Academic journal article AEI Paper & Studies

Double-Counting of Investment

Academic journal article AEI Paper & Studies

Double-Counting of Investment

Article excerpt

In setting up a system of national accounts, Kuznets (1941) stressed that the only true final goods are consumption at various dates. Therefore, a reasonable test for a national accounting system for production and income is how well it measures the potential for consumption over time. As Kuznets put it (p. 46): "Is it the value of goods produced that leads to the most valid appraisal of the positive contents of economic activity? Since the final aim is to satisfy the wants of ultimate consumers, we might perhaps more properly center attention on ultimate consumption."

If the only final goods are consumption in various periods, a reasonable requirement for a measure of national product or income is that it accurately reflect, subject to data constraints, the resources available for consumption. More specifically, a necessary condition from an intertemporal perspective is that--at least conceptually--the present value of measured production and income should equal the present value of consumption. However, the usual concepts of national or domestic product and income fail this basic test because they double-count investment. Gross or net product includes gross or net investment when it occurs and includes the corresponding present value a second time when additional rental income results from the enhanced stocks of capital. From the standpoint of the intertemporal budget constraint for consumption, aggregates such as GDP and national income overstate the resources available for consumption and also exaggerate capital's share of product and income.

In a model with a representative agent, such as the one constructed in the next section, welfare corresponds to the single agent's attained utility. Then, with no labor-leisure choice, welfare depends only on the time path of consumption. More generally, measured welfare would factor in the path of leisure time and the distributions of consumption and leisure. Thus, a report written for the U.S. Senate by Kuznets (1934, pp. 6-7) said:

"Economic welfare cannot be adequately measured unless the personal
distribution of income is known. And no income measurement undertakes
to estimate the reverse side of income, that is, the intensity and
unpleasantness of effort going into the earning of income. The welfare
of a nation can, therefore, scarcely be inferred from a measurement of
national income..."

The present paper deals with how the constructed aggregates of product and income relate to the path of aggregate consumption. Therefore, the analysis relates to welfare in so far as welfare depends on the path of aggregate consumption, rather than, per se, the paths of aggregate production and income. (1)

The dynamic problems focused on in this paper arise in the standard national-accounting framework because the setup is fundamentally static. The setting is not well grounded in intertemporal budget constraints and, therefore, does not handle appropriately the economic role of investment and capital stocks. These issues emerge clearly within a simple, well-known framework, the steady state of the neoclassical growth model. However, the results generalize beyond this specific setting. The key element of the model is its respect for intertemporal budget constraints.

I. Intertemporal Framework

The setup is standard, corresponding to the well-known infinite-horizon neoclassical growth model for a closed economy. (2) The representative agent's assets are held as internal loans (private bonds that aggregate to zero) or claims on capital, K(t), which depreciates at the constant rate [delta]>0. Perfectly competitive producers of goods produce output, Y(t), using K(t) and labor, L(t), through a constant-returns-to-scale production function, F(*), which satisfies the usual neoclassical properties. Output divides in a one-sector-production-function setup between consumption, C(t), and gross investment, I(t). (3)

The representative agent's budget constraint at a point in time is:

(1) Y(t) = F[K(t), L(t)] = C(t) + I(t) = w(t)L(t) + R(t)K(t),

where w(t) is the real wage rate, equaling the marginal product of labor, and R(t) is the real rental price of capital, equaling the marginal product of capital. …

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