- It overlooks business-to-business activity: GDP solely examines final products production and new capital investment, netting out intermediate spending and business interactions. GDP overstates the importance of consumption in the economy in comparison to output, making it less responsive to economic swings than measurements that include business-to-business interaction.
- Costs and waste are counted as economic benefits: GDP recognizes all final private and government expenditures as contributions to societal revenue and output, regardless of whether they are productive or profitable. This means that actions that are clearly unproductive or even harmful are frequently counted as economic activity and contribute to GDP growth. For example, spending on investment projects for which the necessary complementary goods and labor are not available or for which actual consumer demand does not exist (such as the construction of empty ghost cities or bridges to nowhere, unconnected to anything); spending on investment projects for which the necessary complementary goods and labor are not available or for which actual consumer demand does not exist (such as the construction of empty ghost cities or bridges to nowhere, unconnected to anything); and spending on investment projects for which the necessary complementary goods and labor are not available or for which actual consumer demand (such as the production of weapons of war or spending on policing and anti-crime measures).
What does GDP actually represent?
The Gross Domestic Product, or GDP, is a metric that represents the entire value of goods and services generated in a country over a specific period of time. GDP growth is simply the percent change in this metric over time, indicating whether the economy is expanding or declining overall. The problem with looking at GDP growth in aggregate is that it ignores the most important economic issue of our time: how income growth has varied between the top 1% and the rest of society over the last four decades. (See Illustration 1.)
Is income included in the GDP calculation?
- All economic expenditures should equal the entire revenue created by the production of all economic products and services, according to the income approach to computing gross domestic product (GDP).
- The expenditure technique, which starts with money spent on goods and services, is an alternative way for computing GDP.
- The national income and product accounts (NIPA) are the foundation for calculating GDP and analyzing the effects of variables such as monetary and fiscal policies.
Is GDP an indicator of wealth or income?
The Gross Domestic Product (GDP) is not a measure of wealth “wealth” in any way. It is a monetary indicator. It’s a relic of the past “The value of products and services produced in a certain period in the past is measured by the “flow” metric. It says nothing about whether you’ll be able to produce the same quantity next year. You’ll need a balance sheet for that, which is a measure of wealth. Both balance sheets and income statements are used by businesses. Nations, however, do not.
Why is GDP a poor indicator?
GDP is a rough indicator of a society’s standard of living because it does not account for leisure, environmental quality, levels of health and education, activities undertaken outside the market, changes in income disparity, improvements in diversity, increases in technology, or the cost of living.
What does GDP not account for?
In reality, “GDP counts everything but that which makes life meaningful,” as Senator Robert F. Kennedy memorably stated. Health, education, equality of opportunity, the state of the environment, and many other measures of quality of life are not included in the number. It does not even assess critical features of the economy, such as its long-term viability, or whether it is on the verge of collapsing. What we measure, however, is important because it directs our actions. The military’s emphasis on “body counts,” or the weekly calculation of the number of enemy soldiers killed, gave Americans a hint of this causal link during the Vietnam War. The US military’s reliance on this morbid statistic led them to conduct operations with no other goal than to increase the body count. The focus on corpse numbers, like a drunk seeking for his keys under a lamppost (because that’s where the light is), blinded us to the greater picture: the massacre was enticing more Vietnamese citizens to join the Viet Cong than American forces were killing.
Now, a different corpse count, COVID-19, is proving to be an alarmingly accurate indicator of society performance. There isn’t much of a link between it and GDP. With a GDP of more than $20 trillion in 2019, the United States is the world’s richest country, implying that we have a highly efficient economic engine, a race vehicle that can outperform any other. However, the United States has had almost 600,000 deaths, but Vietnam, with a GDP of $262 billion (and only 4% of the United States’ GDP per capita), has had less than 500 to far. This less fortunate country has easily defeated us in the fight to save lives.
In fact, the American economy resembles a car whose owner saved money by removing the spare tire, which worked fine until he got a flat. And what I call “GDP thinking”the mistaken belief that increasing GDP will improve well-being on its owngot us into this mess. In the near term, an economy that uses its resources more efficiently has a greater GDP in that quarter or year. At a microeconomic level, attempting to maximize that macroeconomic measure translates to each business decreasing costs in order to obtain the maximum possible short-term profits. However, such a myopic emphasis inevitably jeopardizes the economy’s and society’s long-term performance.
The health-care industry in the United States, for example, took pleasure in efficiently using hospital beds: no bed was left empty. As a result, when SARS-CoV-2 arrived in the United States, there were only 2.8 hospital beds per 1,000 people, significantly fewer than in other sophisticated countries, and the system was unable to cope with the rapid influx of patients. In the short run, doing without paid sick leave in meat-packing facilities improved earnings, which raised GDP. Workers, on the other hand, couldn’t afford to stay at home when they were sick, so they went to work and spread the sickness. Similarly, because China could produce protective masks at a lower cost than the US, importing them enhanced economic efficiency and GDP. However, when the epidemic struck and China required considerably more masks than usual, hospital professionals in the United States were unable to meet the demand. To summarize, the constant pursuit of short-term GDP maximization harmed health care, increased financial and physical insecurity, and weakened economic sustainability and resilience, making Americans more exposed to shocks than inhabitants of other countries.
