National Income, National Product
by Jack Powelson
When I went to work for the International Monetary Fund (IMF) in 1950, my first assignment was to fly to Caracas to get the Venezuelan balance of payments statement, which (by the Articles of Agreement) should have been supplied to the IMF. When I arrived, I asked the central bank why they had not done so. "Because it depends so much on oil," they said, "that the balance of payments would be meaningless without oil, and the oil companies won't give us the information."
So I went to the chief accountant at Creole Petroleum Company (later Exxon) and asked why not. His reply: "Because we're afraid that if the government knew what we were exporting, they would decide we could pay more taxes." So I asked him if he would like to see a consolidated statement of all the oil sector (about twenty companies), and he said Yes. I promised I would tell no one (not even the IMF) of the particular transactions of Creole but would present the consolidated statement to both the bank and the IMF, and to the oil companies. Since I was a CPA, formerly with Price Waterhouse (the largest CPA firm in the world), and CPAs in 1950 were trusted to keep secrets, he and the accountants of other companies gave me the data, and a week later I returned triumphantly to Washington. The next year Price Waterhouse itself did the same, and after a few years of greater trust, the data were given (by all companies) directly to the central bank. So, if you look historically (through UN or IMF data) at the balance of payments of Venezuela, you will discover that the series began in 1950.
"Now go to New York and get the balance of payments of Saudi Arabia," I was asked when I had returned to Washington. But Aramco was the only company in Saudi Arabia, and they did not want the king to know how much they were producing. The chief accountant sat across from me, holding up the information I wanted, but he would not let me see it.
Despite these early refusals to provide data, the practice of creating similar consolidated financial statements for entire national economies gradually became a vital governmental function. Just about every government in the world now publishes its national accounts.
National Income = National Product
Income equals product, by definition. What a nation produces is what it gets. We have different measures for each of income and product: gross, net, national, domestic, etc, for which the United Nations and International Monetary Fund have prepared a uniform standard that most counties (including the USA) use. I represented the IMF on the UN committee that prepared the standard method.
The data for preparing the national accounts for the United States come from the Bureau of Economic Analysis (BEA) of the Department of Commerce. The people who prepare them are professionals, whom I knew personally in the 1950s. When President Nixon once asked them to doctor the data for political purposes, they refused.
Here is a table showing a consolidated statement for the national income and product of the USA, in 2005:
The credit total of the Income-and-Product account (column 2) shows that the gross domestic product (GDP) of the United States was $12,480 (billion) in the year 2005.
Where All the Money Went
Who spent our gross domestic product and imports? That is shown by the individual items on the Credit column of the Income-and-Product account: $8,746 was consumed by households, $585 was consumed by the military for all its activities including the war in Iraq, $1,775 was consumed by non-military government expenditures, and $2,100 was used to build real capital (roads, buildings, machinery). Finally, goods and services with a value of $1,299 were exported.
The Government Consumption line includes government at all levels: federal, state, and local. I have divided it into military ($585) and everything else ($1,775), presuming that this division would interest Friends.
The sum total of consumption (personal and governmental), domestic investment, and exports is not yet the gross domestic product, because it includes items that were imported. Therefore, to arrive at the GDP we have to subtract out all imports ($2,025). The final result, $12,480, is the GDP in billions of dollars.
To make an analysis of the country's economy easier, I wish the BEA would publish this single table as well as the many tables from which I extracted the data. Since the data come from many separate sources, they do not in reality add up as simply as in this table. The BEA always adds a "statistical discrepancy" covering errors or omissions. It is usually tiny, and for convenience I have combined it with business saving. Technical explanations are found in my two books, Economic Accounting and National Income and Flow-of-Funds Analysis (McGraw-Hill, 1955 and 1960, respectively).
Where All the Money Came From
So, who received our gross national income? This is shown in the Debit column of the Income-and-Product account: $7,113 was paid in labor costs (including everything from unskilled labor to CEOs), while $2,797 went to profits, $1,438 was paid to government as business taxes, and $1,132 went to undistributed profits and depreciation.
