Measuring economic activity

GDP, GNP & NNP

Choosing between GDP, GNP and NNP

Capital consumption

Net material product

Omissions from GDP data

Surveys and sampling

Unrecorded transactions

GDP, GNP & NNP

Total economic activity may be measured in three different but equivalent ways.

Perhaps the most obvious approach is to add up the value of all goods and services produced in a given period of time, such as one year. Money values may be imputed for services such as health care which do not change hands for cash. Since the output of one business (for example, steel) can be the input of another (for example, automobiles), double counting is avoided by combining only "value added", which for any one activity is the total value of production less the cost of inputs such as raw materials and components valued elsewhere.

A second approach is to add up the expenditure which takes place when the output is sold. Since all spending is received as incomes, a third alternative is to value producers' incomes.

Thus output = expenditure = incomes.

The precise definition of economic activity varies. The three main concepts are gross domestic product, gross national product and net national product.

Gross domestic product. GDP is the total of all economic activity in one country, regardless of who owns the productive assets. For example, the UK's GDP includes the profits of a foreign firm located in the UK even if they are remitted to the firm's parent company in another country.

Gross national product. GNP is the total of incomes earned by residents of a country, regardless of where the assets are located. For example, the UK's GNP includes profits from UK-owned businesses located in other countries.

Net national product. The "gross" in GDP and GNP indicates that there is no allowance for depreciation (capital consumption), the amount of capital resources used up in the production process due to wear and tear, accidental damage, obsolescence or retirement of capital assets. Net national product is GNP less depreciation.

The relationship between the three measures is straightforward:

GDP (gross domestic product)

+ net property income from abroad (rent, interest, profits and dividends)

= GNP (gross national product)

- capital consumption (depreciation)

= NNP (net national product)

Choosing between GDP, GNP and NNP

Net national product (NNP) is the most comprehensive measure of economic activity, but it is of little practical value due to the problems of accounting for depreciation. Gross concepts are more useful.

Analysts tend to say that GDP is a better measure than GNP, and that now seems to have been accepted by all the major industrial countries. The US, Germany and Japan, which had until the early 1990s focused on GNP, now use GDP. The difference between GDP and GNP is usually relatively small, perhaps 1% of GDP, but there are a few exceptions; for example, in 1995 Kuwait's GNP was 15% bigger than its GDP, owing to the country's income from foreign assets. In the short term a large change in total net property income has only a minor effect on GDP. When reviewing longer-term trends, it is advisable to check net property income to see if it is making GNP grow faster than GDP.

Capital consumption

Capital consumption is not identifiable from a set of transactions; it can only be imputed by a system of conventions. GDP is measured gross - ie total new investment counts in GDP even though some of it is replacing obsolete plant and equipment. But NNP is a net concept, and so capital consumption is subtracted. But the rate at which investments are depreciated is essentially a decision made by statisticians. Getting the depreciation rate wrong will affect both figures for NNP and data on the capital stock in an economy.

Net material product

Some countries, mainly centrally planned economies, have used net material product (NMP) to measure overall economic activity. This has been supplanted by GDP in the former communist countries as they adopt market economies. NMP is less comprehensive than GDP because it excludes "non-productive services", such as banking, government administration, health and education, and is quoted net of capital consumption (depreciation).

Omissions from GDP data

There are many things which are not in GDP, including the following.

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Some of the exclusions can be identified elsewhere. For example, environmental costs are seen in statistics on pollution and most countries report known oil or coal reserves (although these estimates may be over-optimistic or clouded by genuine ignorance about the size of underground reserves).

One other point to note is that the more advanced government statistical agencies include in GDP an allowance for the imputed rent paid by home owner-occupiers. This avoids an apparent change in national output because of any switch between owner-occupation and renting.

Surveys and sampling

Many of the figures which go into GDP are collected by surveys. For example, governments ask selected manufacturing or retailing companies for details of their output or sales each month. This information is used to make inferences about all manufacturers or all retailers. Such estimates may not be correct, especially as the most dynamic parts of the economy are small firms constantly coming into and going out of existence, which may never be surveyed.

Sample evidence is supplemented by other information, including documentation required initially for bureaucratic purposes such as customs clearance or tax assessment. Such data take a long time to collect and analyse, which is why economic figures are frequently revised even when they are several years old.

Unrecorded transactions

GDP may under-record economic activity, not least because of the difficulties of keeping track of new small businesses and because of tax avoidance or evasion.

Deliberately concealed transactions form the black, hidden or shadow economy. This is largest at times when, and in countries where, taxes are high and bureaucracy is smothering. Estimates of the size of the shadow economy vary enormously. For example, differing studies put the US's at 4 - 33%, Germany's at 3 - 28% and the UK's at 2 - 15%. What is agreed, though, is that among the industrial countries the black economy is largest in Italy, at perhaps one-third of GDP, followed by Spain, Belgium and Sweden, while the smallest black economies are in Japan and Switzerland at around 4% of GDP.

The only industrial countries that adjust their GDP figures for the shadow economy are Italy and the US and they may well underestimate its size.

Related topics:

Gross domestic product