National Economic Measures: GNP, GDP, and Balance of Payments
Gross National Product: Definition and Scope
Gross National Product (GNP) is defined as “the value of all final goods and services produced by the country’s factors of production and sold in the market in any given period” (Krugman, 2015).
To measure a country’s total output, we sum the market value of all goods and services produced.
Avoiding Double Counting in GNP
When calculating GNP, it is crucial to avoid double counting. This means not accounting for intermediate goods.
For example, if a pen is sold for 1€, and 30 cents were paid for the ink, the ink is not counted separately in the GNP. Its contribution to the national output’s value is already included in the 1€ price of the pen. However, a machine used in production is considered an investment, not an intermediate good.
Gross National Product and National Income
GNP must equal national income, which is the income earned by the factors of production. This implies that what is spent on purchasing products is earned by someone as salaries or benefits. Every euro spent on the purchase of a good or service eventually ends up in someone’s bank account.
Adjustments for National Income Calculation
For the equality between GNP and national income to be accurate, two adjustments are necessary:
- Include Depreciation: Machinery wears out and loses value over time.
GNP - Depreciation = Net National Product (NNP) - Include Unilateral Transfers: These are transfers sent to a country without any compensation, such as money sent to retirees living abroad or foreign aid. Unilateral transfers are part of the national income but not part of its product.
National Income = GNP - Depreciation + Unilateral Transfers
Following Krugman’s perspective, due to their insignificant difference in many contexts, the terms GNP and National Income are often used interchangeably.
GNP vs. GDP: Understanding the Difference
While Gross Domestic Product (GDP) measures the volume of production within a country’s borders—everything produced in a country regardless of the origin of the factors of production—GNP measures the production of national factors of production, whether located within the country or abroad.
The relationship can be expressed as:
GNP = GDP + Net Receipts of Factor Income from the Rest of the World
GNP thus corrects for the portion of a country’s production carried out using services provided by foreign-owned capital and labor.
Components of National Output (Y)
National output (Y) is typically broken down into four main components:
1. Consumption (C)
This is the portion of GNP purchased by private households. It represents what individuals buy to fulfill their needs and wants. Examples include spending on food, a laptop, or a dinner at a restaurant.
2. Investment (I)
This refers to the portion of production consumed by private companies to produce their own output. It’s important not to confuse this with the common household meaning of “investment” (e.g., purchasing stocks or funds). Economic investment includes consulting services, facilities built, and new machinery.
3. Government Purchases (G)
This includes all consumption and investment by local and national authorities, from the construction of a hospital to money spent on education. Transfer payments, where the recipient provides nothing in return (e.g., unemployment insurance payments), are not considered government purchases in this context.
4. Current Account (CA)
In modern economies, not everything produced domestically is purchased within the country’s borders, and not everything purchased domestically is produced within the country. The Current Account (CA) is the difference between a country’s exports (EX) and imports (IM).
CA = EX - IM
The aggregate demand for a country’s output (Y) can be expressed as:
Y = C + I + G + EX - IM
Current Account Rationale and Implications
Consider an economy with only private consumption. If 100€ worth of output is produced, but 105€ is consumed, the extra 5€ worth of consumption must come from outside the country (imports).
- When a country imports more than it exports, it has a current account deficit.
- When a country exports more than it imports, it has a current account surplus.
For example, China, as one of the world’s largest exporters, typically has a current account surplus, whereas the U.S. often has a current account deficit.
If a country incurs a current account deficit, it must fund it. Importing more than exporting necessitates borrowing money, which increases foreign debt. This implies that at some point in the future, the country will need to export more than it imports to repay this debt.
A long and sustained current account deficit can lead to a large foreign debt and a negative Net International Investment Position (IIP), which is the difference between a nation’s claims on foreigners and its liabilities to them.
Balance of Payments
To understand and track the composition of the current account balance and the transactions that finance it, we use the Balance of Payments (BOP). The BOP records a country’s payments to and receipts from foreigners. These transactions are classified into three main types:
- Current Account: Records exports and imports of goods and services.
- Financial Account: Records the purchase or sale of financial assets (e.g., money, stocks, factories).
- Capital Account: Records transfers of wealth, mostly from non-market or intangible assets (e.g., copyrights, forgiven debt).
Every transaction in the balance of payments has a double entry, ensuring that the balance always sums to zero. Therefore, there is no such thing as a “deficit in the balance of payments,” as is sometimes mistakenly reported in the media.