1. Estimating Real Income – GNI and Gross Disposable Income UN-ESCWA 22 – 25 September 2007 Cairo

2. 2 ‘Real’ Income Measures Unlike, output or production, the income flows can not be divided into a price and a quantity component. Thus for income flows no meaningful price or volume measured can be defined. However, income flows can be expressed in terms of theirs purchasing power over some selected basket of goods and services. Nominal income deflated by a price index for the selected basket is called “real income”.

3. 3 Need for Real Income Measures GDP at constant prices reflects growth of an economy’s production. But, the total real income that the residents derive from domestic production also depends on the rate at which the exports are traded against imports (terms of trade). The difference between growth rates of GDP and real income can be substantial if exports and imports are large relative to GDP. About two-thirds of Iraq’s domestic production is exported.

4. 4 Real Measures – different from Constant-Price Measures Constant-price measure: volume measures expressed in monetary terms. Real Income measure: measures purchasing power of income with respect to a selected basket of goods & services. But, there is no obvious choice of the basket. Yet, 1993 SNA (Chp. XVI) recommends compilation of at least some measures of real income. But, 1993 SNA fails to recommend a single method. It illustrates that no one deflator is optimal in all circumstances.

5. 5 Terms of trade effects (1) Total real income which residents derive from domestic production depends on –the volume of goods and services produced and –the rate at which exports can be traded against imports. If the exports’ prices rise faster than the imports’ prices (terms of trade improves) less exports are needed to pay for a given volume of imports. Improvement in the terms of trade leads to increase in volume of (final consumption + capital formation) for the same level of domestic production.

6. 6 Terms of trade effects (2) Thus, the total real income generated by domestic production (GDI) = GDP at constant prices + the real gains from changes in the terms of trade with the rest of the world. Question is “how to measure the real gains from changes in the terms of trade?” 1993 SNA does not give any final solution to the problem. In fact, no measure is optimal in all circumstances.

7. 7 Real Gains from Changes in Terms of Trade Definition: The difference between the “real” trade balance and the trade balance at constant prices: X = exports at current prices M = imports at current prices P x = export price index P m = import price index P = price index based on some selected numeraire

8. 8 Choice of Trade Balance Deflator But, there is no agreement on choice of P –‘trade balance deflator’ – for deflating current-price trade balance to derive the “real” trade balance. Proposed alternatives fall in two broad categories: –First: some general price index – GDP deflator, –Second: MPI, XPI or a combination of MPI & XPI. Use of MPI strongly advocated, since are exports used for paying for imports. But, the resulting measure is not consistent with the general definition of real income measures.

9. 9 MPI as Trade Balance Deflator In countries with high exports-GDP ratio and high imports to gross domestic final expenditure ratio, MPI seems to be an appropriate choice. [Both these ratios are over 60% for Iraq] A team of IMF experts, in an illustration, has used MPI as trade balance deflator for a GCC country having similar features.

10. 10 A Framework for Real measures for Income aggregates Real GDI = GDP at constant prices + Real Gains from changes in terms of trade. Real GNI = Real GDI + real net primary incomes from abroad (primary income deflated by trade balance deflator) Real Gross National Disposable Income = Real GNI + real net current transfers from abroad (current transfers deflated by trade balance deflator).

11. 11 Practical Guidelines (1) Compute Real Gains from changes in terms of trade as (X – M)/MPI – [(X/XPI) – (M/MPI)] = X/XPI – X/MPI = X at constant prices - X/MPI In absence of MPI, for example when UVIs are use for deriving imports at constant prices, use implicit import price index in place of MPI, where implicit import price index = (M at current prices) / (M at constant prices) Obtain real net primary incomes from abroad as (primary income )/MPI

12. 12 Practical Guidelines (2) Obtain real net current transfers from abroad as (current transfers)/MPI. Obtain Real GDI, Real GNI and Real Gross National Disposable Income using the identities discussed earlier.

13. We will now work out estimates of ‘real’ GNI and ‘real’ gross disposable income