Time to rethink GDP?
Back in the 1960s US politician Robert Kennedy spoke of the flaws inherent in using gross domestic product (GDP) as the major measure of economic progress for a country. GDP has certainly had its detractors on the left, who allege that economic productivity can both lead to income inequality and environmental degradation.
Such criticisms are valid, as is the fact that GDP fails to capture non-market activities, such as voluntary work which has an economic impact. But even these criticisms imply that GDP still captures national productivity or economic power. However, in reality, it fails to give a complete picture of either.
GDP is best described as the monetary value of all finished goods and services produced within a country's borders in a specific time period, usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory.
GDP can be calculated in nominal terms or by purchasing power parity, i.e. how much money would be needed to purchase the same goods and services in two countries, and uses that to calculate an implicit foreign exchange rate. GDP per capita is often considered an indicator of a country's standard of living.
GDP measures productivity, not ownership or national economic power. It is easily manipulated and subject to considerable revision. It rewards debt-fuelled government spending and consumption, while it undercounts wealth creation in other areas.
For instance, a Japanese car company makes cars in the UK. That contributes to British GDP but Japanese GNP, or more simply, the productivity is in Britain but the ownership is in Japan, to which money will flow back. To take another example, a car company in one country may have a majority of shareholders in others.
Saudi Arabia has a GDP of US$577bn, UAE $360bn, Bahrain US$177bn, Qatar US$174bn, Oman US$72bn and Bahrain US$26bn. Yet through sovereign wealth funds such as the Qatar Investment Authority, Abu Dhabi Investment Authority, SAMA Foreign Holdings, Kuwait Investment Authority and State General Reserve Fund, the Gulf Cooperation Council holds trillions of dollars worth of assets, as do financial institutions in London and New York. Equally China has a lower GDP than America but more net foreign assets.
For GDP, all transactions are neutral. This means public and private sector spending €" based on savings or debt €" are counted equally. For many European countries, their public sector makes up over half the counted economy. France is an example of this. For those who believe that private enterprise is a better long-term bet for national wealth and economic power, an economy primarily based on the public sector creates problems.
Governments seeking to boost GDP could artificially inflate it. Firstly they could borrow money to bankroll a big public sector. This is how most European countries operated over the last thirty years. As an illustration, compare South Korea and Spain. South Korea has a population of nearly 49 million people and Spain just over 46 million.
South Korea has a higher human development index (15th in the world) compared to Spain (23rd), with a vastly superior education system. Yet South Korea's official GDP is US$1.163 trillion while Spain's is US$1.495 trillion. Consider the technological lead South Korea has not only over Spain but over most countries on earth and, that it can afford a much wealthier military (US$27.6 trillion) than Spain can (US$15.8 trillion). Who really believes that Spain has more national economic power than South Korea?
Moreover in many countries not just governments, but people, borrowed to fund extravagant spending. For many Americans, Britons and others, credit card debt fuelled the boom of the last ten years. Since GDP counts consumption as a major component (70% of America's US$15 trillion GDP is private consumption) it rewards debt as much as big government. Meanwhile socially destructive behaviours, such as crime, can inadvertently boost GDP by increasing the need for lawyers and ancillary prison costs.
Inflation also impacts GDP because GDP is measured in dollars (or some other country's currency as appropriate), therefore dollar-inflation alone would cause an apparent increase in GDP. Comparing the current GDP to the nominal GDP of other years will not account for the impact of inflation on the relative value, unless other years are converted into current dollars as well. In contrast to Current Dollar GDP, Real GDP does account for inflation changes when comparing two or more years.
Constant dollar GDP is adjusted for price changes. Current dollar GDP €" the current measurement €" reflects increases and decreases in the general level of prices (inflation or deflation). While new technologies can change the nature of the goods and services an economy produces, constant dollar GDP is a better overall reflection of an economy.
GDP leaves many economic activities out of the accounting. GDP does not account for non-market transactions. Unpaid work conducted on Free and Open Source Software contributes nothing to GDP, but would have cost over US$1bn for a company to develop.
Other economic activities do not get counted. GDP does not count purchases of financial products €" which get classed as €savings'. If one purchased shares in a company and the company used the money to buy equipment, the equipment would be counted towards GDP. Counting the purchase of the shares would be to count two times an amount which only corresponds to one group of products, even though the person buying the shares has received as much of a benefit as the company spending the money.
GDP fails to take into account the value of all assets in an economy. It looks at productivity, not ownership. Ranking countries by assets, market capitalisation or company profits and revenue would produce very different results to just ranking countries based on GDP. It is no accident that GDP was first adopted by US President Franklin Roosevelt's government in the 1930s, when government was being used to kick-start a depression economy. GDP ignores countries' balance sheets and simply focuses on their income statements. GDP is valuable, but looking at it alone cannot give one an accurate reading of the economic health, wealth, power or prosperity of any given country or teritory.
