Tuesday, 13 March 2012

GNP versus GDP

The Irish case
Ireland has experienced large trade surpluses and current account deficits. The data show that the income paid by Irish residents to non-resident owners of domestic factor of production (such as capital) is often larger than the trade balance surplus. (click to enlarge)

We are told that most of the foreign direct investment to Ireland was in capital intensive industries (such as pharmaceuticals). The implication is that labour compensation (Irish residents) commands a relatively small share of the product of those industries.


There are two main concepts of aggregate measure of goods and services produced: GNP and GDP. GDP covers the goods and services produced by labor and capital located in Ireland. As long as the labor and capital are located in Ireland, the suppliers may be either Irish residents or non-residents. GNP covers the goods and services produced by labor and capital supplied by Irish residents.

Portugal is well aware of the difference between GNP and GDP as in the past its trade balance deficit was mostly entirely covered by labour income remitted by emigrants. The advantage with GDP is certainly that it is more precisely measured than GNP. However when the focus is on the availability of a Nation's resources to finance itself, GNP appears to be the relevant aggregate.

It should be now clear that when it comes to the capacity of financing its external debt, the relevant flow concept is the current account. Obviously improving the trade balance is crucial but data have to be analyzed with a grain of salt. Assume a foreign export oriented futuristic motor-vehicle plant that produces and assembles vehicles in minutes and is controlled by 2 workers.Part of the value added produced (net exports) by the plant will stay in the country (the 2 workers wage) and part will flow out (income payments) to the plant owners.


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