In the 2000s, the shallowness of GDP thinking had already been apparent. Following the success of the United States in raising GDP in previous decades, European economists encouraged their leaders to adopt American-style economic strategies. However, as symptoms of trouble in the US banking system grew in 2007, France’s President Nicolas Sarkozy learned that any leader who was solely focused on increasing GDP at the expense of other indices of quality of life risked losing the public’s trust. He asked me to chair an international commission on measuring economic performance and social progress in January 2008. How can countries improve their metrics, according to a panel of experts? Sarkozy reasoned that determining what made life valuable was a necessary first step toward improving it.
Our first report, provocatively titled Mismeasuring Our Lives: Why GDP Doesn’t Add Up, was published in 2009, just after the global financial crisis highlighted the need to reassess economic orthodoxy’s key premises. The Organization for Economic Co-operation and Development (OECD), a think tank that serves 38 advanced countries, decided to follow up with an expert panel after it received such excellent feedback. We confirmed and enlarged our original judgment after six years of dialogue and deliberation: GDP should be dethroned. Instead, each country should choose a “dashboard”a collection of criteria that will guide it toward the future that its citizens desire. The dashboard would include measures for health, sustainability, and any other values that the people of a nation aspired to, as well as inequality, insecurity, and other ills that they intended to reduce, in addition to GDP as a measure of market activity (and no more).
These publications have aided in the formation of a global movement toward improved social and economic indicators. The OECD has adopted the method in its Better Life Initiative, which recommends 11 indicators and gives individuals a way to assess them in relation to other countries to create an index that measures their performance on the issues that matter to them. The World Bank and the International Monetary Fund (IMF), both long-time proponents of GDP thinking, are now paying more attention to the environment, inequality, and the economy’s long-term viability.
This method has even been adopted into the policy-making frameworks of a few countries. In 2019, New Zealand, for example, incorporated “well-being” measures into the country’s budgeting process. “Success is about making New Zealand both a terrific location to make a livelihood and a fantastic place to create a life,” said Grant Robertson, the country’s finance minister. This focus on happiness may have contributed to the country’s victory over COVID-19, which appears to have been contained to around 3,000 cases and 26 deaths in a population of over five million people.
Key Points
- GDP = consumption + investment + government expenditure + exports imports, according to the expenditures method.
- The output method is also referred to as the “net product” or “value added” method.
Key Terms
- Total spending on all final goods and services (Consumption goods and services (C) + Gross Investments (I) + Government Purchases (G) + (Exports (X) Imports (M)) is the expenditure approach. GDP = C + I + G + I + I + I + I + I + I + I + I (X-M).
- GDP is estimated using the income approach by adding up the factor incomes and the factors of production in the community.
- GDP is estimated using the output approach, which involves summing the value of items sold and correcting (subtracting) for the cost of intermediary goods used to make the commodities sold.
Is GDP sufficient to assess a country’s prosperity?
To describe prosperity, most economists use a simple economic statistic known as GDP. GDP is the most recognizable and extensively used metric of national progress, whether measured in total for a country or per capita. It is an exceptionally helpful single assessment of a country’s well-being because it incorporates the value of all goods in the economy, whether consumed by people, governments, or enterprises.
However, there are issues with the GDP measurement. Some goods and services, such as government-provided free health care or family care services, may not have prices, thus statisticians must infer values to obtain a more complete GDP measure. Imputation, on the other hand, is unreliable because the necessary subjective evaluations are carried out by remote statisticians rather than by users of the services. Discrepancies also develop when the assumed values of these services differ across national borders. Many services, for example, are valued higher in Finland than in the United States since the former has a larger government sector. Finland’s GDP would be skewed downward in relative terms if these services were not included.
Another flaw in the GDP calculation is that it fails to account for quality increases where there has been no change in price: BlackBerries or iPhones can do far more and are far more useful than similarly priced phones from a decade ago. Overestimating inflation, for example, has the same overall effect as failing to account for technological quality improvements: it undervalues changes in GDP. Examining these flaws, as well as others, reveals that GDP may not be the most reliable indication of actual income, let alone prosperity. Continuous improvements in statistical approaches help to mitigate these issues, but they don’t totally eradicate them.
Even with advancements, dry, objective measurements like GDP still fall short of capturing a lot of life. In a speech in 1968, Robert F. Kennedy expressed his concern about GDP growth “Everything is measured, except what makes life valuable. “GDP, for example, reports resource consumption positively but fails to account for resource depletion, whether due to environmental damage or ill working conditions.
