8 major difficulties that are faced in Estimating National Income



Measurement of national income poses several difficulties, which include both conceptual and statistical ones. They are briefly described below.

1. National income consists of not one but innumerable goods, service, and they have to be somehow added up to arrive at a measure of national income. The real difficulty arises from the fact that dissimilar things cannot be added up. They have to be converted into some common denominator before doing so and the only practical way of doing so is to take their market prices. Now it is widely recognized that market prices do not represent the true social valuation of the goods and services. In the case of officially determined prices, they reflect only what the authorities decide them to be and in the case of market determined prices, all kinds of market imperfections distort them. The market prices are deeply influenced by

(i) The market structure.

(ii) The sales and marketing campaigns of the suppliers.

(iii) Taxation, subsidies and other rules, regulations and restrictions of the authorities.

(iv) The prices of productive resources and distribution of income and wealth.

(v) The role of speculative forces.

(vi) Shifts in prices of imports and exports.

(vii) Several other factors.

In other words, we do not have a reliable method of adding flows of diverse goods and services.

2. The problems of addition increase manifold when we consider the question of estimating national income in real terms. All the problems faced in the compilation of price index numbers are encountered in this case.

3. There are also serious problems regarding the reliability of information to be used in estimating national income. They include the following.

(a) Several pieces of information are available with undue delay and it is not possible to use them in time for formulation of effective policy measures. At the most, this information may be used to revise the past estimates.

{b) A modern economy is so complex that it is next to impossible to gather complete information needed for estimates of national income. A number of intelligent guesses have to be made and used for this purpose. These omissions can be quite serious, particularly in the case of developing countries where adequate records are not maintained. Moreover, in the absence of records, most individuals and households are not able to provide correct information of their consumption and investment values.

(c) In some cases, relevant information may not be available to the authorities because the households and business units required to provide the information may have reasons to hide the information. In still other cases, they may not have the exact information.

4. National income estimates are faulty in terms of their conceptual approach as well. They tend to concentrate on the market pricing of production flows. This in itself is a major limitation of these estimates. The problem is that there is a lack of consistency even in this.

(a) Thus, the household services performed by the members of the household are left out of estimates of income generation. But if the same services are performed by others and are paid for in money terms, they are included in national income estimates. The logical inconsistency of this stand comes to the fore when we compare two Situations. In situation, one, two households perform various household services for themselves and no payment is involved. In situation two, the two households perform same domestic services for each other and pay each other in money terms. Clearly, there is no difference in real national income when we move from one situation to the other. But in national income estimates, this is not so.

(b) Take the case of houses, factory buildings and other structures. When they are constructed, there is a corresponding addition to national production. However, they are also taken to add to the national income in later years when they are used for residential purposes or as production centers. Moreover, this methodology is given up when we consider certain other structures like roads. While the construction of roads is taken to contribute to national income in the year of construction and the repairs are taken to add to national income later, the use of roads is not taken to add to national income. However, if there is a road, which is owned privately and can be used only on payment, the income received by the road owner is again counted as a part of national income. There are similar contradictions in the case of several other durable goods also. Thus, the manufacture of cars is counted as part of national product during the year of manufacture but they are also taken to add to national income in later years if they are hired out on payment instead of being used by the owners themselves. In reality, however, the consumption service provided in both cases is the same.

(c) While consumption of fixed capital is considered for arriving at net output of the economy, loss of other productive assets is ignored. Production activities not only lead to a permanent loss of several mineral deposits, but also lead to degradation of many reproducible resources. Examples include degradation of land fertility, forest resources, pollution of water, discharge of harmful chemicals in the air and soil and so on. Some of these activities also lead to a loss of human health. However, all such forms of losses to the economy are ignored while estimating net value produced by the economy.

(d) Even if the national income estimates ignore the loss of other productive resources and confine themselves only to the consumption of fixed capital, certain questions are not answered satisfactorily. It can be debated as to whether depreciation should be estimated on the basis of the cost of acquisition and technical life of the capital assets, or it should be estimated on the basis of replacement cost.

5. The national income estimates do not cover illegal activities even though they may be adding to national product. They include smuggling, inland trade activities, production and income generation concealed from the authorities for avoiding tax obligations and prosecution etc.

6. Several economic activities only add to the disutility of the members of society and entail use of resources (resource cost) which could be used for more productive purposes. But an increase in such activities is taken to add to national income rather than reduce it. For example, let us take the case of a worker who has shifted his residence to a greater distance from his work place. Therefore, compared with the earlier situation, he has to commute a longer distance to his work and has to spend additional time, effort and money fordoing so. Though, in reality, both the individual worker and the country are losers on account of the shifting of residence of this worker, national income estimates record the additional resource cost as an addition to national income.

7. Similarly, economic activities of the country may add to the output of goods and services (like drugs) which adversely affect the health and productivity of their users. But national income estimates do not take this fact into account. So long as a good or service has a market value, its production is added to the national income estimates.

8. National income estimates include profit of the corporate sector. However, the profit of a business does not reflect the productive contribution of the entrepreneurship. Instead, it varies in relation to several factors like the overall expected or prevailing rate of profit in the economy. This rate itself tends to vary from economy to economy, region-to-region, industry to industry and with the passage of time. In this context, mention may also be made of the fact that a large number of public sector undertakings are not run with the motive of earning a profit, while during a period of deficient demand, even private enterprises often fail to earn a profit. As a result, national income estimates can vary simply because of shifts in rate of profit without any, corresponding change in real output.