Financialisation of gross domestic product

Inclusion of fee-based financial revenues since 1993 overstates size of GDP

LAHORE:

Gross domestic product (GDP) has remained a powerful metric in the history of nations as it is a techno-political tool across the globe. This metric determines the economic strength of a country. Economic textbooks inform us that there are three methods to measure GDP: value-added, expenditure and income.

The measurement of economic activity through the value-added approach started in the first decade of the 20th century. However, the measurement through the expenditure method started around the mid-1930s as government services were included in the calculation of GDP at that time. Till 1953, the GDP was restricted to the sphere of production, while financial activities were not part of it. Financial activities were considered as a net transfer.

The System of National Accounts (SNA) is an international system to calculate and harmonise GDP across the world. SNA compiles and integrates macroeconomic concepts and definitions according to accounting rules. These tasks used to be performed by the United Nations Statistical Agency.

The international finance got ascendency in the early 1990s owing to financial globalisation. Financial globalisation is manifested through financial liberalisation and international capital/financial mobility. In the making of SNA 1993, the International Monetary Fund (IMF), the World Bank and a few central banks played an important role.

In the SNA 1993, fee-based financial revenues were declared as a final output/service and included in GDP. The practice was even followed in SNA 2008. Now, the calculation of GDP includes these fee-based incomes.

GDP is the sum total of final output of business firms, consumption of consumers, services of government and net exports. Transfer payments such as social security benefits, pensions and subsidies are not included in GDP. Similarly, financial activities used to be considered as transfer payments from 1953 to 1993.

The Financial Intermediation Services Indirectly Measured (FISIM) provides an estimate of the value of financial services provided by banks and financial institutions. These are also called net interest income – the difference between borrowers and depositors. These net interest incomes are considered as intermediate inputs to business firms and hence deducted from GDP.

However, banks and other financial institutions generate fee-based incomes. For instance, commercial banks collect ATM fee, account maintenance fee, wire transfer fee, overdraft protection fee, etc. Financial corporates gather Letter of Credit fee, underwriter fee, foreign exchange transaction fee and merger and acquisition advisory fee. In addition, wealth management firms accumulate the fee for advising clients and charge commission for selling their products.

Insurance agents sell invisible services to their clients. They get a certain percentage of commission out of the annual premium. Similarly, real estate agents also get a percentage of commission when they facilitate their clients in buying and selling plots, houses and commercial buildings. These are all fee-based incomes which are included in GDP.

Finance, insurance and real estate are termed FIRE. The acronym FIRE is the sub-sector of the services sector. Hence, the concept of GDP was modified through the inclusion of FIRE.

These FIRE sub-sectors contribute around 20% to 25% to the US/UK GDP. This shows that FIRE has a significant weight in the GDP of advanced countries. In Pakistan, FIRE contributes around 7% to 7.5% to GDP. The weight of FIRE has been on the rise since 1993. Therefore, FIRE has inflated the size of GDP.

In a nutshell, the financialisation of GDP started in 1993. The conceptual modification of GDP was carried out to fit the emerging realities. Historically, GDP was restricted to the domain of production and trade, while financial activities remained an intermediate input from 1953 to 1993. Last but not the least, the inclusion of FIRE overstated the size of GDP.

The writer is an independent economist who authored a book: Pakistan's Structural Economic Problems in the era of Financial Globalization