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The Essence of National Income Accounting
Gross National Product (GNP) records the market value (i.e., price times quantity) of goods and services sold to final users (private consumers, businesses and governments). According to its standard interpretation, GNP is a barometer of a country’s overall prosperity. If it increases from one point in time to the next then it is agreed that ‘the economy’ has grown. Under these circumstances government ministers and their backbenchers claim that their party’s policies have succeeded, congratulate one another for their efforts and proclaim that consumers have good reason to be confident about the future. The greater GNP’s increase the greater the rejoicing. Conversely, if GNP falls then consternation is the order of the day: it is decided that ‘the economy’ has shrunk and, if this patently intolerable state of affairs persists, businessmen and politicians fill the air with recriminations. Under these circumstances, and also when GNP’s rate of growth slows, politicians and central bankers exhort consumers to spend and to become (more) confident about the future; politicians and consumers demand (sometimes stridently) that central banks reduce interest rates; some consumers and some central bankers urge governments to increase their spending; and others press governments to reduce their taxing.
Clearly, then, mainstream economic thinking inextricably links GNP, expenditure and confidence. Underlying this thinking is the view that uncertainties, animal spirits and irrationalities – which are perceived to be deep-seated features of voluntary transactions in the marketplace – dominate economic transactions and behaviour. These uncertainties, it is said, are reflected in the level of consumer confidence. Its level underpins not just contemporary explanations of prosperity and recession but also current prescriptions to maintain good times and combat recession. The notion that slowdowns (the use of the word ‘recession’ is regarded as bad form, and ‘depression’ has been banned from the lexicon) are attributable to consumers’ pessimism about the future and consequent unwillingness to spend suggests the need for central direction and policy activism. According to this conventional view, prosperity stems from – indeed, is virtually synonymous with – strong growth of consumer spending; and this spending, in turn, depends upon prescient, decisive and optimistic policies by politicians (i.e., high spending, low taxing) and central bankers (i.e., high creation of credit, low standards of credit).
Table 1 sets out the components of Australia’s GNP for 1994-95 (the most recent year for which the corresponding data in Table 2 could be found). It shows that personal consumption expenditure comprised half of GNP in that year. (Other years and other countries’ figures are broadly similar in this respect). This percentage, far higher than the other three, is the empirical basis of the contention that the continuation of prosperity in Australia depends upon the continuation of high levels of consumer spending and policies which facilitate this spending. Hence the growing attention accorded recently by the Reserve Bank of Australia, the U.S. Federal Reserve and other central banks to consumer expenditure and confidence; hence central bankers’ relaxed attitude in recent years vis-à-vis the rapid growth of consumer debt; and hence, between January and March 2001, the most aggressive reductions of interest rates in a decade.
Table 1: GNP, Australia, 1994-95 ($m)
| Personal Consumption Expenditure |
$243,539 |
(51%) |
| Gross Private Domestic Investment |
$ 67,424 |
(14%) |
| Government Purchases |
$ 88,508 |
(18%) |
| Net Exports |
$83,365 |
(17%) |
| Gross National Product |
$482,836 |
(100%) |
The prominence of consumer spending as a percentage of GNP is also the basis of mainstream business media’s obsessive coverage of consumer spending and confidence. The Wall Street Journal (30 March 2001), for example, stated that “consumption of big-ticket items was strong and sentiment rose in March. [That] could be the key to keeping the economy afloat, since consumer spending accounts for the bulk of economic activity.” According to The Australian (5 April 2001), “what [Reserve Bank Governor Mr Ian] McFarlane really wants is for us not to be gloomy, and not to stop spending our money because we are gloomy.” The Australian Financial Review (5 April 2001) added for good measure (under its congratulatory banner headline “RBA slashes [interest] rates to boost confidence“) that “the focus in Australia, as in the U.S., is now trained on consumer confidence . . .”
The figures in Table 1 also imply that spending by governments is at least as important as private (i.e., individual and business) investment. These figures’ implication is clear: if the road to prosperity in Australia were indeed paved in government contracts and spending sprees at Myer-Grace Bros., Woolworths,’ the local Holden dealership and neighbourhood bottle shop, then policies which encourage consumers and governments to spend will not just promote but actually achieve prosperity. Over the past half-century, a range of consequences has cascaded from this implication. To give just one example: under its influence Christmas has, in a British and Christian country, largely ceased to be a period of reflection and religious observance. Instead it has become an excuse for self-indulgence, a carnival of personal consumption and the ‘make or break’ period for many merchandisers and most retailers.
