Chapter 7 National Income Accounting & Balance of Payments PDF

EEB21003 INTERNATIONAL ECONOMICS & TRADE CHAPTER 7 NATIONAL INCOME ACCOUNTING AND BALANCE OF PAYMENTS  Study Outline: NATIONAL INCOME ACCOUNTING AND BALANCE OF PAYMENTS 7.1 Accounting principles 7.2 National Income Accounting for Open Economy  Preview National i...

EEB21003 INTERNATIONAL ECONOMICS & TRADE CHAPTER 7 NATIONAL INCOME ACCOUNTING AND BALANCE OF PAYMENTS  Study Outline: NATIONAL INCOME ACCOUNTING AND BALANCE OF PAYMENTS 7.1 Accounting principles 7.2 National Income Accounting for Open Economy  Preview National income accounts – measures of national income – measures of value of production – measures of value of expenditure National saving, investment, and the current account Balance of payments accounts  The National Income Accounts Records the value of national income that results from production and expenditure. – Producers earn income from buyers who spend money on goods and services. – The amount of expenditure by buyers = the amount of income for sellers = the value of production. – National income is often defined to be the income earned by a nation’s factors of production.  The National Income Accounts National Income defines a country's wealth. This income depicts the value of goods and services which are produced by an economy. This gives effect to the net result of all the economic activities performed in the country. National income is the sum total of the value of all the goods and services manufactured by the residents of the country, in a year., within its domestic boundaries or outside. It is the net amount of income of the citizens by production in a year. To be more precise, national income is the accumulated money value of all final goods and services produced in a country during one financial year. Computation of National Income is very vital as it indicates the overall health of our economy for that particular year. The National Income Accounts Definition of National Income The definition of National Income if of two types- Traditional Definition of National Income Modern Definition Traditional Definition of National Income- According to Marshall: “The labor and capital of a country acting on its natural resources produce annually a certain net aggregate of commodities, material and immaterial including services of all kinds. This is the true net annual income or revenue of the country or national dividend.” Modern Definition This definition has two subparts GDP GNP  The National Income Accounts Gross national product (GNP) is the value of all final goods and services produced by a nation ’ s factors of production in a given time period. Gross national product (GNP) is the total value of all the final goods and services made by a nation's economy in a specific time (usually a year). GNP is different from net national product, which considers depreciation and the consumption of capital. – What are factors of production? Factors that are used to produce goods and services: workers (labor services), physical capital (like buildings and equipment), natural resources and others. – The value of final goods and services produced by US-owned factors of production are counted as US GNP. – GNP = GDP + Net Factor Income from Abroad  The National Income Accounts Which is an example of national income accounting? A national income accounting example is the GDP expenditure model. This is GDP = Consumer spending + Business investment + Government Spending + Net Exports. GDP is calculated by adding the value of expenditure on final goods and services produced: 1. Consumption: expenditure by domestic consumers 2. Investment: expenditure by firms on buildings & and equipment 3. Government purchases: expenditure by governments on goods and services 4. Current account balance (exports minus imports): net expenditure by foreigners on domestic goods and services  The National Income Accounts What are the 5 measures of national income? Gross Domestic Product (GDP) Net National Product (NNP) Gross National Product (GNP) Personal income. Disposable income. The GDP is widely used for economic analysis on the domestic level and represents the total market value of the goods and services produced within a specific nation over a selected period of time.  The National Income Accounts What are the 5 measures of national income? Net national product (NNP) is a term that is often used to represent the difference between gross national product and depreciation. In numerical terms, the NNP is the total market value of the goods and services produced by a nation during a specified period (generally a year) with depreciation subtracted from it. Net National Product (NNP):. NNP = GNP - Depreciation  Criticisms of National Income Accounting Criticisms of National Income Accounting The accuracy of analysis relating to national income accounting is only as accurate as the data collected. Failure to provide the data in a timely fashion can render it useless in regard to policy analysis and creation. Additionally, certain data points are not examined, such as the impact of the underground economy and illegal production. This means these activities are not reflected in the analysis even if their effect on the economy is strong. As a result, it can be argued that certain national accounts, such as GDP or the consumer price index (CPI) used to measure inflation do not accurately capture the real economic output of the economy.  The National Income Accounts Gross national product (GNP) includes GDP, income earned by residents from overseas investments, minus income earned by foreign residents. GNP is one measure of national income, but a more precise measure of national income is GNP adjusted for following: 1. Depreciation of physical capital results in a loss of income to capital owners, so the amount of depreciation is subtracted from GNP. Depreciation (or consumption of fixed capital) measures the total income that has to be spent to repair wear and tear on fixed capital assets in order to maintain the existing physical capital stock. For example, machinery needs to have parts replaced in order to continue its consistent output—the price of those parts is subtracted from the total value as “depreciation.”  