Such criticisms are valid, as is the fact that GDP fails to capture non-market activities, such as voluntary work which has an economic impact. But even these criticisms imply that GDP still captures national productivity or economic power. However, in reality, it fails to give a complete picture of either.
GDP is best described as the monetary value of all finished goods and services produced within a country's borders in a specific time period, usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory.
GDP can be calculated in nominal terms or by purchasing power parity, i.e. how much money would be needed to purchase the same goods and services in two countries, and uses that to calculate an implicit foreign exchange rate. GDP per capita is often considered an indicator of a country's standard of living.
GDP measures productivity, not ownership or national economic power. It is easily manipulated and subject to considerable revision. It rewards debt-fuelled government spending and consumption, while it undercounts wealth creation in other areas.
For instance, a Japanese car company makes cars in the UK. That contributes to British GDP but Japanese GNP, or more simply, the productivity is in Britain but the ownership is in Japan, to which money will flow back. To take another example, a car company in one country may have a majority of shareholders in others.
Saudi Arabia has a GDP of US$577bn, UAE $360bn, Bahrain US$177bn, Qatar US$174bn, Oman US$72bn and Bahrain US$26bn. Yet through sovereign wealth funds such as the Qatar Investment Authority, Abu Dhabi Investment Authority, SAMA Foreign Holdings, Kuwait Investment Authority and State General Reserve Fund, the Gulf Cooperation Council holds trillions of dollars worth of assets, as do financial institutions in London and New York. Equally China has a lower GDP than America but more net foreign assets.
For GDP, all transactions are neutral. This means public and private sector spending €" based on savings or debt €" are counted equally. For many European countries, their public sector makes up over half the counted economy. France is an example of this. For those who believe that private enterprise is a better long-term bet for national wealth and economic power, an economy primarily based on the public sector creates problems.
Governments seeking to boost GDP could artificially inflate it. Firstly they could borrow money to bankroll a big public sector. This is how most European countries operated over the last thirty years. As an illustration, compare South Korea and Spain. South Korea has a population of nearly 49 million people and Spain just over 46 million.
South Korea has a higher human development index (15th in the world) compared to Spain (23rd), with a vastly superior education system. Yet South Korea's official GDP is US$1.163 trillion while Spain's is US$1.495 trillion. Consider the technological lead South Korea has not only over Spain but over most countries on earth and, that it can afford a much wealthier military (US$27.6 trillion) than Spain can (US$15.8 trillion). Who really believes that Spain has more national economic power than South Korea?
Moreover in many countries not just governments, but people, borrowed to fund extravagant spending. For many Americans, Britons and others, credit card debt fuelled the boom of the last ten years. Since GDP counts consumption as a major component (70% of America's US$15 trillion GDP is private consumption) it rewards debt as much as big government. Meanwhile socially destructive behaviours, such as crime, can inadvertently boost GDP by increasing the need for lawyers and ancillary prison costs.
Inflation also impacts GDP because GDP is measured in dollars (or some other country's currency as appropriate), therefore dollar-inflation alone would cause an apparent increase in GDP. Comparing the current GDP to the nominal GDP of other years will not account for the impact of inflation on the relative value, unless other years are converted into current dollars as well. In contrast to Current Dollar GDP, Real GDP does account for inflation changes when comparing two or more years.
Constant dollar GDP is adjusted for price changes. Current dollar GDP €" the current measurement €" reflects increases and decreases in the general level of prices (inflation or deflation). While new technologies can change the nature of the goods and services an economy produces, constant dollar GDP is a better overall reflection of an economy.
GDP leaves many economic activities out of the accounting. GDP does not account for non-market transactions. Unpaid work conducted on Free and Open Source Software contributes nothing to GDP, but would have cost over US$1bn for a company to develop.
Other economic activities do not get counted. GDP does not count purchases of financial products €" which get classed as €savings'. If one purchased shares in a company and the company used the money to buy equipment, the equipment would be counted towards GDP. Counting the purchase of the shares would be to count two times an amount which only corresponds to one group of products, even though the person buying the shares has received as much of a benefit as the company spending the money.
GDP fails to take into account the value of all assets in an economy. It looks at productivity, not ownership. Ranking countries by assets, market capitalisation or company profits and revenue would produce very different results to just ranking countries based on GDP. It is no accident that GDP was first adopted by US President Franklin Roosevelt's government in the 1930s, when government was being used to kick-start a depression economy. GDP ignores countries' balance sheets and simply focuses on their income statements. GDP is valuable, but looking at it alone cannot give one an accurate reading of the economic health, wealth, power or prosperity of any given country or teritory.
Source...