The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 1971 was awarded to Simon Kuznets, for his empirically founded interpretation of economic growth which has led to new and deepened insight into the economic and social structure and process of development.
I always used to wonder how can one determine the economic growth, I used to think how will government know how much I am earning, how much I am spending and how much I am saving. The thing which was even more perplexing for me was how would the statisticians or the government agencies would arrive at per capita income. There are just more than a billion individual living in India, and it is just impossible to ask each individual about their income. Well, actually we can, we can get a good approximation of total spending in an economy, total savings in an economy, and we can figure out how much an average citizen in an economy earns.
Like most of the economist Simon Kuznets loved data. He worked with lot of macroeconomic data and found out how to best use these data. His Nobel Prize was dedicated for establishing the means and the format for collecting the empirical data necessary to complete and make usable macroeconomic models.
Simon Kuznet was born to a Jewish family in Kharkov, the second largest city in Ukraine since the country’s independence from the Soviet Union in 1991. Kuznets migrated to United States after the World War I, and resumed his studies at Columbia University. He was very influence by Joseph Schumpeter and his theory of innovation and business cycle. His doctoral thesis was published as book “Secular Movements in Production and Prices” in 1930. He joined National Bureau of Economic Research (NBER) in 1927, and then as apart-time professor at University of Pennsylvania. Kuznet joined Johns Hopkins University in 1954 as Professor of Political Economy and then from 1961 till his retirement he was a Professor at Harvard University.
I did got a chance to resolve my confusion and could learn how the economic growth and per capita is calculated. It is not very easy to calculate and work with data, but quite interesting to know how it is calculated.
Calculation of per capita income or disposable income
Simon Kuznet was one of the pioneer who contributed to the construction of national income accounts that represents the total economic data about a nation’s total production, consumption and about macroeconomic factors like interest rates, level of unemployment, inflation etc. The national income accounts have four components: investment, government spending, consumption, and net exports as defined in Keynesian theory. The total spending in all of these categories is called Gross Domestic Product (GDP). The GDP is the sum of value of final goods and services produced in a country in a particular year. The GDP can be further divided or categorised into Nominal GDP and Real GDP. The Nominal GDP values from a time period to a different time period captures the differences or changes in the quantities produced, while Real GDP captures the changes in prices i.e. they are adjusted for inflation. In 2014, as per the data by World Bank, the GDP of United States was $17.4 trillion, GDP of India was $2 trillion, and lowest GDP is of Tuvalu $38 million.
Essentially, GDP is the production of new wealth in a country. But not every investment in an economy contributes towards generation of new wealth. For example if a manufacturer of goods replaces worn out machinery then it will not be generating more goods, such investments can be considered for depreciation and can be deducted form GDP to arrive at Net Domestic Product (NDP).
Whenever a consumer buys a good at its final value, not all the amount goes to the producer. The producer have to pay a certain percentage of money to local, state or central government in the form of taxes. These taxes are known as indirect taxes, which a consumer pay on buying goods and not on their incomes. The revenue which is left with businesses after paying tax is what we called National Income and it is the income earned by factors of production: land, labor, capital, and entrepreneurship.
Before the businesses distribute the revenue to the factors of production, there are some amounts to be deducted from the National Income for transfer payments such as Social Security Contribution, Corporate Income taxes. These payments differ from country to country. After making all these subtractions and addition from GDP, it would yield Personal Income.
We are almost there to calculate disposable income. The Personal Income which we calculated is not ready to be spend by the factors of production. The last step is to deduct personal income taxes or what we call as direct taxes from the personal income and what we will have is called Disposable Income. The Disposable Income divided by the total population of a country will yield Per Capita Income. It looks more simple when we work with actual data, and sometime numbers helps us to tell more than what we want to know or we want to learn.
References:
Kuznets S. (1959), Six Lectures on Economic Growth, The free press of glencoe, Illinois.
McCarty M. H. (2001), The Nobel Laureates, How the world’s greatest economic minds shaped modern thought, McGraw-Hill publication.
http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1971/
https://en.wikipedia.org/wiki/Simon_Kuznets
http://data.worldbank.org/indicator/NY.GDP.MKTP.CD?order=wbapi_data_value_2014+wbapi_data_value+wbapi_data_value-last&sort=asc
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