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Measurement of welfare: domestic product versus national income

To clarify the terms: The gross domestic product (GDP) corresponds to the value of all material goods and services (hereinafter: goods) that are produced in a country within a year - minus the intermediate consumption. These are deducted to avoid double counting. The GDP thus measures the economic added value of a country. An indicator closely related to GDP is gross national income (GNI), which was previously called gross national product. The GNI records all income that accrues to domestic economic actors - regardless of whether the associated economic activity takes place at home or abroad. So if a citizen has his job abroad, for example, his economic activities take place abroad and therefore belong to the foreign GDP (domestic principle). The earned income that is paid for the provision of these economic services, on the other hand, belongs to the German ESD (national principle). Capital income generated abroad is also included in GNI, but not in GDP.

The difference between GNI and GDP is thus the balance of income payments, more precisely the balance of primary income. If Germany receives more income from the rest of the world than it pays, there is a positive income balance, and German GNI is correspondingly larger than GDP.

Empirical study of the difference between GDP and GNI

Switching from GDP to GNI with the aim of measuring social prosperity only makes sense if there are significant differences between the two variables. There are no objective criteria for answering the question of when a corresponding difference is relevant for economic policy. A look at the results of the national accounts (VGR) in Germany shows that this difference has been between 60 billion and 70 billion euros since 2011 (see Figure 1).

illustration 1
Difference between GNI and GDP (both nominal) in Germany

Note: A positive balance means: GNI is greater than GDP.

Source: Federal Statistical Office: Fachserie 18, Reihe 1.5, 2018, Wiesbaden 2019, p. 15.

In relation to the respective GDP of the year in question, this amounted to around 2% in each of the last few years (see Figure 2). Whether this difference is large enough to justify a switch from the traditional indicator of GDP to GDP is ultimately a question of value. Nevertheless, it can be stated that the difference of 70 billion euros corresponds to more than half of the nominal GDP growth of the last few years (between 2014 and 2018 the growth of nominal GDP in Germany was between 3.3% and 4.0%). It is therefore a question of a volume that cannot be neglected.

The decisive factor for the differences between the two indicators is not so much the German commuters who receive wage income abroad, but the foreign investments of German investors. The main reason for this is in turn the high trade and current account surpluses of the German economy, which go hand in hand with net capital exports. This export of capital results in interest, dividends and profits that increase German GNI. The basis for the balance of Germany's investment income from abroad is the net wealth compared to the rest of the world. This has increased significantly in recent years. While it was just under 17 billion euros at the end of 2003, it reached more than 2 trillion euros at the end of 2019 (see Figure 3).

Figure 2
GNI as a share of GDP in Germany

Source: Federal Statistical Office: Fachserie 18, Reihe 1.5, 2018, Wiesbaden 2019, p. 17.

GDP versus GNI in industrialized countries

In an international comparison, too, there are a number of countries whose GNI deviates by 2% or more from GDP. In its “World Development Indicators”, the World Bank shows both indicators nominally in US dollars. If the values ​​are put in relation to one another, for example for Japan 2017 there is a positive deviation of GNI from GDP of around 3.5%. The reason for this is also here the country's export surpluses, which have been achieved for years, with the corresponding net capital exports. In Norway, nominal GNI is even 4% above GDP. This is due in large part to the Norwegian state pension fund. It is the largest sovereign wealth fund in the world and at the end of June 2019 was worth a little over 9.1 trillion Norwegian kroner, the equivalent of around 1 trillion US $ the income from oil production is fed and these proceeds are used exclusively for assets abroad (shares, securities and real estate). 2

Table 1
Nominal gross domestic product (GDP) and gross national income (GNI) in selected countries1
In billion US dollars, values ​​for 2017; sorted according to the ratio of GNI to GDP
in billions of US $
in billions of US $
GNI / GDP ratio
Japan4 872,45 043,41,035
France2 582,52 646,51,025
Germany3 693,23 770,91,021
United States19 485,419 872,21,020
Italy1 943,81 954,81,006
Spain1 314,31 312,90,999
China12 237,712 206,50,997
Canada1 647,11 629,30,989
Great Britain2 637,92 589,00,981
Brazil2 053,62 015,50,981
Russia1 578,41 538,90,975
India2 650,72 572,00,970
Czech Republic215,9202,60,938

1 EU countries, G7 countries as well as Norway, Switzerland, China, Brazil, Russia and India, no complete data for Lithuania.

