Earlier today on Twitter, RahulRG pointed out a research report by Credit Suisse analysts Neelkanth Mishra and Ravi Shankar which talks about India’s massive informal economy. The report says that by nature the informal economy cannot be measured, because of which our estimates of GDP may not be accurate. The analysts point out that every time we move to a new series of GDP (we last did so in 2004, and are likely to do so again shortly), there is an upward revision in the GDP for the preceding series, which they attribute to underestimation of the contribution of the informal sector.

While these numbers are likely to get fixed when we move to a new series, what I’m concerned about is what this uncertainty in GDP estimation means with respect to the GDP growth rate, since that is the one number that analysts of all hues track when trying to understand how the country is doing. For example, if you google around you will see analysts arguing about whether India’s GDP growth in the next quarter will be 4.7% or 4.8%. Before we settle to argue on such minutae, I argue, we first need to understand the possible uncertainty in GDP estimates.

In order to estimate the impact of uncertainty of the GDP calculation on uncertainty in GDP growth, I did what I know best – a simulation. For different levels of accuracy, I calculated the range that the actual GDP growth can take. The results are presented in the following table. The first column in the table refers to the accuracy of the GDP estimate at the 95% confidence level. That is, if the first column shows 1%, it means that if the GDP is estimated to be 100, the “true” value of the GDP will be between 99 and 101 95% of the time.

Error | True GDP Growth Rate | |||

5% | 6% | 7% | 8% | |

0.05% | 4.93-5.07 | 5.93-6.07 | 6.92-7.08 | 7.92-8.08 |

0.1% | 4.85-5.15 | 5.85-6.15 | 6.85-7.15 | 7.85-8.15 |

0.2% | 4.7-5.3 | 5.7-6.3 | 6.7-7.3 | 7.69-8.31 |

0.5% | 4.26-5.74 | 5.26-6.75 | 6.25-7.76 | 7.24-8.77 |

1% | 3.54-6.49 | 4.51-7.52 | 5.5-8.52 | 6.48-9.53 |

2% | 2.09-8.03 | 3.03-9.02 | 4-10.05 | 4.98-11.13 |

Notice that even if the measurement of the actual GDP is accurate up to 0.05% (or 5 basis points), we can estimate the growth in GDP only up to an accuracy of 15 basis points! So arguing whether the GDP growth will be 4.7% or 4.8% is, in my opinion, moot! Unless our statisticians can say that the accuracy in measurement of the GDP is within 5 basis points that is!

PS: Also read Neelkanth Mishra’s excellent op-ed in the Indian Express on India’s informal economy.