Net Domestic Product
Net domestic product is the value of the goods and services produced in a country during a period, after deducting the consumption of fixed capital. It differs from gross domestic product, which does not deduct the consumption of capital.
Definition
Net domestic product is calculated by subtracting the consumption of fixed capital from gross domestic product. The consumption of fixed capital is the depreciation of the capital stock, which represents the capital that is used up in production during the period.
The deduction recognises that a portion of the output of the economy is required to replace the capital that has been consumed, and that this portion is not available for consumption or for net investment. The net measure therefore provides a better indication of the sustainable level of output.
Gross versus Net
The distinction between gross and net measures is important for the analysis of the economy. The gross measure overstates the sustainable level of income, since it does not account for the capital that must be replaced. The net measure provides a better indication of the income that can be consumed without reducing the capital stock.
The difference between the two depends on the size of the capital stock and on its rate of depreciation. In economies with large capital stocks and high rates of depreciation, the difference is substantial. In economies with small capital stocks, the difference is smaller.
The use of the gross measure is more common in practice, because it is easier to measure and because the estimates of depreciation are subject to uncertainty. The net measure is used when the analysis requires an assessment of the sustainable level of output.
Measurement
The measurement of net domestic product requires estimates of the consumption of fixed capital, which in turn require estimates of the capital stock and of its rate of depreciation. The estimates are based on the perpetual inventory method, in which the capital stock is estimated by accumulating past investment and applying depreciation rates to each vintage.
The estimates are subject to uncertainty, since they depend on assumptions about the useful lives of the assets and about the patterns of depreciation. The measurement of the capital stock is particularly difficult, since the assets are heterogeneous and their prices change over time.
The measurement also requires attention to the treatment of inventories and of natural resources, which are not included in the measure of fixed capital. The depletion of natural resources is recorded separately, and its treatment in the national accounts is a subject of debate.
Uses
Net domestic product is used in the analysis of the sustainability of growth, of the productivity of the economy, and of the adequacy of investment.
The net measure is used to assess whether the economy is consuming its capital stock, which occurs when investment is less than the consumption of capital. It is used to measure the contribution of capital to production, since the measurement of productivity requires consistent treatment of capital in the measures of output and of input.
Net Measures and Sustainability
The net measures of output and income are central to the analysis of sustainability. The net measure deducts the capital that is consumed, and it therefore reflects the income that can be consumed without reducing the capital stock.
The analysis of sustainability distinguishes between the consumption of produced capital and the depletion of natural capital. The depletion of natural resources is not deducted in the standard net measures, which means that the measures overstate the sustainable income of resource-dependent economies.
The adjustment of the measures for the depletion of natural resources and for the degradation of the environment is the objective of the environmental accounting framework. The framework extends the national accounts to record the stocks and the flows of natural resources.
Productivity Measurement
The net measures are used in the measurement of productivity, since the measurement of output and of capital must be consistent in their treatment of capital consumption.
The measurement of productivity relates output to the inputs that produce it, including labour and capital. The capital input is measured as the flow of services from the capital stock, and the measurement must account for the depreciation of the stock.
The failure to deduct capital consumption would overstate the output relative to the input and would bias the measure of productivity. The consistent treatment of capital is therefore essential for the measurement.
International Comparison
The comparison of net measures across countries requires consistent methods for the estimation of capital consumption. The estimates depend on the assumptions about asset lives and depreciation patterns, which vary across countries.
The international standards provide a framework for the estimates, and the statistical agencies follow the standards. The implementation varies, however, and the comparison of the measures requires attention to the differences in the methods.
The comparison of net measures is further complicated by the differences in the composition of the capital stocks and in the prices of the assets. The adjustment for these differences is required for a meaningful comparison.
Summary
Net domestic product is the value of output after deducting the consumption of fixed capital, and it provides a better indication of sustainable income than the gross measure. Its measurement and its use in the analysis of sustainability and of productivity require attention to the estimation of capital consumption.