Here is a simplified formula of calculating GDP.
GDP =
Private Consumption + Govt. Spending + Investments + (Exports-Imports)
So GDP has basically five components. The consumption or
spending (both by Private and Govt.) is the biggest component of GDP, contributing approximately 70% to GDP. This consumption demand is partially met by producing those
goods & services internally, fueling investments within the system. And
some portion of this consumption demand is met by importing resulting in a negative
cash flow. Any surplus goods or services exported bring a positive cash flow to
the system.
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| Cash flow of GDP components for a nation |
Biggest component of GDP, Private and Govt. spending, can
expand or shrink based on what is happening with investments. When investments
grow, new jobs are created, it brings more people under tax net and helps both
Govt. and private spending to grow further. If consumption demand is met by
increasing imports and less by investments, it creates jobs elsewhere draining cash from the system, so
limits the expansion of an economic system.
Let us see what the data is for India during the last
decade.
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| Source: RBI data |
During 2000 to 2007, investments were distinctively higher
than imports. It was self-reinforcing, GDP grew at a healthier rate. During the last two years, investments slowed and
were less than imports. It was self-defeating, resulted in a slower growth of GDP.
