Measuring a Nation's Economic Development with GNP

Gross national product (GNP), a term used as a measure of a country's economic growth and wealth, is often misleading. There are certain situations wherein using GNP is useful, but if used improperly, it can confuse and deceive. In this article, we'll show you how to properly read the GNP map to make sure you arrive at your data destination safely.

GNP includes the aggregate value of goods, such as cars, houses, food and drinks, as well as the value of services such as legal and medical fees that are produced and purchased by a nation during a given time period. The market value of these outputs is added together to calculate GNP.

Here are some important characteristics that should be noted about the input data:

1. GNP is calculated using the value of final (and only final) goods and services produced. For example, timber is sold to a paper manufacturer. The paper manufacturer makes paper from the timber. The paper is then sold to a book manufacturer, who then sells the book to a publisher, who sells it to a bookstore, who finally sells it to an individual buyer. In order to avoid double counting, only the final book price is used to calculate GNP. The value of the intermediary transactions is embedded in the final cost.
2. GNP uses only the values of output currently produced. Therefore it excludes sales of used items and existing houses. For example, GNP includes new cars on dealers' lots but not the used cars selling on the same lot.

Another term, gross domestic product (GDP), is closely related to GNP, but there are differences between the two. Whereas GNP is the final value of goods and services produced by domestically owned means of production (using domestic labor and resources), GDP is the final value of goods and services produced within a given country's border. Part of GNP, therefore, is earned overseas, while some domestic production is added to GDP only. (To find out more about GDP, see "The Importance of Inflation and GDP.")

Example - GNP versus GDP Honda manufactures cars in the U.S., but is incorporated in Japan. The cars it produces in the U.S. are added to U.S. GDP, but not U.S. GNP, as these cars use domestic factors of production (labor and resources), but are produced by a foreign nation. Conversely, the values are added to Japan's GNP, but not Japan's GDP. Another example involves U.S. company Intel, which manufactures silicon chips in Ireland. The production from that facility is added to U.S. GNP, but not U.S. GDP. When U.S. residents earn more abroad than foreigners earn in the U.S., GNP exceeds GDP and vice versa.

Nominal GNP measures the total value of all output produced using the prices of that time period. For example, the nominal GNP for 2000 is calculated using the 2000's price level (as measured by the consumer price index), while the nominal GNP for 2005 uses 2005's price level. The difference in these two figures is the rate of inflation during the time period. (Keep reading about inflation in "All About Inflation" and "Curbing the Effects of Inflation.")

While GNP measures total supply of output produced during a given period, it then must also equal total demand (assuming there is no savings in an economy).

Total demand for domestic output is made up of five components: consumption, government spending, investment, net exports and net factor payments. Because GNP must equal total demand for output, it can then be expressed mathematically by:

$\text{GNP}=\text{C}+\text{G}+\text{I}+\text{NX}+\text{NFP}$GNP=C+G+I+NX+NFP

The calculation is broken up as follows:

• Consumption (C) is the actual consumption spending of the household sector. It consists of food, clothing and all consumer spending. Consumption is by far the largest component of GNP and accounts for approximately two-thirds of total demand.
• Goods and services (G) is the next largest component of government purchases. These items include salaries for government employees, national defense, and state and local government spending. Government transfer payments, such as unemployment compensation, are not included.
• Investment spending (I) is not what we commonly think of when we discuss investing. It does not include the purchases of stocks and bonds. Rather, investment spending includes business spending that will improve the ability to produce in the future. Inventory spending, capital improvements and building machinery are included in this category. Investment in housing construction is also included.
• The net exports (NX) component is equal to exports (goods and services purchased by foreigners) minus imports (goods and services purchased by domestic residents). For some time the U.S. has been buying more foreign goods and services than it sells abroad, which creates a trade deficit, thereby reducing its GNP.

While GNP measures production, it is also commonly used to measure the welfare of a country. Real GNP growth is seen as an improvement in living standards. Unfortunately, GNP is not a perfect measure of social welfare and even has its limitation in measuring economic output. Improvements in productivity and in the quality of goods are difficult to calculate. For example, personal computer prices have dropped dramatically since their introduction, yet their capabilities have vastly improved.

National income accountants try to adjust for improvements, but the process is not easy and far from precise. Some outputs are poorly measured because they are not priced in an active market. Work done by volunteers, do-it-yourselfers and stay-at-home parents certainly contributes to a nation's well-being, but this work is not calculated into the GNP because it is not purchased, nor is there an active market to measure the value of such activities.

Further, the recovery efforts for disasters add to GNP, yet the welfare of the nation does not improve. Take, for example the damage done to New Orleans by Hurricane Katrina. Katrina destroyed homes, businesses and resorts. Many people were killed, while many were displaced. Consumer and investment spending to clean up and replace lost possessions and buildings added to C and I in the formula above, while government spending for relief and clean up added to G. As a result, GNP may have risen, but the welfare of the U.S. overall was diminished.

Finally, GNP places no value on leisure time. Most would agree leisure time is important to our well-being. In fact, as countries get richer, citizens generally take more leisure time for themselves. As a result, the gap between GNP and some other measure of national well-being widens as a country's fortunes improve. (To read more on our love of leisure, see "Life Planning - More Than Just Money.")

As you can see, the GNP has its limitations. It adds the costs associated with correcting social ills, but charitable works often are not accounted for. While not precise, it is still a useful tool in measuring a nation's economic output and overall demand.

To read more about economic indicators, see "A Top-Down Approach to Investing," "Macroeconomic Analysis," and "Economic Indicators to Know."