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Good business environment necessary to increase growth

Published:Wednesday | September 10, 2014 | 12:00 AM

ACCORDING TO the Global Competitiveness Report 2014, Jamaica's has improved eight places on the rankings, from 94th last year to 86th this year.

Jamaica has a more competitive business environment than Trinidad and Tobago, currently ranks at 89th, down from 92nd last year.

Barbados continues to lead the Caribbean despite falling in rank, from 47th to 55th. A good business environment is necessary to increase economic growth in a country and to stabilise total prices.

In today's Briefing, we will discuss the fundamental principles of economic growth; in particular, define and explore the concept of gross domestic product (GDP) and the aggregate price level, inflation.

What is GDP?

GDP measures the total amount of goods and services produced in a given economy during a specific period of time. GDP can be calculated three ways - the income approach, the output approach and the expenditure approach.

In the circular flow, households provide labour to firms in exchange for a salary, while firms sell goods and services to households in exchange for the income they earn.

If a particular product enters several production processes, GDP takes into consideration the final value of the product. The value of the intermediate good is not added when calculating GDP since this would have already be counted in the value of the final product.

For example, assume there is only one farmer in Jamaica who produces sugar cane. He sells this sugar cane to the factory for $1.The factory uses this sugar cane to produce sugar and sells the sugar to a juice company for $3. The juice company uses the sugar to make juice and sells it for $5. GDP, in this case is $5, the value of the final product, since the value added is already included in the final price.

How is it calculated?

From and expenditure point of view, GDP is the sum of all that is consumed in the country, plus all investments, government spending and net exports. An economy can grow, therefore, if one of these variables increases without a corresponding decrease in another.

In the current Jamaican reality, neither consumption nor government spending will grow significantly given the tight fiscal space and low levels of income received by households.

The key to growth is really investments which can have a positive impact on net exports.

People often confuse GDP with Gross National Product (GNP). They are similar but different. Whereas GDP measures all that is produced on Jamaican soil, regardless of whether the producer is a Jamaican or not, GNP measures what Jamaica produces over a particular period of time, regardless if it is produced in Jamaica or not. There is also the issue of real versus nominal GDP.

What is the difference?

Let us assume that Jamaica produces only five oranges two years in a row, 2012 and 2013. Real GDP in both years is the same, regardless of price, since the same amount was produced both years. Let us assume the price of oranges in 2012 was $2, so total value of everything produced in 2012 was 5x$2 = $10. If the price in 2013 was $3, then total value of what was produced was 5x$3=15. In this case, given that prices would have increased from 2012 to 2013, nominal GDP increased from $10 to $15, even though the same number of oranges (only five) was produced both years. Essentially, real GDP measures the absolute change in what is produced, irrespective of price changes. Real and nominal GDP are connected by the GDP deflator.

What is the GDP deflator?

The GDP deflator removes the effect of inflation (change in aggregate prices) on GDP, which converts nominal GDP to real GDP. Inflation is the percentage increase in the level of prices overall. GDP deflator is one such measure and the other is the consumer price index (CPI). The CPI is the regular measure of the inflation rate that we are familiar with, and is usually published by Statistical Institute of Jamaica (STATIN). The CPI keeps track of changes to the cost of living of a regular household, which allows comparisons as to what can a dollar purchase over time. How does STATIN compute the CPI?

STATIN conducts a survey collecting data to determine what people would normally buy in the average supermarket basket on a monthly basis. Every month, STATIN collects data on the price of these good in the typical basket. The CPI measures how the cost of the goods in the basket changes from month to month.

Dr Andre Haughton is a lecturer in the Department of Economics on the Mona campus of the University of the West Indies. Follow him on twitter @DrAndreHaughton; or email editorial@gleanerjm.com.