the government is running a deficit and it must borrow some private saving. Note that increased government spending does not increase GDP, it just increases the share of GDP (resources) commanded by the public sector (assuming full employment, an assumption that will be relaxed later). Building the tank reduces food production.

This raises the question, then, of whether or not an increase in government spending can increase GDP (e.g. does a stimulus package work?).

Dividing our identity through by Y yields: 1.0 = C + I + G + X

This relationship says that if any one component gets bigger, it must do so at the expense of the other. To build a tank we had to give up 40 units of C goods. G share went from 0 to 10% and C share fell.

But, what if there is unemployment? This introduces dynamics. The government can indeed hire unemployed workers, but where will it get the money? It must either raise taxes, borrow the money, or print it (find more stones).

All of these methods to raise funds for G will adversely impact the other components of GDP. In the context of the stimulus package, if G cuts taxes, it reduces its spending (assuming it doesn’t borrow) and increases C or I.

If it just gives back a surplus, this can stimulate C and maybe I, but the budget surplus was part of S, and was made available to finance I. Of course, the dynamics are interesting if you have elections every two years!

To the extent that private saving is borrowed, investment will be reduced. Consumers have put 100 stones into the STONEAGEBANK. These funds were routinely borrowed by TRACTOR Inc. to make the tractor (which we assume depreciates in a year).

If the government borrows some or all of these funds, the tractor cannot be completed in the year. Thus, the growth in productivity and in per capita income will be impaired.

Savings in our economy are accumulated at the STONEAGEBANK, a financial intermediary. This is more efficient than each of us trying to put it in piggy bank or bamboo pole, remember that?

In this simple world, the tractor factory borrows the funds, supports the workers, then sells the services of the tractor in the next period (where it is used up in production) and repays the loan, only to borrow again to build another tractor for the next year.

The Concept of Import/Export

The next concept to add is that of “TRADE”, the rest of the world. Of course, we have been trading with each other all along, but trade takes on special significance if the trade between individuals crosses political boundaries. If we spend all of our stones buying stuff from another country, we don’t generate any output in our own country. Thus, IMPORTS, are subtracted from our GDP figure since they are not made domestically. If we sell stuff to another country, however, this does generate production and income in our country, so we add EXPORTS to the GDP measure:

Y = C + I + G - IM + EX

Consumption includes the purchase of goods made domestically and in foreign countries. Subtracting imports adjusts for foreign production in the computation of domestic production.

The Concept of Net Foreign Investment

For trade to occur, the other country has to have something you want to buy and we must have something they are willing to take in exchange. Real prices are important here the lower the real price, the more the other country is willing to take in exchange.

In the long haul, trade is driven by the law of one price (purchasing power parity) which says that a ton of steel ought to have the same real price in Asian or the U.S. (assumes transportation costs etc. are the same) as long as markets are competitive and trade is free (like trade between NJ and NY).

This says that the purchasing power of a Php1 in the Philippines (denoted as Php1/P, P= our price or price level) should be the same in Europe. This means that Php1/P = (Php1 x exchange rate)/P*, where P* is the price or price level in Europe.

The other reason why we might want currency of another country is because investment is more attractive there. To invest in the other country, we need their currency and will sell our currency to get theirs. This changes the exchange rate, depreciating our currency. The increased spending in their ccountry will decrease spending here, and increase their demand for stuff.

With a lower exchange rate, our stuff is cheaper and they import more and we export more to their country. This produces the flow of trade that is equal to the flow of capital.

In the context of our model Y=C+I+G+NETX and Y-C-G= I+NETX. Y-C-G is national saving which is allocated to domestic investment, I or NFI (net foreign investment) which must be identical to NETX.

How do you forecast GDP growth?

Figuring out where the economy is going to go, involves forecasting the course of each component of GDP. Then, the growth in aggregate demand (spending, C, I, G and NETEX) is compared to the growth in the ability of the economy to provide additional real output, aggregate supply (output that can be made by the number of workers, the number of tractors and the technology).

This comparison shapes the forecast for imports to satisfy demand, unemployment, and inflation (which occurs wehn real output is insufficient to meet demand at current prices). The determinants of the capacity of the economy to produce output to satisfy demand are discussed below in the section on GROWTH.

We can use the GDP identity above to provide a simple forecasting framework.

1.0 = C + I + G + X = .69 +.15+.21 -.05

Then, the expected percentage change in GDP will be the weighted sum of the expected changes in its components:

Forecast for GDP growth = .69(%C) + .15 (%I) + .21 (%G) -.05 (%X)

If C is expected to grow 3%, I to fall 10%, G to grow 8% and X to grow by 2%, then:

%change in GDP = .69(3) + .15 (-10) + .21 (8) -.05 (2) = 2.2% growth

Summary

So kids, there’s your GDP. The only way to appreciate these news is to understand the basics. You need not be an accounting graduate. I know my neighbor is a computer programmer, but he is very, very well versed with these kinds of news. So, whenever you read anything about a spectacular, a stunner or a rising GDP, always think about:

• CONSUMPTION - this is where OFW remittances falls. Why? The more money we send, the more money they spend on goods and services.

• INVESTMENT - remember the tractor investment? Think about investment in industrial facilities to increase our production.

• GOVERNMENT - you should know by now what deficits means. Government can only spend what it collects in taxes. Do we hear budget surplus? Surplus is good. But how they use the surplus is what matters.

• NETEX (Meaning: plus Exports, minus Imports)

You’re looking for a perfect balance or at least a good balance of each component and everything that affects it.

• What good would a high consumption rate when the government is overspending?

• Why is it that infrastructure is very, very important? Can you follow it now? Simple - so goods can be delivered to the market or be exported fast.

• Why is health care and education very, very important? Labor force. Para hindi ka uubo-ubo.

• Why is savings very, very important? Equate this one with news that most of the industrial countries have high savings rate. Where is the Philippines? What’s the average savings rate of Pinoys? O marunong ba tayo mag-save? Savings is very important because we need Investments to go up.

• Why do we need stop counterfeiting? Remember the story of finding stones? Because we don’t want a flood of money. Causes inflation.

• Why is eradicating poverty very important? So you’d have productive people.

• Why is it very important to get rid of corruption? A ewan! ~!@#$%^&* BLAG!

(Lintek, nagmukha na akong nanga-ngampanya nito na parang Senatorial Candidate!)

Anyway, I hope this is  a good start for you in understanding GDP, to understand that these matters to you, especially YOU, my dear OFW.

Final exams will be announced later.

Class is dismissed.

Popularity: 9% [?]

Share This

• How to save if you’re young, ambitious…and earning only P20K
• Start a business in your home
• GDP Exercise: Business news analysis
• How to deal with rising food prices
• The Godfrey Group