According to the National Income Committee, ‘‘A national income estimate measures the volume of commodities and services turned out during a given period, counted without duplication.’’ Thus, a total of national income measures the flow of goods and services in an economy. National income is a flow and not a stock concept. Economists measure national income in terms of its production aspect, income aspect, and expenditure aspect. Production aspect of national income points to the flow of goods and services in the economy or the process of value adding. Income or distribution aspect points to the generation of income in terms of wages, rent, interest, and profit. Expenditure or disposition aspect points to the disposal of income in terms of consumption expenditure or investment expenditure. Accordingly, we have three methods of measuring national income: product method, income method and expenditure method (Jain & Ohri, 2010).
The four ways to look upon ‘income’ of an economy, even though poles apart from each other, in some way, are the concepts of GDP, NDP, GNP, and NNP. All are a form of the national income but are different from one another. They all say a different story about the income of a nation in their own specific way (Singh, 2013). The distinction between Gross and Net is just a matter of depreciation. While calculating national income, it is important to bear in mind that depreciation charges are to be excluded.
Now, the million dollar question is: what do we mean by depreciation?
Depreciation, also called consumption of fixed capital refers to the loss of value of fixed assets (in use) on account of normal wear and tear due to their continuous use, expected obsolescence because of some capital equipment becoming obsolete or out of date with the introduction of latest machines and equipments, and accidental damages or breakdown of the machinery (Jain & Ohri, 2010). While estimating depreciation, loss of value of only those assets is to be considered which are in use. Moreover, only expected obsolescence is to be considered which may occur due to change of technology, and change in demand. Unexpected obsolescence occurring due to natural calamities like fire, torrents, tsunami or floods is not to be considered. It is important to note that current replacement cost is the expenditure incurred by a nation on the replacement of worn out assets during the year. It is the same as depreciation estimated for the economy as a whole.
Another equally important question is: what is the role of depreciation in National Income estimation? Net Domestic Product (NDP) is the GDP calculated after adjusting the weight of the value of ‘depreciation ‘or consumption of fixed capital. This is, basically, net form of the GDP, i.e. GDP minus the total value of the ‘wear and tear’ (depreciation) that happened in the assets while the goods and services were being produced. Every asset (except human beings) undergoes depreciation in the process of their use, which means these ‘wear and tear’.
The NDP of an economy has to be always lower than its GDP for the same year, since there is no way to cut the depreciation to zero. But, mankind has achieved too much in this area by developments such as ‘ball-bearing’, ‘lubricants’, and so on all revolutionized, modernized and innovated to minimize the levels of depreciation. The governments of various economies decide and announce the rates by which assets depreciate (done in India by the Ministry of Commerce and Industry) and a list is published, which is used by the different sections of the economy to determine the real levels of depreciations in or of different assets.
For example, a residential house in India has a rate of 1 per cent per annum depreciation, an electric fan has 10 per cent per annum, and so on, calculated in terms of the asset’s price. This is one method how depreciation is used in economics. The other way it is used in the external sector while the domestic currency floats freely in front of the foreign currencies, If the value of the domestic currency falls following market mechanism in front of a foreign currency, it is the situation of ‘depreciation’ in the domestic currency, calculated in terms of loss in value of the domestic currency.
Depreciation Reserve Fund helps in keeping the existing stock of capital integral and intact. In case, depreciation reserve fund is not maintained, fixed assets (like plant and machinery) would wear out without replacement. Consequently, production capacity of the producers would start dwindling. Hence, in order to improve the productive capacity in an economy and increase the income and employment levels, it is very important for policy makers and planners to maintain a Depreciation Reserve Fund. An important and sufficient condition for more efficient depreciation costs used to replicate fixed assets, even as the connected calculation structures and methods improve, is to uphold creditworthiness, predominantly in the setting of widespread inflation and fiscal instability.
Depreciation plays an important role as far as reproduction and regeneration of fixed assets in an economy is concerned, particularly in the construction sector. It is the main source for adoption of innovative technologies and advanced equipment but its role is undermined due to the fact that very less amount of depreciation funds are used directly for repayment and accumulation and most of the depreciation funds are misused by business houses, particularly construction businesses in terms of remuneration, working capital, and other purposes. That is to say that depreciation funds are used to sponsor activities unconnected to reproduction of assets. It is high time to bunk the depreciation junk, particularly in the current situation with investment leakages and shortages and dog-tired fixed assets which definitely calls for a centralized government level decision to implement targeted use of depreciation reserve funds. The need of the hour is to adopt the better systematic method of depreciation that sufficiently and therefore, satisfactorily represents real wear and tear of capital assets, and assesses depreciation better.
Jain, R.T. & Ohri, K.V. (2010). Introductory Microeconomics and Macroeconomics. VK Publications, New Delhi. ISBN: 81-87344-21-0.
Singh, R. Indian Economy, 5e, McGrawHill Education (India) Private Limited, 2013.
—The author is Research Scholar at the Department of Economics, Central University of Kashmir, and an Academic Counsellor, IGNOU STUDY CENTRE 1209,S.P. College, Srinagar. She is also Editor in EPH – International Journal of Business and Management Science & Asian Journal of Managerial Science and a recipient of IJRULA title awards, 2018 winner (Best Researcher, 2018). She can be reached at: firstname.lastname@example.org