13 chapter part three National Income Accounting and the Balance of Payments B etween 2004 and 2007, the world economy boomed, its total real product growing at an annual average rate of about 5 percent per year. The growth Exchange Rates and Open-Economy Macroeconomics rate of world production slowed to around 3 percent per year in 2008, before dropping to minus 0.6 percent in 2009—a reduction in world output unprecedented in the period since World War II. These aggregate patterns mask sharp differences among individual countries. Some, such as China, slowed relatively modestly in 2009, while the output of other countries, such as the United States, contracted sharply.
Can economic analysis help us to understand the behavior of the global economy and the reasons why individual countries’ fortunes often differ? Previous chapters have been concerned primarily with the problem of making the best use of the world’s scarce productive resources at a single point in time. The branch of economics called microeconomics studies this problem from the perspective of individual firms and consumers. Microeconomics works “from the bottom up” to show how individual economic actors, by pursuing their own inter- ests, collectively determine how resources are used. In our study of international microeconomics, we have learned how individual production and consumption decisions produce patterns of international trade and specialization.
We have also seen that while free trade usually encourages efficient resource use, government intervention or market failures can cause waste even when all factors of produc- tion are fully employed. With this chapter we shift our focus and ask: How can economic policy ensure that factors of production are fully employed? And what determines how an economy’s capacity to produce goods and services changes over time? To answer these questions, we must understand macroeconomics, the branch of economics that studies how economies’ overall levels of employment, produc- tion, and growth are determined. Like microeconomics, macroeconomics is concerned with the effective use of scarce resources. But while microeconomics focuses on the economic decisions of individuals, macroeconomics analyzes the behavior of an economy as a whole.
In our study of international macroeco- nomics, we will learn how the interactions of national economies influence the worldwide pattern of macroeconomic activity. 293 294 PART THREE Exchange Rates and Open-Economy Macroeconomics Macroeconomic analysis emphasizes four aspects of economic life that, until now, we have usually kept in the background to simplify our discussion of inter- national economics: 1. We know that in the real world, workers may be unemployed and factories may be idle. Macroeconomics studies the factors that cause unemployment and the steps governments can take to prevent it.
A main con- cern of international macroeconomics is the problem of ensuring full employ- ment in economies open to international trade. In earlier chapters we usually assumed that every country consumes an amount exactly equal to its income—no more and no less. In reality, though, households can put aside part of their income to provide for the future, or they can borrow temporarily to spend more than they earn. A country’s saving or borrowing behavior affects domestic employment and future levels of national wealth.
From the standpoint of the international economy as a whole, the world saving rate determines how quickly the world stock of productive capital can grow. As we saw in earlier chapters, the value of a country’s imports equals the value of its exports when spending equals income. This state of balanced trade is seldom attained by actual economies, however. In the following chapters, trade imbalances play a large role because they redis- tribute wealth among countries and are a main channel through which one country’s macroeconomic policies affect its trading partners.
It should be no surprise, therefore, that trade imbalances, particularly when they are large and persistent, quickly can become a source of international discord. Money and the price level. The trade theory you have studied so far is a barter theory, one in which goods are exchanged directly for other goods on the basis of their relative prices. In practice, it is more convenient to use money—a widely acceptable medium of exchange—in transactions, and to quote prices in terms of money.
Because money changes hands in virtually every transaction that takes place in a modern economy, fluctuations in the supply of money or in the demand for it can affect both output and employ- ment. International macroeconomics takes into account that every country uses a currency and that a monetary change (for example, a change in money supply) in one country can have effects that spill across its borders to other countries. Stability in money price levels is an important goal of inter- national macroeconomic policy. This chapter takes the first step in our study of international macroeconomics by explaining the accounting concepts economists use to describe a country’s level of production and its international transactions.
To get a complete picture of the macroeconomic linkages among economies that engage in international trade, we have to master two related and essential tools. The first of these tools, national income accounting, records all the expenditures that contribute to a country’s income and output. The second tool, balance of payments accounting, helps us CHAPTER 13 National Income Accounting and the Balance of Payments 295 keep track of both changes in a country’s indebtedness to foreigners and the fortunes of its export and import-competing industries. The balance of payments accounts also show the connection between foreign transactions and national money supplies.
LEARNING GOALS After reading this chapter, you will be able to: • Discuss the concept of the current account balance. • Use the current account balance to extend national income accounting to open economies. • Apply national income accounting to the interaction of saving, investment, and net exports. • Describe the balance of payments accounts and explain their relationship to the current account balance.