The National Income Accounts 2. Unilateral transfers to and from other countries can change national income: payments of expatriate workers sent to their home countries, foreign aid and pension payments sent to expatriate retirees. A unilateral transfer is a one-way transfer of money, goods, or services from one party to another. It is often used to describe payments made by a government to their citizens, or from one country to another country in the form of foreign aid. Examples of unilateral transfers of income are pension payments to retired citizens living abroad, reparation payments, and foreign aid such as relief funds donated to drought-stricken nations  The National Income Accounts National Income:National income includes gross and net national income, savings or net lending/net borrowing. It is the total value of the primary incomes receivable within an economy less the total of the primary incomes payable by resident units. Primary incomes are incomes that accrue to institutional units as a consequence of their involvement in processes of production or ownership of assets that may be needed for purposes of production. National Income = NNP + Subsidies - Direct Taxes  The National Income Accounts Another approximate measure of national income is gross domestic product (GDP): – Gross domestic product measures the final value of all goods and services that are produced within a country in a given time period. – GDP = GNP – payments from foreign countries for factors of production + payments to foreign countries for factors of production  The National Income Accounts Personal income refers to all income collectively received by all individuals or households in a country. Personal income includes compensation from a number of sources, including salaries, wages, and bonuses received from employment or self-employment, dividends and distributions received from investments, rental receipts from real estate investments, and profit sharing from businesses. Personal Income = National Income - Corporate profit less dividend - Social insurance payment + Transfer payments to personals  The National Income Accounts Disposable Income: Disposable income is the amount of money that a person or family has left after paying their taxes. It is the portion of income that can be spent on necessities, such as food and rent. Disposable Income = Personal Income - Personal taxes  National Income Accounting for an Open Economy The national income identity for an open economy is Y = C + I + G + EX – IM = C + I + G + CA Expenditure by domestic Net expenditure by foreign individuals and institutions individuals and institutions  National Income Accounting for an Open Economy CA = EX – IM = Y – (C + I + G ) When production > domestic expenditure, exports > imports: current account > 0 and trade balance > 0 – when a country exports more than it imports, it earns more income from exports than it spends on imports – net foreign wealth is increasing When production < domestic expenditure, exports < imports: current account < 0 and trade balance < 0 – when a country exports less than it imports, it earns less income from exports than it spends on imports – net foreign wealth is decreasing National Income Accounts for Agraria, an Open Economy (bushels of wheat)  Saving and the Current Account National saving (S) = national income (Y) that is not spent on consumption (C) or government purchases (G). S=Y–C–G An open economy can save by building up its capital stock or by acquiring foreign wealth. S = I + CA  Private and Government Saving Private saving is the part of disposable income (national income, Y, minus taxes, T) that is saved rather than consumed: Sp = Y - T – C Government saving is net tax revenue, T, minus government purchases, G: Sg = T - G Private and government saving add up to national saving. S = (Y – T – C) + (T – G) = Sp + Sg  Balance of Payments Accounts A country’s balance of payments accounts accounts for its payments to and its receipts from foreigners. An international transaction involves two parties, and each transaction enters the accounts twice: once as a credit (+) and once as a debit (–). The balance of payments (BOP), also known as the balance of international payments, is a statement of all transactions made between entities in one country and the rest of the world over a defined period, such as a quarter or a year. It summarizes all transactions that a country's individuals, companies, and government bodies complete with individuals, companies, and government bodies outside the country.  Balance of Payments Accounts The BOP consists of three main accounts: the current account, the capital account, and the financial account. The current account is meant to balance against the sum of the financial and capital account but rarely does. Globalization in the late 20th-century led to BOP liberalization in many emerging market economies. The balance of payments (BOP) is the method countries use to monitor all international monetary transactions at a specific period. Usually, the BOP is calculated every quarter and every calendar year. All trades conducted by both the private and public sectors are accounted for in the BOP to determine how much money is going in and out of a country. If a country has received money, this is known as a credit, and if a country has paid or given money, the transaction is counted as a debit. Theoretically, the BOP should be zero, meaning that assets (credits) and liabilities (debits) should balance, but in practice, this is rarely the case. Thus, the BOP can tell the observer if a country has a deficit or a surplus and from which part of the economy the discrepancies are stemming.  Balance of Payments Accounts The balance of payments accounts are separated into 3 broad accounts: – current account: accounts for flows of goods and services (imports and exports). – financial account: accounts for flows of financial assets (financial capital). – capital account: flows of special categories of assets (capital): typically nonmarket, non-produced, or intangible assets like debt forgiveness, copyrights and trademarks.  