Gross Value Added, GDP & Base Effect

Gross value added:

  • Gross value added (GVA) is defined as the value of output less the value of intermediate consumption.
  • Value added represents the contribution of labour and capital to the production process.
  • When the value of taxes on products (less subsidies on products) is added, the sum of value added for all resident units gives the value of gross domestic product (GDP).
  • Thus, Gross Domestic Product (GDP) of any nation represents the sum total of gross value added (GVA) (i.e, without discounting for capital consumption or depreciation) in all the sectors of that economy during the said year after adjusting for taxes and subsidies. 

What is it?

  • GDP or gross domestic product is a measure of economic activity in a country.
  • It is the total value of a country’s annual output of goods and services. Until about two years ago, GDP was all you needed to see, to gauge a country’s economic activity.
  • Now, there are other pieces of jargon that you need to know if you have to decode CSO numbers. The gross value added (GVA) is one key number.
  • Over two years ago, the CSO introduced a new method to calculate growth numbers. This differed from the earlier method in many ways. Another key change was to move from factor cost to basic prices. GDP at factor cost represents what the producers in the economy make from industrial activity — wages, profits, rents and capital — called ‘factors of production’, if you jog your memory on economics.
  • Aside from these costs, producers may also incur other expenses such as property tax, stamp duties and registration fees before sale. These are included in the GDP, but not the GVA. Essentially, GVA captures what accrues to the producer, before a product is sold.

Why is it important?

  • GVA, under the new method, has assumed importance as it is the closer representation of the economic activity on the ground. The RBI too considers only GVA to spell out its economic projections in its policy reviews.
  • Adjustments made to the GVA number to arrive at GDP, under the new method, can throw the resultant number out of whack. The growth in the economy under the old series was gauged by the growth in GDP at factor cost — period. Now the headline GDP growth is adjusted for net indirect taxes — indirect taxes are added while subsidies are subtracted from GVA. This is to reflect the price paid by the consumer. But at different points in time, GDP and GVA have been telling different stories.

Why should I care?

  • How the economy is doing is critical to your job prospects and your annual pay hike.
  • A higher GDP is usually good news, implying better living standards for the country at large.
  • For the investor, the implications are more direct — a higher growth in the economy will mean better corporate earnings.
  • Higher GDP or GVA growth in India may also lure more foreign investors to pour capital into the country.

Base Effect:

  • The base effect refers to the impact of the rise in price level (i.e. last year’s inflation) in the previous year over the corresponding rise in price levels in the current year (i.e., current inflation): if the price index had risen at a high rate in the corresponding period of the previous year leading to a high inflation rate, some of the potential rise is already factored in, therefore a similar absolute increase in the Price index in the current year will lead to a relatively lower inflation rates.
  • On the other hand, if the inflation rate was too low in the corresponding period of the previous year, even a relatively smaller rise in the Price Index will arithmetically give a high rate of current inflation.

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