Welcome back my fellow Earth economists. Today, we will discuss how economists measure production and income. It is important to understand the ins and outs of measurement because having numbers is important, but understanding their strengths and weaknesses is even more important. Numbers in economics often look precise, but they are not always reliable. In economic discussions, the most important numbers are those that relate to production and income. These numbers are based on National Accounts. Three approaches or lenses exist for its measurement; production, income and expenditure. The Earth economist of course, is interested in gross planets product or GPP and uses Planet Accounts for which we use the same approaches. Now, let's take a look at how we can measure GPP. I deal with an economy that consists of firms and households only, but you should not be disappointed: we will introduce the government soon and we will collect data on government already in the data exercise. So we have two sectors; households and firms. The circular flow in the Earth economy, starts with firms that produce goods. This requires payments of consumer expenditure. Firms need the four factors of production in order to produce these goods. The firms pay households for their labor, nature, capital and entrepreneurship. The Earth economy is circular, because money circles in the economy as income is generated and spent. This circular model is the basis of one of the key principles of GPP measurement, namely, value added equals income. Firms of course do not only have to pay the households but also pay other firms for intermediate inputs such as components and raw materials. This happens at each stage of production. A banana that is produced in agriculture will be transported and moved through wholesale and retail to the grocery shop or to a restaurant in order to become final consumption. We can just measure GPP from the income side and collect data on interest, rent and wages, and profits or losses of everybody involved. The tax income records for individuals and firms provide that information. Alternatively, we start at the production side and calculate value-added as sales minus costs of intermediate inputs for each step. Here, the accounting statements of firms are an important source of information. Now, all goods and services that are used in production are intermediate. Goods and services that are not used for further processing are final. The distinction between intermediate and final is determined by the exchange. The banana that is sold to a restaurant is an intermediate good but the banana bought by a consumer is final consumption. When you pay the bill, the banana is consumed; not when you eat it. So we arrive at the third way to measure GPP and that is expenditure. Final production in the planetary economy consists of two items; consumption (and that includes public services as well) and investment, that is the rest. Now let me summarize. We need these three lenses; income, production and expenditure to get the picture right. We know that each approach, each side, each lens will provide somewhat different numbers, and also that very often, we will not have all the numbers that we need. Making planet accounts is therefore an art rather than a science, and often, as you will discover in the reading material, revisions need to be made when missing information is uncovered. Planet accounts is an art. It looks a lot like a sudoku with some known figures and some that are unknown. A sudoku that is super difficult because of measurement error, but missing numbers is not the biggest problem of planet accounts. The biggest problem are in what is and what is not measured. This has to do with the conventions or the rules of planet accounting. It is important to recognize that many transactions go unregistered. This is often the case for street-vending and for illegal transactions including crime, drugs and prostitution. All these activities are located in the informal or shadow sector of the economy. So it is outside the public sector and the enterprises from which the statistical offices collect their data. At the global level between a fifth and a quarter is not reported. The use of GPP is increasingly being criticized, because it is only considering income generated and it neglects that in the end, welfare is determined by Earth's assets. Running down assets is observed as a stream of income but wealth is decreasing and thus people may actually be worse off. The depletion and destruction of natural assets only shows up in the national accounts as a positive income stream, while actually Earth and in particular next-generation are becoming poorer. Professor Peter, I don't quite get it: How can we become poorer if income increases? Any examples? A clear example is global warming. All the CO2 that has been emitted in the past has generated income, but it also creates a lot of problems for the new generations. Yeah. You're from the Netherlands and live below sea level. So you might even lose a part of your country? Even my house! Other countries experience more natural disasters; heat waves, droughts, cyclones. It's actually disturbing that reconstruction after a natural disaster is counted as GPP. We did not become richer at all. True. These flows are significant as you can see in this graph that uses World Bank data to quantify damage and depletion. The loss of assets adds up over time. A mineral depleted is depleted forever. For the graph, the loss over the years 1980-2016 inclusive, adds up to 133 percent of GPP. It is clear, that what we destroy should not be counted as income, but it is more difficult to see that this criticism also extends to our daily lives. Consumption is valued as something positive, but consumption actually destroys goods. If we would consume less, then the stock of assets would not be depleted. So humanity could be said to become richer when humanity consumes less. It is also important to understand that investment in education and knowledge adds to the human capital stock because it can be used over and over again without creating a stream of income. Otherwise, Pythagoras theorem could easily have solved the Greek crisis The capability to read and write are not part of GPP. Such essential elements of the human capital stock are not covered by National Accounts because they do not generate income directly. As an Earth economist, I agree with the criticism, but I also see that GPP itself is not wrong. However, the narrow minded use of it is problematic. Planet accounts continue to provide a consistent instrument to measure economic activity. We need instruments to understand what is happening to our planet.