Source: World Development Indicators, download on June 24, 2019.

The largest downward deviations in Europe are in Ireland and Luxembourg: In Ireland, GNI only reached 79.6% of GDP in 2017 and in Luxembourg even just under 71% (see Table 1). The reason for these considerable deviations is the fact that many (multinational) companies have their headquarters in these countries, but transfer the capital income generated to the owners abroad.

ESD as an indicator of prosperity

The answer to the question of whether GDP or GNI is a better indicator for measuring the material prosperity of a country depends crucially on the purposes for which the prosperity measurement is to serve. Ultimately, it is a question of whether the economic value creation of the country is in the foreground (regardless of whether this is provided by residents or foreigners in the sense of the national accounts) or the value creation of the citizens (regardless of whether the economic activity takes place in Germany or abroad) .

For the decision as to which size is more relevant for the material prosperity of the citizens, an analogy to microeconomic considerations is allowed. A private household who works in a domestic company and also owns shares in companies abroad is considered:

  • The economic contribution of this household to the economic value added of its economy corresponds to the value added in the company concerned.
  • What is decisive for the consumption possibilities of this household and the associated material prosperity is the sum of all income accruing to it - regardless of whether it is the wage payments of his employer, the interest of his bank or the dividend of his company participation abroad.

Applied to the economy, this means that when a society's potential consumption of goods - both for consumption and investment - is concerned when measuring material wealth, the decisive factor is the income accruing to the citizens of the country. Seen in this way, national income is a better indicator than domestic product. This is shown particularly impressively by the example of Ireland and Luxembourg: The income available to residents in these countries is 20% and 29% less than the respective GDP (see Table 1).

ESD and debt sustainability

In addition to measuring the material well-being of an economy, GDP is also used to measure the debt sustainability of society. The economic performance of an economy is then viewed as the real economic basis for the ability to repay the loans taken out in the past. The key indicator in this context is the debt ratio, defined as the ratio of government debt to GDP. This concept is based on the idea that GDP is the tax base of the state.

Whether the GDP is actually the appropriate basis for a country's tax revenue depends on the principle of taxation applied. In view of increasing globalization, international income taxation is becoming increasingly important. There are two basic principles here: 3

  • Territorial principle: With this principle, the income that is generated within a country is taxed. Taxation follows the domestic principle and thus GDP.
  • World Income Principle: Here, all income earned by the citizens of a country is taxed - regardless of where the income is earned. Taxation is thus based on the national principle and thus on the GNI.

In Germany, the income of those who are residents within the meaning of the national accounts are taxed according to the world income principle. For those who are not residents within the meaning of the national accounts, on the other hand, the territorial principle applies.4 Since by far the majority of taxpayers are residents, income tax is primarily based on the level of German GNI.

In addition to income, other economic activities are taxed. In fact, with a view to the revenue volume of the state, the taxation of consumption - above all through sales or value added tax - is particularly relevant. Here the basic principle applies that the consumption of goods is charged with the tax rate of the country in which the consumption takes place. This means that the country of destination principle applies, and VAT is due to the country in which the final consumption of a product takes place.5 This means:

  • A car made in Germany that is sold in the USA is not charged with German, but with American sales tax. The corresponding tax revenue is incurred in the USA. The German state does not receive any income.
  • For an automobile manufactured in the USA that is sold in Germany, the German state receives the value-added tax applicable under German tax law.

For Germany's state revenue - and the ability of the German state to settle the loans it has taken out - this means the following: VAT revenues are based on the products sold in Germany - regardless of whether they come from Germany or the rest of the world. Here, too, it is not about the goods produced in their own country (the GDP), but about the goods that German consumers and investors acquire on the basis of the income available to them (the GNI).

The national debt ratio of a country should therefore refer to the GNI and not to the GDP, both in terms of income tax and value added tax or sales tax. The same then applies to the state's annual financial balance and other financial policy indicators such as B. the tax and contribution ratio and the government expenditure ratio.

