Japanese Investment Income Surplus Soars

Usually when I discuss economic growth I use the measure called Gross Domestic Product (GDP), even though it suffers from two short-comings: it does not take into account the losses from capital consumption and it does not take into account the flow of factor income (investment income and income from workers living in one country and working in another)from abroad. Despite my awareness of these problems I still use GDP for simplistic reasons: namely because it is the most readily available gauge (gauges that adjust for one or both of these shortcomings , like Net Domestic Product, Gross National Product and National Income are often hard to find) and because the changes in deductions from capital consumption and net factor income usually aren't big enough to make any significant difference anyway.

There are some exceptions however. When discussing the burden of taxes and government spending , one should always keep in mind that comparisons of them with GDP nearly always significantly underestimates the burden of government. The private sector cannot pay taxes with "income" derived from investments that just compensate for capital consumption. And because capital consumption usually amounts to 10-15%, this means that the real burden of government is about 15% higher than what government to GDP ratios suggest. Still though, as the level of capital consumption is fairly similar in most countries, this have little effect on international comparisons of the burden of government, as the burden of government would have to be upwardly revised to a similar degree in all countries.

And in some cases capital consumption do fluctuate enough to make a significant difference, like in the third quarter of 2005 in America when it rose sharply due to Katrina. This implied that growth was greatly exaggerated during the third quarter while being underestimated in the following quarter.

And in some cases, the flow of net factor income is significant enough to make a difference. One obvious example is Ireland, whose GDP is to a significant extent accounting fiction created by foreign (mainly American) companies that have founded holdings in Ireland to "buy" their own products for cheap from their continental factories (without shipping) and selling them for profit via Ireland - thereby reducing their taxes and increasing Irish GDP. GNP, which deducts these artificial profits, is therefore a much better measure of Ireland's economy ( who even after taking this distortion into account have been a great success story).

Meanwhile, some countries have a higher GNP than GDP. Switzerland for example have a higher GNP than GDP despite a negative income balance to foreign workers due to the massive investment income surplus.

In today's balance of payments report from Japan's Ministry of Finance, we can see how Japan's GNP is now increasing a lot faster than GDP due to a surging investment income surplus, in part the result of rising profits of the subsidiaries of Toyota and other large Japanese companies and in part the result of rising interest income from Japanese bond holdings.

In March 2006, the current account surplus rose to 2.4 trillion yen ($22 billion) from 1.8 trillion yen ($16.4 billion) in March 2005. Nearly the entire increase was due to a increase in the factor income surplus from 1.03 trillion yen ($9.4 billion) to 1.61 trillion yen ($14.6 nillion).

For the entire first quarter, the current account surplus actually fell somewhat, from 5.63 trillion yen ($51.2billion) to 5.32 trillion yen ($48.4 billion) due to a trade deficit in January related to the Chinese New Year. The investment income surplus, however, rose sharply from 2.926 trillion yen ( $26.6 billion) to 4.107 trillion yen ( $37.3 billion). With Japan having a quarterly GDP of roughly 130 trillion yen, this 1.2 trillion increase in the investment income surplus means that whatever the GDP increase (preliminary figures, which most analysts expects will show a significant slowdown from the very strong fourth quarter, are due on Friday), the more relevant measure of GNP will have increased 0.9%:points more.