• Relate the current account to changes in a country’s net foreign wealth. The National Income Accounts Of central concern to macroeconomic analysis is a country’s gross national product (GNP), the value of all final goods and services produced by the country’s factors of pro- duction and sold on the market in a given time period. GNP, which is the basic measure of a country’s output studied by macroeconomists, is calculated by adding up the market value of all expenditures on final output. GNP therefore includes the value of goods like bread sold in a supermarket and textbooks sold in a bookstore, as well as the value of serv- ices provided by stock brokers and plumbers.
Because output cannot be produced without the aid of factor inputs, the expenditures that make up GNP are closely linked to the employment of labor, capital, and other factors of production. To distinguish among the different types of expenditure that make up a country’s GNP, government economists and statisticians who compile national income accounts divide GNP among the four possible uses for which a country’s final output is purchased: consumption (the amount consumed by private domestic residents), investment (the amount put aside by private firms to build new plant and equipment for future production), government purchases (the amount used by the government), and the current account bal- ance (the amount of net exports of goods and services to foreigners). The term national income accounts, rather than national output accounts, is used to describe this fourfold classification because a country’s income in fact equals its output. Thus, the national income accounts can be thought of as classifying each transaction that contributes to national income according to the type of expenditure that gives rise to it.
Figure 13-1 shows how U. GNP was divided among its four components in 2009.1 Why is it useful to divide GNP into consumption, investment, government purchases, and the current account? One major reason is that we cannot hope to understand the cause of a particular recession or boom without knowing how the main categories of spending 1 Our definition of the current account is not strictly accurate when a country is a net donor or recipient of foreign gifts. This possibility, along with some others, also complicates our identification of GNP with national income. We describe later in this chapter how the definitions of national income and the current account must be changed in such cases.
296 PART THREE Exchange Rates and Open-Economy Macroeconomics Figure 13-1 Billions U. GNP and Its Components of dollars America’s $14.4 trillion 2009 gross 16000 national product can be broken down GNP into the four components shown. Department of Commerce, Bureau of Economic Analysis. 12000 Consumption 10000 8000 6000 4000 Government purchases 2000 Investment 0 Current –2000 account have changed.
And without such an understanding, we cannot recommend a sound policy response. In addition, the national income accounts provide information essential for studying why some countries are rich—that is, have a high level of GNP relative to popu- lation size—while some are poor. National Product and National Income Our first task in understanding how economists analyze GNP is to explain in greater detail why the GNP a country generates over some time period must equal its national income, the income earned in that period by its factors of production. The reason for this equality is that every dollar used to purchase goods or services auto- matically ends up in somebody’s pocket.
A visit to the doctor provides a simple example of how an increase in national output raises national income by the same amount. The $75 you pay the doctor represents the market value of the services he or she provides for you, so your visit raises GNP by $75. But the $75 you pay the doctor also raises his or her income. So national income rises by $75.
The principle that output and income are the same also applies to goods, even goods that are produced with the help of many factors of production. Consider the example of an economics textbook. When you purchase a new book from the publisher, the value of your purchase enters GNP. But your payment enters the income of the productive factors that cooperated in producing the book, because the publisher must pay for their services with the proceeds of sales.
First, there are the authors, editors, artists, and compositors who pro- vide the labor inputs necessary for the book’s production. Second, there are the publishing company’s shareholders, who receive dividends for having financed acquisition of the cap- ital used in production. Finally, there are the suppliers of paper and ink, who provide the intermediate materials used in producing the book. CHAPTER 13 National Income Accounting and the Balance of Payments 297 The paper and ink purchased by the publishing house to produce the book are not counted separately in GNP because their contribution to the value of national output is already included in the book’s price.
It is to avoid such double counting that we allow only the sale of final goods and services to enter into the definition of GNP. Sales of intermedi- ate goods, such as paper and ink purchased by a publisher, are not counted. Notice also that the sale of a used textbook does not enter GNP. Our definition counts only final goods and services that are produced, and a used textbook does not qualify: It was counted in GNP at the time it was first sold.
Equivalently, the sale of a used textbook does not gener- ate income for any factor of production. Capital Depreciation and International Transfers Because we have defined GNP and national income so that they are necessarily equal, their equality is really an identity. Two adjustments to the definition of GNP must be made, however, before the identification of GNP and national income is entirely correct in practice. GNP does not take into account the economic loss due to the tendency of machinery and structures to wear out as they are used.
This loss, called depreciation, reduces the income of capital owners.