Figure 3
Balance of Germany's international investment position1

1 Difference between assets and liabilities, as of the end of the respective year, exception 2018: provisional figure for the end of the 4th quarter of 2018.

Source: Deutsche Bundesbank: Balance of Payments Statistics August 2019, Statistical Supplement 3 to the Monthly Report, Frankfurt am Main 2019, p. 96.

Measuring welfare in an aging society

In addition to the fact that in the age of globalization, cross-border income generation is becoming more and more important, there is another argument for ESD as an indicator of prosperity, especially for economies with an aging society: 6 In a closed economy with an aging society, the number of Employed to an increasing number of retirees. The overall social employment rate, defined as the share of employed persons in the total population, is falling as a result. Under otherwise unchanged economic framework conditions, there will be a decline in GDP per inhabitant - and in GNI per inhabitant, because GDP corresponds to GNI in an economy without economic transactions with the rest of the world. This means that material prosperity per inhabitant is falling.

In order to secure its material prosperity in old age, a private household would build up savings during the employment phase and gradually dissolve them in retirement age. A consumption waiver of 5,000 euros while working in 2019 increases the consumption possibilities of the pensioner household by 5,000 euros plus interest in 2040. The pensioner household receives the associated goods from households that will be gainfully employed in 2040 and that in turn will create savings for old age.

In a closed economy, this instrument is not available to the entire population of a country: the employed and pensioners of the year 2040 can only consume the goods that the employed persons of the year 2040 produce. The Society of the Year 2019 cannot postpone the consumption of the goods produced in 2019 to the year 2040. Macroeconomic saving in the sense of postponing consumption into the future is only possible in an open economy. The country has to generate export surpluses for this in the present:

  • An export surplus means that society will produce more goods in 2019 than it consumes for consumer and investment purposes. The surplus goods are exported abroad on balance. Seen in this way, the country lives under its conditions, because the overall economic consumption of goods is less than the amount of goods produced.
  • This means that the country spends less money on foreign trade than it earns. An export surplus leads to an accumulation of wealth vis-à-vis other countries. This is expressed in the form of shares, government bonds, receivables, etc. These assets result in income in the following years, e. B. dividends, profits or interest income that increase the total income of society and thus also increase the amount of goods available. The capital income resulting from the accumulation of wealth ensures that the country's GNI is greater than its GDP. At the same time, the income paid from abroad creates a current account surplus, which in turn is the source of further wealth accumulation abroad. The positive difference between GNI and GDP continues to grow. This relationship applies as long as the country has an export surplus.
  • In addition, the economy can in the future afford an import surplus, which it will achieve by dissolving the assets generated with the export surpluses. Seen in this way, “living under the circumstances” in the phase with a large number of gainfully employed persons (i.e. the present) allows a “life above the circumstances” in the phase of social aging in the future. The prerequisite for this, however, is that the savings invested abroad do not become worthless. In this case, the country would have given away its export surplus. 7

The GDP does not capture the property income generated with the export surpluses, nor the net asset accumulation vis-à-vis foreign countries. This also underestimates the consumption options actually due to an old society that has achieved export surpluses for many years: The material prosperity that society will have at its disposal in 2040 results from the goods produced domestically in 2040 plus the goods that the economy draws from abroad and is paid for with the dividends, profits and interest income earned abroad. Income paid abroad must be deducted from this. These relationships are also not represented by GDP, but by GNI.

With regard to the countries in which aging societies invest their export surpluses, however, GDP overestimates the goods available to the population: The capital flows from abroad allow the recipient countries of these foreign portfolio and direct investments to have a larger capital stock. The result is greater production capacities and thus a higher GDP. For the population, however, this does not mean higher material prosperity to the same extent as the associated increase in GDP: Even if the capital inflows from abroad increase the level of employment through an increase in production capacities and thus increase labor income, the associated capital income flows abroad . The GDP of the recipient countries of foreign investments is consequently larger than their GNI.

