Question

Ireland is one of the few countries where GDP and GNP differ significantly. Using GDP per person, Ireland has the third-highest income per person in Europe. An article on the Financial Times website stated, "With GDP being about 20 percent larger than GNP, Irish people appear (when using GDP per person) to be richer than what they feel they are." Briefly explain the author's reasoning.

Short answer

The author's reasoning is that using GDP per person to measure average income in Ireland gives an inflated picture of wealth. Since a portion of Ireland's GDP is produced by entities not benefiting Irish residents, the actual economic prosperity of Irish people is better reflected by GNP per person, which is lower than the GDP per person. Thus, Irish people might 'feel' less affluent than GDP statistics suggest.

Step-by-step solution

Understand the difference between GDP and GNP

GDP refers to the total value of all goods and services produced within a country during one year. GNP, on the other hand, is the total value of all goods and services produced by the residents of a country, regardless of where the production takes place. If a country's GDP is larger than its GNP, it means that more goods and services are produced within the country than are produced by its residents elsewhere.

Apply concept to Ireland's situation

In Ireland, the GDP is about 20% larger than the GNP. This means that a significant portion of the goods and services produced within Ireland are produced by entities (like foreign corporations) that do not primarily benefit the Irish residents. For example, if a foreign company operates in Ireland and sends its profits back to its home country, this production contributes to Ireland's GDP but not its GNP.

Understanding the author's reasoning

When citizens or economists try to measure a nation's wealth, they could rely on either GDP or GNP. Given that the Irish GDP is bigger than its GNP, the use of GDP to calculate average income will result in a higher figure. However, this doesn't fully reflect the actual economic condition of the average Irish person. As a result, Irish people may appear richer in statistics (when GDP per person is used) than they feel because the GNP per person – which might reflect their circumstances better – is lower.

Key concepts

National Income Accounting

National income accounting is a system used by countries to measure economic activity and indicate the economic well-being of their country. It involves keeping track of major economic activities such as total production, income, and expenditures.

Key components in national income accounting include:

• Gross Domestic Product (GDP): It measures the total value of all goods and services produced within a country during a specified period.
• Gross National Product (GNP): It includes the value of goods and services produced by the residents of a country, regardless of where the production occurs.

Understanding the distinction between GDP and GNP is crucial because it helps determine a country's true economic performance. GDP gives insight into domestic economic activities, while GNP reflects the income received by residents from international and domestic sources.

Thus, in Ireland's case, GDP being 20% higher than GNP highlights economic activity influenced significantly by foreign entities. This discrepancy illustrates the impact of foreign corporations that operate within the country but repatriate profits, not contributing to the national income measured by GNP.

Economic Indicators

Economic indicators are statistics about economic activities that help gauge a nation's economic health. They often influence government policy and investment decisions.

Three primary types of economic indicators include:

• Leading indicators, which predict future economic activities. Examples include stock market returns and new business start-ups.
• Coincident indicators, which move simultaneously with the economy. GDP is considered a coincident indicator because it mirrors the current economic situation.
• Lagging indicators, which change after the economy has already begun to follow a particular pattern. Unemployment rate is typically a lagging indicator.

When assessing Ireland’s economy, GDP per person as an indicator might overstate the wealth of its residents due to the large presence of foreign businesses contributing to GDP but not GNP.

Thus, this indicator does not fully capture the economic experience of the Irish there might be a divergence between statistical wealth and real economic conditions.

International Economics

International economics explores the flow of goods, services, and finances across borders. It focuses on how countries interact economically, the role of international trade, and the impact of globalization.

There are several important aspects of international economics:

• Trade Balances: Refers to the difference in value between a country's exports and imports. A positive trade balance indicates more exports than imports.
• Foreign Direct Investment (FDI): Involves investment from entities based in one country into business interests within another country.
• Exchange Rates: Represent the value of one currency in terms of another, affecting international trade and investment.

The situation in Ireland is an example of international economics in action. The significant difference between its GDP and GNP is largely due to international corporations investing and operating within Ireland, contributing to GDP.

These corporations’ repatriation of profits illustrates the complexity of international economics, where domestic figures like GDP might present an inflated view of economic prosperity that does not translate fully into local wealth.