Since we are using double-entry book-keeping here, the debit and credit columns of each account must be equal (apart from rounding errors).
Some have been disturbed that "depreciation" is included in "undistributed profits." The BEA reasoning on this point is that if you buy a personal automobile, you don't depreciate it in your household accounts and put an equal amount of dollars in the bank, to spend when you replace that car. Instead, you spend or save your income as you will, and when you have enough (or can borrow enough), you buy a new car. So (they figure) do businesses. They record depreciation only in order to pay lower profits taxes. Instead, they buy new machines as they need to and when the financing (maybe borrowing) becomes available. This is why, in the GNI calculation, depreciation has been restored to undistributed profits as if it had never occurred.
"Depreciation" is also the difference between gross and net domestic product; our table shows gross domestic product, or GDP.
Now look at the next three accounts (Households, Government, and Balance-of-Payments). Every row in the table contains equal debits and credits reading across, as also does each pair of columns reading downwards. (Sometimes a debit in one account will instead be a negative debit in another.)
In each of the sector accounts (Households, Government, and Balance-of-Payments), debits equal saving plus consumption, and credits represent income. (The "increase in net worth" of traditional business accounting would be income minus consumption, therefore "household saving" and "government saving" appear as debits in this account. Both were negative in 2005. Households and Government each spent more than it earned. Debits and credits in this consolidated statement follow the general rules of business accounting (but readers who have not studied business accounting may ignore this fact.)
The Balance-of-Payments account shows debits and credits from foreigners' point of view, so US exports are their expenditures (debits), and our imports their income (credits).
The Saving-and-Investment account is a consolidated comparative balance sheet of all producers in the country, with increases in assets (investment) as debits and how the increases came about as credits. Thus we find that in 2005 the real domestic investment ($2100) and the dissaving of households sand government ($286) were financed by business saving (including depreciation allowances) and by foreigners ($1254). Foreigners finance our excesses mainly by buying Treasury certificates, and they received interest of $584 from us in 2005 (a debit in the Balance-of-Payments account.)
GDI (= GDP, remember?) was distributed to the items shown in the debit column of the Income-and-Product account, which may be thought of as a consolidated profit and loss account of all domestic businesses. Business saving is the residual (including the statistical discrepancy), the inclusion of which makes gross domestic income (GDI) exactly equal to product (GDP).
Negative Saving in Households and Government
The Households and Government accounts show that each of these sectors is spending more than its income, and therefore has negative saving. I do not know how much interest was paid by households to foreigners (maybe I could tell if I examined the BEA tables more studiously), so I have simply treated it as government expenditures, where I believe the bulk of it belongs (because most foreign banks hold their dollar accounts in US Treasury bills). If I am wrong, some government dissaving would belong to households instead.
The Saving-and-Investment account shows that US domestic investment of $2100 was financed by drawing down the net worth of households and government ($286), by undistributed profits ($1,132), and by foreigners lending to us or holding our dollars ($1,254).
Domestic v. National Product
Before the 1950s, the United States used the term "Gross National Product" instead of "Gross Domestic Product." GNP was considered to include all products of US factors of production (labor, capital, etc). Thus much of Venezuelan oil was an American product, because it was produced with American machinery and labor, while wages of Venezuelan labor and land were Venezuelan product. Naturally, Venezuela objected.
When I consulted with the UN committee on behalf of the IMF, we reached a compromise solution. Each country might use whichever definition it wished: GDP would include all product on the soil of the country concerned, while GNP would include all product by labor and capital of the country concerned. The main problem was that the accounts of different countries would not fit together. Venezuelan oil would be Venezuelan in the Venezuelan GDP accounting, while much of the very same oil would be American in the GNP accounting of the US. After some years of this the Americans quietly switched over to publishing GDP without any announcement.
