Why GDP Is a Gross Domestic Problem
A critique against this economic barometer.
It is perhaps the most popular and widely used term from the world of economics — Gross Domestic Product. From being on the headline of any news coverage to the source of worry for any job seeking college grad, there is no escaping this three letter word.
With the mass hysteria, comes a few misconceptions — actually more like misinterpretations. These are often fueled by politicians, who use this economic metric for their political advantage. Leaving the general public in a state of national pride — or worse, despair.
People associate quantitative measurements with objectivity and precision, hence it is easy to abuse GDP to create an illusion of “real results”. So it is no surprise that our perception of “10 % increase in GDP!!” is positive (when it shouldn’t always be).
The Gross Domestic Past
As with many things, exploring the past can be helpful in explaining the present. Simon Kuznets developed this concept during the manufacturing age in hopes to quantify all the goods produced within a country.
Much has changed since the 1940s, most developed countries have shift focus from manufacturing (secondary sector) to the tertiary sector. For instance, up-to to 80% of production in the US is from the service industry.
While it is established that GDP has no place in the modern economy, how it measures things is even more confusing. If the service quality at a restaurant improves, GDP doesn't account for it. Likewise, GDP would prefer more car accidents so that money is spent on rebuilding, irrespective of driver safety.
Perhaps, this is the reason for the newfound criticism against the statistic. GDP is no more king; it is well past its expiry date. How can we simplify such a complex idea like economic well being into one compact number. Do doctors only run one test for a diagnosis?
Normally, we think the inventor or in this case — economist, would be opposed towards any criticism, but Mr.Kuznets felt the exact opposite.
Famously he said, “The welfare of a nation can scarcely be inferred from a measurement of national income”.¹
Being a gross number, GDP doesn't discriminate between weapons of mass destruction or chicken nuggets; in the eyes of GDP they are all the same. Which brings us to the next issue.
Symptoms: Social Ills
Its quite fascinating how GDP has become the choice differentiator in our quest to rank nations. Certainly, nominal GDP— real GDP if you want to be precise, should tell us how well a nation is doing.
Take China for example, the residents of Beijing with their 24,000 dollars per capita must be doing well. So what if the high rise down the street is invisible because of air pollution or if their children are susceptible to lung disease. I’m sure the number reflects their standard of living.
GDP cant represent social well being effectively. It includes the money spent on electric cars, but it doesn’t tell if the air quality is better or worse. It includes spending on burglar alarms but doesn’t address the issue of rampant crime.
The use of GDP alone never tells the full story especially when it comes to matters of environment and society. While the GDP per capita of the US is higher than that of Germany, the average American worker works hundreds of hours more in the year. In the laborious task of calculating GDP, we have overlooked work-life balance.
If we only look at the numbers; we also avoid all the nuances and complexities that come with them. A cursory glance will tell you that Vietnam and Pakistan have a similar per capita GDP; hence their standard of living is equal. Of course, this overlooks the fact that both life expectancy and literacy is higher in Vietnam than in Pakistan.
If I said that “the standard of living for women in Saudi Arabia and the UK is the same,” it would sound outlandish. Regardless, both countries having a real per capita GDP of forty nine thousand. Obviously, the figure doesn’t show the inequality present in Saudi Arabia. Speaking of which….
E for Equality
Despite all of this, one would think that at least GDP should be good at measuring income. But…. that's not the case. If we look at GDP per capita of any country, it is easy to assume that this numbers represents the average salary of the common man.
This assumption misses out on a very important factor — inequality. The aforementioned 10% growth wont translate to every citizen being 10% richer. Its very likely that it would be the top 10% reaping the rewards.
A classic example is South Africa during the Apartheid, which ranked high in term of GDP per capita. However, this wealth wasn't disturbed equally among the populous. Black South Africans remained in poverty while the GDP kept growing.
Towards the north of the continent, Nigeria faced a similar fate. Before the oil prices crash, GDP was soaring in the country thanks to the lucrative oil output. Soon though, the oil deposits were exhausted and the wealth that only a few benefited from, wasn't invested back into the country for future income.
This problem lies in the theory; GDP only handles aggregates. A major cause of social dislocation is inequality, GDP has nothing to say about distribution. Averages can easily be manipulated whereas medians offer a realistic perspective. When assessing a countries GDP per capita it is important to consider the Gini Index.
The Upgrade
Since the invention of GDP, various alternatives have emerged. Most notably, the Human Development Index (HDI) which tries to account for social development through the inclusion of literacy rates and life expectancy.
More similar to GDP, the Genuine Progress Indicator (GPI) subtracts out the costs of negative effects such as crime, environmental degradation and climate change from GDP. This allows for a more accurate measure of the economic output.
On the brighter side, there is the Happy Index which may sound frivolous but has some merit to it. After all, the Declaration of Independence states the pursuit of happiness. Why not measure it?
Final Thoughts
We’ve made progress in measuring the well being of the economy — but not the well being of the people in it. When you hear that the GDP per capita has gone up, ask yourself what has happened to leisure time? Is all the income being distrusted towards the top 10% ?
That’s not to say GDP is complete useless, it does measure output very well. However, GDP should not be the center of any macroeconomic policy. As Robert Kennedy said “it [GDP] measures everything in short, except that which makes life worthwhile.”²
[1]: Simon Kuznets in report to the Congress, 1934; Cited in: Gernot Kohler, Emilio José Chaves (2003) Globalization: Critical Perspectives. p. 336.
[2]: Halberstam, David (5 March 2013). The Unfinished Odyssey of Robert Kennedy. Open Road Media.
