Measuring a Nation's Economic Development With GNP

What Is Gross National Product (GNP)?

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

Understanding Gross National Product (GNP)

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 the final (and only final) goods and services produced. For example, timber is sold to a paper manufacturer. The paper manufacturer makes paper from 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.

Gross National Product vs. Gross Domestic Product

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.

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 between these two figures is the rate of inflation during the time period.

Example of GNP

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.

Formula for GNP

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

The 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) are 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.
• Finally, net factor payments (NFP) are the net amount of payments that an economy pays to foreigners for inputs used in producing goods and services, less money the economy receives for selling the same factors of production.

Criticism of 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 measures of national well-being widens as a country's fortunes improve.

How Do You Calculate a Country's GNP?

A country's gross national product is calculated by adding up total consumption, government spending, investments, net exports, and net factor payments (the payments to foreign actors for factors of production, minus the payments received by domestic actors from foreign buyers). Note that this is the same calculation as gross domestic product, with the additional term for net factor payments.

Why Did GDP Replace GNP?

In 1991, the Bureau of Economic Analysis began reporting gross domestic product as the key measure of U.S. productivity. This replaced gross national product, which had been the default measure since 1934. According to the BEA, this is because GDP was the more "appropriate" measure for aggregative production, because many other countries had adopted it and it had become an international standard. In addition, GDP was more consistent with coverage of other indicators, like employment and productivity.

When Is GNP More Useful Than GDP?

While GDP is now the preferred metric for a country's productivity, there are circumstances where GNP may be useful. One example may be in measuring the productivity of a country's multinational corporations: the foreign income of these companies is part of the GNP, even though they are produced and sold abroad. Another example might be a country with a large population of overseas citizens, whose foreign incomes are included in the country's GNP.

The Bottom Line

As a measure of productivity, 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.