Honesty and Accuracy in National Accounts
Besides their professional status, there are two main reasons why the BEA would not falsify the data for political purposes. First, every time they falsify one figure, they would have to falsify others, and outsiders would catch them. Second, the government itself uses these figures, and false ones would disrupt their analyses. On the other hand, various government branches may falsify these data for political purposes, or combine them in misleading ways, but they cannot get away with doing that when all complementary data are shown in a single table. As Lincoln said, "It is true that you may fool all of the people some of the time, you can even fool some of the people all of the time, but you can't fool all of the people all of the time."
Some readers have been confused by the omission of capital gains. The BEA reasons that capital gains are simply a revaluation of assets, not new product. No product, no income. If you buy a house for $1,000 and next year sell it for $2,000, it is still the same house. You may have a capital gain, but no new product has been produced; hence your gain is not part of the national income.
Still others have questioned why military expenses do not include whatever is paid, by whomever, for war support. Should not household consumption be debited for gasoline spent to get to work in a war factory? The answer here (I believe) is that an estimation of that, and "military" expenses of other sectors would be only guesses. GDP is not based on guesses. However, individual economists may make these guesses all they wish.
Others have been concerned that money and other financial instruments are not included (though flow-of-funds statements do that). The GDP treats personal consumption, taxes, etc., as if they were entirely goods and services.
I have not made any judgments in this paper (except that I think other government agencies, but not the BEA, falsify data). I have merely presented the data as I see them.
Sincerely your Friend,
Please send comments on this or any TQE, at any time. Selected comments will be appended to the appropriate letter as they are received. Please indicate in the subject line the number of the Letter to which you refer!
Another good letter, thanks Jack. I like your topics better than the ones from Loren Cobb, though I have nothing against stories about third world poverty and excesses, you somehow give much better perspective to the underlying economic (and political) issues. All the best to you and Robin.
Jack, I am glad to see you are still productive. I read your presentation and didn't understand a lot. My field was more political science than economics.
I cannot evade, however, a feeling that our economy will come crashing down. I don't worry so much for myself, at 72, than for the children, who seem to be be heading for doom. Do you think my expectations are unreasonable, or what?
Maurice Boyd, FMW.
Thank you for this letter. I have a story that I think is important to consider. It concerns affordable housing.
I am involved in a battle with my landlord, who is demolishing our apartment complex in favor of high proced condos. I live in Venice, California. The problem is that the building were built with federal money for low to moderate income families, and the company in question has a relationship with HUD whereby it buys up affordable housing to turn it into luxury condos, thus exaserbating the divide between the rich and poor in our community. The company also agreed to a development plan with the city that provided for the relocation of the existing tenants in the same complex as a part of the affordable housing component, which is a requirement for all development projects.
It has been 19 years from the time they first started to want to do this project, and for 19 years, the tenants association has successfully fought them, up until 6 Dec 2005, when 52 families were illegally locked out by sheriffs in two hours. It was the largest single eviction in Los Angeles history. They used the gray areas between the State Ellis Act, and local planning department rules to "game the system." It's pretty complicated, but a very interesting story, and relevant to many people all over California, the US, and the world. We're getting emails from tenants associations in Boston and in Germany they have heard of our struggle because they are going through the same battle with the privitization of socialist housing with AIMCO as one of the REIT's involved! (Real Estate Investment Trust's half the shares of AIMCO are owned by Deutsche Bank).
AIMCO is the name of the company that owns our complex (and is the largest single landlord in the US) and if you search the web for "Lincoln Place" and "AIMCO" you will see our story. Also, our website is pretty informative with links to various publications in the press. Our web address is: www.lincolnplace.net. Thank you,
Clare Sassoon, Venice, California.
Economics, by Ralph Byrns and Gerald Stone. New York: HarperCollins College Publishers, 1993.
Copyright © 2006 by John P. Powelson. All rights reserved. Permission is hereby granted for non-commercial reproduction.