During the approach of the Christmas holidays, Australian mass media report almost daily about the extent of retail sales – implying and not infrequently stating overtly that the stronger the sales the healthier the state of the economy. Taking this contention to its logical conclusion, if the Yuletide season could extend beyond the summer and into the autumn – indeed, if it could extend throughout the year – then the economic benefits of this spending would be greater still. Australian governments are doing their bit: they regard themselves as de facto Santa Clauses whose ‘gift giving,’ whilst concentrated upon particular recipients, is a constant rather than a seasonal phenomenon.
GNP and Net Value Added
GNP, to repeat, records the market value of goods and services sold to final users (private consumers, businesses and governments). It therefore excludes transactions and activities associated with the production of intermediate inputs such as raw materials, wholesale and semi-manufactured goods and other unfinished products and inventories. The heading ‘gross private domestic investment’ in Table 1 includes the purchase of all new durable capital goods such as machines and equipment (which are treated as ‘final’ products) but excludes non-durable capital goods. GNP thus takes into account fixed capital but not circulating capital. For these reasons it is not really a gross figure at all: rather, it is a measure of the total net value added during the course of production.
These omissions and this approach are justified with the contention that the inclusion of all intermediate activities into the national accounts would constitute double counting. To see this, and to see more clearly how GNP measures total net value-added, consider as an example a kitchen table whose manufacture requires several stages to complete. At the first stage a timber company sells its output, the raw logs required to produce the table, to a sawmill for $15. The timber company processes trees into raw logs and during this process it incurs expenses of $5. Its ‘economic profit’ or ‘economic value added’ (as opposed to its ‘accounting profit’) is thus $15 – $5 or $10. At the second stage, the sawmill sells the timber required to produce the table to a cabinetmaker for $40. Assuming for simplicity’s sake that the sawmill incurs no expenses other than the timber, its ‘economic profit’ or ‘value added’ is thus $40 – $15 or $25. At the third and final stage the cabinetmaker sells the finished table directly to the consumer for $100. Assuming that it incurs no other costs, its value added is $100 – $40 or $60.
Note that the sum of the ‘value added’ at each stage of production (including the $5 of ‘value added’ by costs at the first or ‘highest’ stage of production), $100, equals the retail price paid by the final consumer. To add the value of the table to the consumer ($100), the value of the lumber to the manufacturer ($40) and the value of the logs to the sawmill ($15) would, under the conventions of mainstream national accounting, overstate by a wide margin the results of the total productive activity (i.e., the total ‘value added’) undertaken in order to transform the tree into the table.
National Accounts and Company Accounts
Some criticisms of GNP and the sum-of-net-value-added approach to the measurement of a country’s economic activities and transactions are well-recognised: most notably, GNP omits non-market (i.e., intra-household) and illicit (i.e., black market) transactions. Another is less obvious: it violates the principles used by businesses to record their activities and results. From the point of view of an individual company, the surplus of current revenue over current expenditure (a crude analogue of ‘net economic value added’) describes a relevant but nonetheless single aspect of its activities and transactions; accordingly, it comprises only a small portion of its financial statements. The other – and arguably more important – parts detail transactions and activities without which the company could not operate.
Any business must (either by drawing upon retained earnings, borrowing or issuing equity) finance the assets with which it generates revenues. In order to generate revenues it must also incur expenses (i.e., hire staff, stock inventory, make ‘phone calls, send faxes, advertise, rent office space, etc.). And in order more accurately to estimate its results it must accrue revenue and expenses, amortise intangible assets and depreciate tangible assets. If it wishes to remain viable, a business clearly cannot for long neglect the management of either the assets and liabilities on its balance sheet or the revenues and expenses on its P&L. Nations, however, can do (and have done) so for extended periods – which may explain why the assumptions underlying the accounts of nations and companies differ so markedly.
Like company accounts, if the purpose of GNP and national accounts is to record validly the totality of the economic activities and transactions which occur within a country between two points in time – and if (as the trees-to-table example implies) the purpose of these economic actions is to transform raw, unfinished and lower-valued goods into processed, finished and more valuable goods and services – then national accounts must include all (i.e., initial, intermediate and final) of the economic transactions conducted by consumers, businesses and governments. As our example shows, final-stage consumption cannot occur without first- and second-stage production; and as the example implies, by omitting firms’ intermediate expenditures GNP obscures not just the extent of these production-related activities, transactions and expenditures – but also the savings and investment required to finance the capital goods which in turn undertake this production. From the realisation of these elementary points follow implications of the greatest relevance to businessmen and investors.
 
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