What’s the Difference between GDP and GNP?

If you listen to the economic news on a regular basis, then you have probably heard the terms GDP and GNP. You probably also know that the former acronym stands for Gross Domestic Product, and the latter stands for Gross National Product. But how, exactly, are these two terms different?

 

Ownership vs. Location

 

The difference between GDP and GNP comes down to two factors: ownership and location.  

• GDP measures economic output based on location. If economic output occurs in the United States, then it is included in the GDP.

• GNP measures economic output based on ownership. If the resources that produce the economic output are owned by an American entity, they are included in the GNP.

 

Honda and Ford

 

Honda of America is the largest automotive-related manufacturer in Ohio. There are four Honda plants in the state. Because these plants are located in the U.S., their output is included in the Gross Domestic Product (GDP). However, because these plants are owned by a corporation based in Japan, the output is not be included in the Gross National Product (GNP). 

Now here is an opposite example: Ford Motor Company manufactures automobiles at its plant in Hermosillo, Mexico. Ford is an American corporation, so the output from this plant is included in the GNP. Since the plant is outside the United States, though, the output of the Hermosillo facility is not added to the GDP. 

GDP, NDP, and National Income 

Closely related to the concept of GDP is National Domestic Product, or NDP. NDP is based on a simple realization: it takes money to make money; or more precisely, it takes capital to make money.  

In this context, “capital” is simply an economists’ term for goods that are used to manufacture other goods (and services) and deliver them to market. In the world of automotive manufacturing, this would mean machinery, factories, etc. But this is only one example. Across the economy, innumerable varieties of capital are consumed (and worn out) in order to make, sell, and deliver everything from washing machines to landscaping services. 

Economists assume that all this “used-up capital” will be replaced. After all, businesses need to replace the items they consume and wear out in order to stay in business. This used-up capital is referred to as “capital depreciation.” Since it merely represents what business must replace if they want to keep running, it is deducted when economists evaluate the economy’s performance. When capital depreciation is subtracted from the gross domestic product, GDP, the difference between the two is called net domestic product, or NDP: 

gross domestic product – capital depreciation = NDP

 

Don’t Forget about Taxes

 

When you evaluate your own economic performance for the year, you probably consider how much you had to pay to the IRS.  

Businesses also have to pay a wide range of taxes and fees (property tax, etc.), and some taxes (such as sales tax) are paid by the consumers who purchase products and services from businesses.  

From an economic perspective, payments to the government are a dead loss. Therefore, taxes are deducted from national domestic product to arrive at final evaluation of how the economy fared in a given year. The remainder of this equation is called national income:

 

national domestic product – taxes =  national income

 

As you can see, GDP and GNP represent very different numbers; and neither one really provides a precise measurement of economic well-being. Not only is it necessary to account for capital depreciation, but taxes must be factored out before arriving at national income --- which represents the output that will actually be enjoyed.  

As someone once said, it’s not how much money you make that matters--- it’s how much you keep.  The same principle holds true for the economy at large.