31. Although we have been referring to net product, it is more relevant (from a perspective
of economic well-being) to refer to net income. ‘Product’ relates to the supply side of the
economy whereas ‘income’ refers to the ultimate purpose of production, namely use for
11. The United Nations Committee on Economic and Environmental Accounts (UNCEEA) is supervising the work in this area, with the aim of elevating the SEEA Handbook to a statistical standard.
12. For example, OECD Countries recently signed up to a resolution in this area; see www.oecd.org/ environment/resourceefficiency
consumption and higher standards of living. In what follows, we shall therefore reason in terms of ‘income’ rather than ‘product’. When turning to real income as opposed to its money value, a question arises on how to deflate nominal values. Whereas ‘product’ is typically expressed as the quantity or volume of goods and services produced, real income expresses the quantity of products that can be purchased with a given sum of money income. Before turning to the measurement of real income, additional adjustments will be discussed that can be brought to the measure of net (nominal or monetary) income.
32. Globalization may lead to large differences between measures of the income of a
country and measures of its production. The former is more relevant to peoples’ living standards because some of the income generated in production by residents is sent abroad, and some residents receive income from abroad. Consequently, a more relevant measure than GDP and NDP, in our search for a measure of living standards, is net national disposable income (NNDI, see Box 1). This measure accounts for payments and receipts of income to
and from abroad13. This too is a standard variable in countries’ national accounts.
Figure 2: Net national disposable income as percentage of gross domestic product
33. As production shifts from manufacturing to services, the differences between GDP and
NNDI has increased in some countries. This affects the judgments of how well off people are. Assume, for instance, that more and more production occurs inside a country by firms owned abroad. While the profits generated by these firms are included in GDP, they do not enhance the spending power of the citizens of the country. For citizens of a poor developing country, to be told that GDP has gone up may be of little relevance; they want to know about their own living standards. This is especially the case in those countries relying heavily on mining or oil, which may receive a small royalty but where most of the returns accrue to the headquarters of a multinational company. Even among relatively wealthy OECD countries, the gap between NNDI and GDP can be of importance, as Figure 2: Net national disposable income as percentage of gross domestic product2 shows in the case of Ireland. There, the declining share of NNDI in GDP reflects the large foreign direct investments in the economy
13. For the treatment of international capital flows in national see Box 2.
70.0 75.0 80.0 85.0 90.0 95.0 France USA Ireland
and the large profits that are transferred outside of Ireland. By this measure, Irish income has increased by less than GDP growth would have suggested.
34. Changes in standards of living are determined by changes in both money income and
prices of products that can be acquired with a given sum of money. One key determinant of real income is the relative price of foreign products, that is the rate at which exports may be traded against imports from the rest of the world (terms of trade). When a country’s export prices rise more quickly than the prices of its imports, the country’s citizens are better off and vice versa. Such gains or losses in the terms of trade can be important for small open economies, in particular when exports or imports are clustered around particular product groups. They are particularly important for small countries that export oil or other mineral resources but import a significant part of consumption.
Box 1. National Income and National Disposable Income - Two different concepts
Although national income (NI) and national disposable income (NDI) both refer to the income of the whole economy, NDI is a more comprehensive aggregate than NI. NI takes into account international transfers associated with the compensation of employees, taxes on production and imports, subsidies on products and production, and property income (interest payments, dividends , property income distributed to insurance policy holders, rents). NI is the starting point for computing NDI: to NI are added international transfers concerning current taxes on income and wealth, social contributions, social benefits in cash, and other current transfers from and to the rest of the world (e.g. non-life insurance premiums, non-life insurance claims, current international cooperation or current transfers between households).
The difference between NI and NDI hence reflects an element of income distribution between sectors. This is best explained by applying the concept to a household. A household’s (primary) income consists of wages and property income such as dividends received. But households have to pay taxes and social contributions and they may receive social benefits and transfer payments. Accounting for these transactions leads to measures of disposable income. At the level of the whole economy, taxes, social security payments and so on that take place inside the country cancel out; but current transfers from and to other countries do not, and the difference between them mark the difference between NI and NDI. Thus, NDI better measures how well off citizens are.
Both NI and NDI can be computed gross or net of depreciation. As mentioned elsewhere, for the purpose at hand, net measures are conceptually preferable to gross measures.