Example of Balance of Payments Accounting You(US) import a fax machine from Olivetti. Olivetti deposits your check in a U.S. bank. Fax machine (current account, U.S. good import) –$80 Bank deposit (financial account, U.S. asset sale) +$80  Example of Balance of Payments Accounting (cont.) You buy lunch in France and pay by credit card. Meal purchase (current account, U.S. service import) –$30  Example of Balance of Payments Accounting (cont.) You buy a share of BP. BP deposits the money in a U.S. bank. Stock purchase (financial account, U.S. asset purchase) –$90 Bank deposit (financial account, U.S. asset sale) +$90  Example of Balance of Payments Accounting (cont.) U.S. banks forgive a $50 M debt owed by the government of Argentina through debt restructuring. Debt forgiveness (capital account, U.S. transfer payment) –$50 M  How Do the Balance of Payments Accounts Balance? Due to the double entry of each transaction, the balance of payments accounts will balance by the following equation: current account + financial account + capital account = 0  Balance of Payments Accounts The 3 broad accounts are more finely divided: Current account: imports and exports 1. merchandise (goods like DVDs) 2. services (payments for legal services, shipping services, tourist meals, etc.) 3. income receipts (interest and dividend payments, earnings of firms and workers operating in foreign countries)  Balance of Payments Accounts Current account: net unilateral transfers – gifts (transfers) across countries that do not purchase a good or service nor serve as income for goods and services produced Capital account: records special transfers of assets, but this is a minor account for the U.S.  Balance of Payments Accounts Financial account: the difference between sales of domestic assets to foreigners and purchases of foreign assets by domestic citizens. Financial inflow – Foreigners loan to domestic citizens by buying domestic assets. – Domestic assets sold to foreigners are a credit (+) because the domestic economy acquires money during the transaction. Financial outflow – Domestic citizens loan to foreigners by buying foreign assets. – Foreign assets purchased by domestic citizens are a debit (–) because the domestic economy gives up money during the transaction.  Balance of Payments Accounts Financial account has at least 3 subcategories: 1. Official (international) reserve assets 2. All other assets 3. Statistical discrepancy  Balance of Payments Accounts Statistical discrepancy – Data from a transaction may come from different sources that differ in coverage, accuracy, and timing. – The balance of payments accounts therefore seldom balance in practice. – The statistical discrepancy is the account added to or subtracted from the financial account to make it balance with the current account and capital account.  Balance of Payments Accounts Official (international) reserve assets: foreign assets held by central banks to cushion against financial instability. – Assets include government bonds, currency, gold, and accounts at the International Monetary Fund. – Official reserve assets owned by (sold to) foreign central banks are a credit (+) because the domestic central bank can spend more money to cushion against instability. – Official reserve assets owned by (purchased by) the domestic central bank are a debit (–) because the domestic central bank can spend less money to cushion against instability.  Balance of Payments Accounts The negative value of the official reserve assets is called the official settlements balance or “balance of payments.” – It is the sum of the current account, the capital account, the nonreserve portion of the financial account, and the statistical discrepancy. – A negative official settlements balance may indicate that a country is depleting its official international reserve assets, or may be incurring large debts to foreign central banks so that the domestic central bank can spend a lot to protect against financial instability.  U.S. Balance of Payments Accounts (billions of dollars)  U.S. Balance of Payments Accounts The U.S. has the most negative net foreign wealth in the world, and so is therefore the world’s largest debtor nation. Its current account deficit in 2012 was $440 billion dollars, so that net foreign wealth continues to decrease. The value of foreign assets held by the U.S. has grown since 1980, but liabilities of the U.S. (debt held by foreigners) has grown faster.  U.S. Balance of Payments Accounts (cont.) About 70% of foreign assets held by the U.S. are denominated in foreign currencies and almost all of U.S. liabilities (debt) are denominated in dollars. Changes in the exchange rate influence value of net foreign wealth (gross foreign assets minus gross foreign liabilities). – Appreciation of the value of foreign currencies makes foreign assets held by the U.S. more valuable, but does not change the dollar value of dollar-denominated debt for the U.S.  Table 1: National Income of United States Components Amount (Million) GDP 8250 Receipts of factor from the rest of the 250 world Payments of factor income to the rest 300 of the world Depreciation 810 Direct taxes less subsidies 500 Corporate profit less dividend 500 Social insurance payment 700 Personal interest receives from 300 government and consumer Transfer payment to personals 1100 Personal taxes 1000 Calculate Gross National Product (GNP), Net National Product (NNP), National Income, Personal Income and Disposable Income by using the information in Table 1. Calculate Gross National Product (GNP), Net National Product (NNP), National Income, Personal Income and Disposable Income by using the information in Table 1. International Investment Position of the Malaysia  Summary 1. A country’s GNP is roughly equal to the income received by its factors of production. 2. In an open economy, GNP equals the sum of consumption, investment, government purchases, and the current account. 3. GDP is equal to GNP minus net income from foreign countries for factors of production. It measures the value of output produced within a country’s borders.  Summary 4. National saving minus domestic investment equals the current account (≈ exports minus imports). 5. The current account equals the country’s net foreign investment (net outflows of financial assets). 6. The balance of payments accounts records flows of goods & services and flows of financial assets across countries. – It has 3 parts: current account, capital account, and financial account, which balance each other. – Transactions of goods and services appear in the current account; transactions of financial assets appear in the financial account.  Summary 7. Official international reserve assets are a component of the financial account, which records official assets held by central banks. 8. The official settlements balance is the negative value of official international reserve assets, and it shows a central bank’s holdings of foreign assets relative to foreign central banks’ holdings of domestic assets. 9. The U.S. is the largest debtor nation, and its foreign debt continues to grow because its current account continues to be negative. Welcome Queries…