Outlook for measuring welfare

Advancing globalization means that not only is the cross-border exchange of goods and services growing, but also that of production factors and technologies. As a result, the citizens of a country receive income from abroad.This gives them a right to goods produced abroad. This means an improvement in material prosperity in the sense that the population has more goods available for consumption than were produced domestically. At the same time, however, this development also means that not all goods produced domestically are available exclusively to the citizens of the country concerned. The home country also has to give up parts of its GDP to the people living abroad who are involved in the creation of GDP with their labor or capital.

The bottom line is that the material wealth available to a country's citizens is better measured by GNI than by GDP. Even if the replacement of GDP as a traditional indicator of prosperity by GNI is currently unlikely, GDP should at least be supplemented by GNI in the future. The fundamental criticisms of GDP as an indicator of prosperity - above all the failure to take account of the distribution of income, neglecting negative external effects and narrowing the focus to economic activities that are valued using market prices (to name just the most important ones) 8 - remain, however GNI, like GDP, is a result of the national accounts.

  • 1 See Norges Bank Investment Management: The fund’s market value, real-time rate from 2.7.2019, (2.7.2019).
  • 2 See Norges Bank Investment Management: Government Pension Fund Global - Annual Report 2018, Oslo 2019, pp. 25-28.
  • 3 See Expert Council on the Assessment of Macroeconomic Development: Before important economic policy decisions are made, Annual Report 2018/19, Wiesbaden 2018, p. 309.
  • 4 See ibid, p. 309.
  • 5 Cf. OECD: Challenges for Taxing the Digital Economy, Paris 2015, p. 49 f.
  • 6 See for more details A. Esche, M. Lizarazo López, T. Petersen: Fostering Prosperity - Investment and Demographic Transition, Policy Brief T20 Group, Tokyo 2019, /t20-japan-tf10-2-fostering-prosperity-investment-demographic-transition.pdf (16.9.2019).
  • 7 Another topic discussed in this context concerns the question of whether the savings invested abroad generate a “good” return or whether the country “wastes” its savings abroad. In Germany, this question is controversially discussed and answered in different ways. While Matthias Busse and Daniel Gros from the Center for European Policy Studies, for example, are of the opinion that total German investments abroad produce a return that corresponds to that of the other large EU member states, a study by the Institute for the World Economy comes to the conclusion that Germany With its foreign investments it generates significantly less returns than all other G7 countries and also other developed European economies, see M. Busse, D. Gros: The return on German savings abroad: Which measure applies? Ökonomenstimme, 7.8.2017, (9.9.2019); and F. Hünnekes, M. Schularick, C. Trebesch: Export World Champion: The Low Returns on Germany’s Capital Exports, Kiel Working Paper, No. 2133, Kiel 2019, p. 4.
  • 8 See, for example, R. Kroker: The gross domestic product has not had its day as a measure of prosperity !, in: Ifo Schnelldienst, 64th year (2011), no. 4, pp. 3-6; K.-H. Paqué: Precisely wrong or vaguely right? A pragmatic plea for GDP as a measure of prosperity, in: Ifo Schnelldienst, 64th year (2011), no. 4, pp. 7-9; D. Kolbe: We need a new progress indicator, in: Ifo Schnelldienst, 64th vol. (2011), no. 4, pp. 15-18; and R. Zieschank, H. Diefenbacher: The National Welfare Index as a Contribution to the Debate on Growth and Welfare Measures, in: Wirtschaftsdienst, 89th year (2009), no. 12, pp. 787-792, https: //archiv.wirtschaftsdienst .eu / downloads / getfile.php? id = 2270 (16.9.2019).

* The author thanks Torben Stühmeier for valuable suggestions and advice. Any remaining errors are the responsibility of the author.

Title: Welfare Measurement: Domestic Product Versus National Income

Abstract: The traditional indicator for measuring a country’s economic prosperity is gross domestic product (GDP). However, GDP does not measure the income earned by a country’s citizens in the rest of the world. These incomes entitle them to goods and services produced abroad. This means an improvement in material well-being in the sense that the population has more goods available for consumption than were produced domestically. Incomes earned abroad are covered by gross national income (GNI). As a result, the material welfare available to the citizens of a country should be measured better by GNI rather than GDP.

JEL Classification: E01, E21, D60