India’s GDP at Factor Cost

India’s Gross Domestic Product (GDP) at factor cost represents the total value of all goods and services produced within the country’s geographical boundaries, evaluated at the cost incurred by producers. It excludes taxes on products and includes subsidies, thereby reflecting income generated by factors of production such as labour, land, capital, and entrepreneurship within the economy. This measure has historically been used to assess the overall economic performance of India and its productive capacity before the country’s transition to the Gross Value Added (GVA) at basic prices framework in 2015.

Concept and Definition

GDP at factor cost refers to the sum of the value added by all sectors of the economy, measured at the prices paid to the factors of production. It is calculated by summing up the incomes earned by labour and capital within the country, including wages, rent, interest, and profits. Mathematically, it can be represented as:
GDP at Factor Cost = Compensation of Employees + Operating Surplus + Mixed Income of the Self-Employed + Net Indirect Taxes (Subsidies deducted)
Under this concept, the emphasis is on the cost of production rather than the market price. It essentially represents what producers receive for their output before accounting for taxes on products such as excise duty or value-added tax.

Historical Background

Prior to the revision of the national accounting system in 2015, India’s Central Statistics Office (CSO) used GDP at factor cost as the principal measure of national income. This approach was consistent with the methodology recommended by the United Nations System of National Accounts (SNA) of 1968 and 1993. However, to align with international standards set by the 2008 SNA, India adopted the concept of Gross Value Added (GVA) at basic prices and GDP at market prices.
Until 2014–15, most Indian economic analyses, policy documents, and planning commission reports used GDP at factor cost to gauge sectoral and national growth. This measure provided a clear understanding of the productive efficiency of various sectors such as agriculture, manufacturing, and services, without being distorted by government taxation or subsidy policies.

Components of GDP at Factor Cost

GDP at factor cost is derived from the income approach, which measures the earnings of factors of production. The main components are:

• Compensation of Employees: Includes wages and salaries, along with employers’ social contributions.
• Operating Surplus: Represents the profit earned by private corporations, public enterprises, and cooperatives after deducting intermediate costs.
• Mixed Income of the Self-Employed: Reflects earnings from unincorporated enterprises where labour and capital are inseparable, particularly relevant in India’s informal sector.
• Net Indirect Taxes: Taxes on production and imports less subsidies. In GDP at factor cost, these are deducted to isolate the income accruing purely to production factors.

This approach enables an understanding of how much income is generated within the production process, separate from market-based distortions.

Sectoral Contributions

India’s GDP at factor cost was traditionally broken down into three broad sectors — primary (agriculture, forestry, fishing, and mining), secondary (manufacturing, electricity, gas, water supply, and construction), and tertiary (services). Over the decades, the composition has undergone a marked transformation:

• In the 1950s and 1960s, the agricultural sector accounted for nearly 50% of GDP at factor cost.
• By the early 2000s, the service sector had become dominant, contributing over 55% to GDP at factor cost.
• The industrial sector maintained a relatively stable contribution of around 25–30% during this period.

This shift reflects structural changes in the Indian economy from an agrarian to a service-driven model, highlighting the growing importance of information technology, communication, and financial services.

Transition to GVA and GDP at Market Prices

In 2015, India replaced the GDP at factor cost measure with Gross Value Added (GVA) at basic prices and GDP at market prices to harmonise with global statistical norms. The fundamental distinction lies in the inclusion or exclusion of taxes and subsidies:

• GVA at Basic Prices: Measures the value of output less intermediate consumption, excluding product taxes but including production taxes.
• GDP at Market Prices: Includes all taxes on products and excludes subsidies on products.

The relationship between the two is expressed as:
GDP at Market Prices = GVA at Basic Prices + Taxes on Products – Subsidies on Products
While GDP at factor cost and GVA at basic prices are conceptually similar, the new framework provides greater transparency and comparability across countries.

Advantages of the Factor Cost Approach

• Clear Measurement of Production Income: It focuses on the actual income generated by productive factors, excluding fiscal distortions.
• Sectoral Analysis: Useful for analysing sector-wise contributions to national income, particularly in policy design for employment and productivity.
• Historical Comparability: Allows longitudinal study of India’s economic growth patterns before 2015.

However, the factor cost measure is less effective for analysing demand-side variables or assessing the overall spending in the economy, as it does not account for taxes and subsidies influencing market prices.

Limitations and Criticism

The GDP at factor cost method faced several criticisms leading to its discontinuation:

• Lack of International Comparability: Most countries used GDP at market prices or GVA at basic prices, making cross-country comparisons difficult.
• Inadequate Reflection of Market Conditions: Since it excluded indirect taxes and subsidies, it did not represent the actual prices faced by consumers.
• Obsolete Classification: The older sectoral classification and data sources under the factor cost method did not capture the rapid structural shifts in India’s modern economy.
• Data Challenges: Informal sector estimations and lack of standardised income measures often led to underestimation of true economic activity.