When Sarkozy’s group presented its report on September 14, it raised some methodological and substantive difficulties, suggesting that household income may be a stronger measure of success than corporate production, and that median incomes better characterize societal disparity than mean averages. As it is stated,
The main pattern in OECD countries during the last two decades has been a fairly broad growth in income inequality, with particularly substantial increases in Finland, Norway, and Sweden (from a low base), as well as Germany, Italy, New Zealand, and the United States (from a high base). In these circumstances, medians and means would provide distinct perspectives on social well-being.
The authors of the paper wisely point out that no single statistical method can be relied upon “In a single number, the “holy grail” can quantify everything significant. They feel that a variety of additional variables should be included in measuring a country’s success, and that indicators such as social capital, education, governance, and health should be included. The research analyzes how available statistics could be used to this aim. So far, everything has gone well.
However, the committee also wants to evaluate environmental deterioration and climate change, despite the fact that measuring these aspects is highly subjective, complex, and possibly impossible. The report’s underlying premise that all environmental changes over time will be harmful, especially in connection to concerns like energy use and population expansion, makes it much more difficult to make guesstimates operational. But things aren’t that straightforward. Depletion of resources can lead to better resource management, which can lead to an increase in those resources. The fisheries of Iceland are an excellent example. Overfishing of cod and other fish stocks in Iceland prompted a new policy of Individual Transferable Quotas, a legal property rights transfer system that resulted in better resource management and the recovery of some fish species to the benefit of most fishermen.
The report avoids adopting the most outlandish evaluation theories, but it nonetheless gives them plenty of airtime. Take, for example, its “threshold” idea, which states that “sustainability is already far behind us, and we have already entered a decline phase.” There is no no refutation or qualification of the “well-known” claim that we have “exceeded the Earth’s biocapacity by around 25%.” Such notions are frequently exploited in Hollywood films as academic basis for dystopian nonsense of the worst type.
Is GDP a reliable indicator of happiness?
The Gross Domestic Product (GDP) measures both the economy’s entire income and its total expenditure on goods and services. As a result, GDP per person reveals the typical person’s income and expenditure in the economy. Because most people would prefer to have more money and spend it more, GDP per person appears to be a natural measure of the average person’s economic well-being.
However, some people question the accuracy of GDP as a measure of happiness. Senator Robert F. Kennedy, who ran for president in 1968, delivered a powerful condemnation of such economic policies:
does not allow for our children’s health, the quality of their education, or the enjoyment of their play. It excludes the beauty of our poetry, the solidity of our marriages, the wit of our public discourse, and the honesty of our elected officials. It doesn’t take into account our bravery, wisdom, or patriotism. It can tell us everything about America except why we are glad to be Americans, and it can measure everything but that which makes life meaningful.
The truth is that a high GDP does really assist us in leading happy lives. Our children’s health is not measured by GDP, yet countries with higher GDP can afford better healthcare for their children. The quality of their education is not measured by GDP, but countries with higher GDP may afford better educational institutions. The beauty of our poetry is not measured by GDP, but countries with higher GDP can afford to teach more of their inhabitants to read and love poetry. GDP does not take into consideration our intelligence, honesty, courage, knowledge, or patriotism, yet all of these admirable qualities are simpler to cultivate when people are less anxious about being able to purchase basic requirements. In other words, while GDP does not directly measure what makes life valuable, it does measure our ability to access many of the necessary inputs.
However, GDP is not a perfect indicator of happiness. Some factors that contribute to a happy existence are not included in GDP. The first is leisure. Consider what would happen if everyone in the economy suddenly began working every day of the week instead of relaxing on weekends. GDP would rise as more products and services were created. Despite the increase in GDP, we should not assume that everyone would benefit. The loss of leisure time would be countered by the gain from producing and consuming more goods and services.
Because GDP values commodities and services based on market prices, it ignores the value of practically all activity that occurs outside of markets. GDP, in particular, excludes the value of products and services generated in one’s own country. The value of a delicious meal prepared by a chef and sold at her restaurant is included in GDP. When the chef cooks the same meal for her family, however, the value she adds to the raw ingredients is not included in GDP. Child care supplied in daycare centers is also included in GDP, although child care provided by parents at home is not. Volunteer labor also contributes to people’s well-being, but these contributions are not reflected in GDP.
Another factor that GDP ignores is environmental quality. Consider what would happen if the government repealed all environmental rules. Firms might therefore generate goods and services without regard for the pollution they produce, resulting in an increase in GDP. However, happiness would most likely plummet. The gains from increased productivity would be more than outweighed by degradation in air and water quality.
GDP also has no bearing on income distribution. A society with 100 persons earning $50,000 per year has a GDP of $5 million and, predictably, a GDP per person of $50,000. So does a society in which ten people earn $500,000 and the other 90 live in poverty. Few people would consider those two scenarios to be comparable. The GDP per person informs us what occurs to the average person, yet there is a wide range of personal experiences behind the average.
Finally, we might conclude that GDP is a good measure of economic well-being for the majority of purposes but not all. It’s critical to remember what GDP covers and what it excludes.