35. Taking these changes in relative prices into account, along with real international
transfers and real depreciation, yields a measure of real net national income for the entire economy. The figures below show that there is little to report home about the difference between constant price GDP and real net disposable income for some countries – the United States and France being cases in point. However, the example from Norway suggests that international price changes can drive a significant wedge between volume GDP and real
income.14,15 Norway’s economy and real income benefited enormously from rising oil prices
14. Terms-of-trade effects can be worked into real income comparisons more systematically. The methodology for such measures has been worked out by Diewert and Morrison (1986), Kohli (1991) and Diewert et al. (2005) with the first application of the decomposition method to Australia in Diewert and Lawrence (2006). For a comprehensive treatment of terms-of-trade measurement, see IMF et al. (2009).
15. For each country, the deflator of net domestic demand (i.e.: final consumption + net capital formation) has been used to compute real income.
until 2008, allowing Norwegians to buy more imports for the same amount of oil exported. This is reflected in the more rapid rise of real net disposable income compared to that of GDP at constant prices. The measurement effect comes through because real NNDI is obtained by applying a price index for final domestic demand (final consumption and investment), part of which is imported. Note, however, that the ‘net’ calculation that underlies the Norwegian income measure does not reflect the depletion of Norwegian subsoil resources.
Figure 3: GDP and disposable income in the USA and in France
Figure 4: GDP and disposable income in Norway
Source: OECD Annual National Accounts.
36. Just as real income and volume GDP can be compared over time for a particular
country, real income and volume GDP can be compared across countries at a particular point in time. Feenstra et al. (2009) describe the methodology underlying such spatial comparisons. The authors demonstrate large terms-of-trade effects for several countries, including Ireland, Mexico and Switzerland. Real income comparisons across countries and over time will also be discussed when considering measures for the living standards of private households in SectionSecond step: the household perspective below.
70.0 90.0 110.0 130.0 150.0 170.0 190.0 210.0
France GDP at constant prices
France real net national
disposable income USA GDP at constant prices
USA real Net national disposable
income 70.0 90.0 110.0 130.0 150.0 170.0 190.0 210.0 230.0
Norway GDP at constant prices Norway real Net national
Box 2. National accounting treatment of international capital flows
Globalization entails not only more imports and exports of goods and services but also more international capital flows. Inflows and outflows of foreign capital are financial transactions that do not by themselves affect GDP. The impact on GDP is only indirect, for example through the investment expenditures that the international financial flows allow to finance. The same is true for outflows of foreign capital from a country: they impact on GDP only in the sense that some investment expenditures inside the country may be postponed or cancelled.
However, where foreign financial investments are important, national income may evolve differently from national product, as has for instance been the case in Ireland since the beginning of the 1990s.There is a special treatment of the income flows associated with foreign direct investments (FDI). These constitute investments of a long-term nature as opposed to ‘portfolio investments’ that are of a more short-term nature. The treatment of FDI is best explained by way of an example. Say there is a firm with its headquarters in country A (firm A) and it opens a subsidiary in country B (firm B). The following accounting treatment occurs:
• When the subsidiary is created, the flow of cash from firm A is recorded as a purchase by A of the shares or equity issued by B. This purchase constitutes a financial transaction. The cash received by B may then be used to finance a production line or a building. Only these transactions are recorded as formation of fixed capital, and they increase investment and GDP of country B.
• Now suppose that firm B earns profits and repatriates part of them back to firm A. The repatriated profits are property income for firm A and so they raise country A’s national income. In fact, and by convention, national accounts count all of B’s profits as property income (hence of national income) for country A. The imputed flow – the profits that are not repatriated – is recorded under the heading "reinvested earnings on foreign direct investment" in the national accounts. What is the overall consequence of this treatment? GDP of countries A and B is unaffected – all of the profits generated by the subsidiary are simply part of GDP in country B. However, the national income of country A will increase by an amount equal to total profits and the national income of country B will decrease by the same amount. This effect is independent of the extent to which profits have actually been repatriated or reinvested.
• But the story does not end here. Another flow, equivalent in amount to ‘reinvested earnings’, is entered as a financial transaction between the two countries. The reinvested profits are treated as if country A purchased more equity in country B. This is tantamount to saying that investments of firm B are always financed through the emission of new shares or a rise in equity rather than self-financed. Now assume that firm B just accumulates retained earnings rather than purchasing capital goods with them. After several years of sitting in a bank account in country B, the cumulated profits are sent back to the mother company A. There is now neither an effect on GDP, nor on GNI and GNDI, of any of the countries. The transfer of cumulated profits is recorded as a sale of shares or equity and a transfer of currency, that is, as a financial transaction. Similarly, if firm A decides to sell its participation in firm B, the only direct consequence is for the financial accounts of countries A and B.
The treatment of reinvested earnings is an example of how imputations help reducing the dependence of income measures on specific institutional arrangements and accounting decisions of corporations.