Numerical targets are much in vogue these days. The post-election Koizumi government also seems to have caught the bug in light of the Council on Economic and Fiscal Policy’s latest plans for managing the economy over the medium to longer term.
Japan’s gross domestic product is the CEFP’s chosen yardstick for measuring progress in downsizing the public sector. Thus the civil service payroll should be pared down to half of its current percentage of GDP within the next decade. Loans outstanding by government-sponsored financial institutions should likewise be halved in relation to GDP in the coming years. Increases in health-care spending should be pegged to GDP growth to prevent runaway cost burdens.
If the CEFP gets its way with all this, we should start paying more attention to what GDP is.
Numerical targets are all very well. They sound like a well-disciplined and objective way of measuring performance and setting standards. Yet when they are presented as a percentage of — or in relation to — something else, it is important to know what that something else actually means.
To know your GDP, you have to know your GNP, or gross national product. This is more so today than ever before. For the more globalized the world becomes, the more the domestic and the national will start to part company.
GDP is essentially about where production takes place. GNP is about who does the producing. If yours is an open economy where a lot of people come in to set up business from abroad, or alternatively a lot of people earn interest from investing in your country, your GDP is likely to be larger than your GNP.
If yours is an open economy but more of your nationals tend to move economic activity abroad or earn more from investing abroad compared with non-nationals doing business and earning incomes within your borders, then your GNP will be larger than your GDP.
If yours is a closed economy where nobody leaves your shores, nobody invests abroad, nobody comes in and nobody invests in your country, then your GDP will be equal to your GNP.
Japan used to belong very much in the last category. Up until the mid-1990s, the difference between Japan’s GDP and GNP amounted to less than one percentage point of GDP. With only limited numbers of people doing business abroad, the domestic and the national were essentially the same thing.
Now, however, Japan’s GNP tends to be around 2 percentage points larger than its GDP. Albeit very late and very slowly, the Japanese economy is globalizing.
In stark contrast to the Japanese case, there are other places in the world where the difference between GDP and GNP is not only large, but inverted as well. That is to say, their GDPs are a lot larger than their GNPs.
Ireland is a case in point. That country’s GDP has tended over recent years to eclipse its GNP by as much as 20 percent.
This is typical of a very small and very open economy. When such a country manages to attract a lot of foreign direct investment, domestic economic activity expands quite quickly. But the earnings from all that economic activity, if they are sent home by the companies in question, fall out of the GNP calculation.
The Japanese economy is large. The degree and nature of its openness to the rest of the world in the years to come will determine the relationship between its GDP and GNP. We ought to keep a close watch on how that relationship develops. The time may yet come when government officials have to think very carefully before they choose criteria for numerical targeting purposes.