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The Financial Express

Measuring the economy: A fixation on economic growth


Measuring the economy: A fixation on economic growth

Since the end of the World War II, the concept of economic growth has become the barometer  of  economic success  as measured in a three letter acronym: GDP. When the concept of  Gross Domestic product (GDP) was developed in the US in the mid 1930s, the world was undergoing major economic upheaval caused by the Great Depression of 1929-33. GDP was designed as a measure of economic activity to help the Roosevelt Administration to use that statistics --i.e., GDP to justify policies and associated budget expenditures aimed to bring the US out of depression.

However, the modern concept of GDP which all the countries around the world now use was developed by John Maynard Keynes during the second world war. Keynes pointed out a major flaw in Kuznets' estimation method which included government income, but not spending. He argued that if the government's war time expenditures on military procurement  were not considered as demand in calculating national income, the size of GDP would be much smaller than what it was. Thus GDP would not reflect the level of economic activity taking place giving an underestimation of economic growth rate.

Keynes' method of GDP calculation, therefore, included government spending as part of country's income. In simple terms,  GDP merely measures the size of the economy and does not reflect a nation's welfare, The method to estimate GDP devised by Keynes eventually found acceptance by countries around the world in the post WW II period including the multilateral institutions such the World Bank (WB) and the International Monetary Fund (IMF).

There are three different approaches that can be taken to measure GDP. However, it is the expenditure approach which is most commonly used to estimate GDP. The textbook formula for measuring GDP using the expenditure approach is C+I+G+(X-M)=GDP. GDP growth rate is driven by these four components. The main driver is private consumption ( C ), followed by private investment including construction and  inventory ( I ). The third component is government spending (G )which mostly includes social security benefits, health care, education, infrastructure and defence spending. The fourth is net exports (X-M) which is made up of the value of exports minus the value of imports.Therefore, the equilibrium  growth path of the economy  can only be understood as the sum of the growth of each of these components.

The GDP growth rate is the most important indicator of a country's economic health and changes during the four phases of the business cycle -- peak, contraction, trough and expansion. As such GDP can help policy makers make informed decision on interest rates, tax and trade policies including decisions on public spending in general and counter cyclical measures, in particular.

Arthur Okun (1928-1980), Professor of Economics at Yale University and Chairman of the  US President's Council of Economic Advisers between 1968 and 1969, held the firm belief that GDP is an absolute  indicator of economic success, claiming that for every increase in GDP, there would be a corresponding drop in unemployment. Also, policy makers in general consider GDP or GDP per capita as an all encompassing indicator of a nation's development combining its economic prosperity and societal wellbeing.

But GDP was not designed to assess welfare or wellbeing of citizens. It was designed to measure production capacity and economic growth. GDP is not also a measure of sustainability either. In 1934, Simon Kuznets who developed the US national accounting system and GDP, cautioned against equating GDP growth with economic and social well being. In fact,  he argued that "the welfare of a nation can scarcely be inferred from a measure of national income" while economic growth measured only annual flow, rather than stock of wealth and distribution.

In fact, GDP fails to capture the distribution of income, an issue that has become more pertinent in today's world with rising income inequality levels both in developing and developed countries.

In essence, GDP has enabled economic policy planners to trace fluctuations in economic activity ( i.e. business cycle) and to adopt policy measures to smooth out those fluctuations to keep the economy on a steady growth path.  It was definitely not designed as a measure of economic or social wellbeing. Yet, countries around the world continue to use (more precisely misuse) GDP as a scoreboard for national welfare. In other words, the world is still in the grip of the GDP mystique.

It is the two Bretton-Woods institutions the World Bank (WB) and the International Monetary Fund (IMF) who have given the seal of approval and contributed to strengthening  the idea  of using GDP as the principal measure of economic progress, despite the caution not to do so by none other than Simon Kuznets himself. Kuznets also feared that taken simplistically, GDP might be prone to misuse.

 In fact, under the tutelage of the WB and the IMF, GDP has been turned into the principal guide for countries to formulate economic policies with the singular focus on economic growth as measured by GDP. We are indeed led to believe that GDP can perform miracle. Growth as a metaphor for prosperity has become deeply embedded in our thought process. This is because growth has become shorthand for higher living standards.

Despite the apparent scientific approach used in the calculation of GDP, it relies on several assumptions and misses out huge swathes of the economy and wider society that can not be quantified in monetary terms such as unpaid work at  home, environmental degradation and associated health problems, leisure time, work of charities etc. As Robert Kennedy said in his famous election speech in 1968 "it (GDP) measures everything in short, except that which makes life worthwhile".

But increased economic growth will lead to increased output and consumption. The production of goods and services (output) requires energy and materials such as metals, minerals, water, food and fibre-- all of which come from the environment. The impacts of resource extraction, production, transportation and waste generation are central to contributing to environmental degradation.

Increased output can only come at the cost of environment. Increased output also leads to increased consumption.  The consumption of goods and services is a major driver of global resource use and associated environmental degradation.  It is estimated that consumers are responsible for  more than 60 per cent of the world's Green House Gas (GHG) emissions  and about 80 per cent of global water use. Overall,  it is estimated that 60-80 per cent of the impact on the environment come from household consumption.

The crisis is coming at us very hard and fast. We  are also losing forests, biodiversity, agricultural land, fisheries at a frightening rate across the whole world. Fresh water shortages and toxic accumulations are reaching at a critical point threatening  sustainable living on this planet.

Yet, environmental degradation is not  factored into the estimation of GDP.  As output grows, so does GDP regardless of the environmental degradation caused because of this. So, according to GDP, a country like Bangladesh which is recognised to be on the growth trajectory so much so that according to the latest data India has slipped below Bangladesh in terms of per capita income which is estimated at US$2,227 in the financial year 2020-2021, relative to India's per capita income US$1,947 and also achieved a growth rate of 9 per cent during the same period.

Bangladesh is now considered as one of the fastest growing economies in the world in terms of GDP. Since 2004, Bangladesh averaged a GDP growth rate of about 5 per cent and that rate since 2016 further accelerated to above 7 per cent. Rapid economic growth enabled Bangladesh to graduate from a least developed country (LDC)  to become a lower-middle income country in 2024.

As economic growth accelerates, it causes structural shifts in the economy. The share of agriculture now stands at 12.5 per cent of GDP followed by manufacturing at 30 per cent and services at 57.5. But  the distribution of employment follows rather a very different pattern; the agriculture sector accounts for 37.5 per cent of employment, 21.7 per cent in manufacturing and 40.8 per cent in services.

In 2020, the unemployment rate in Bangladesh was at 4.15 per cent but the youth unemployment rate stood at 11.56 per cent during the same year. It is widely recognised that in low income countries the unemployment rate does not reflect the real nature  and extent of unemployment and underemployment. In fact, the majority of workers are found in the informal sector as self-employed or wage earners, barely making a living.

The national poverty rate for Bangladesh is estimated at 20.5 per cent and the extreme poverty rate at 5.6 per cent. Now the poverty rate is estimated to have risen due the impact of the pandemic to 29.5 per cent and the extreme poverty rate to 10.5 per cent.

The Gini coefficient, a measure of income inequality rose from 0.458  in 2010 to 0.482 in 2016 indicating income inequality is worsening. As a result of  the pandemic the coefficient is now estimated to have gone up to 0.52. Income inequality and poverty are directly interrelated as such even small changes in income distribution can have profound effect on poverty.

In developed countries income inequality is primarily a matter of wage inequality. But in a country like Bangladesh there is an added factor - an all pervasive inequality of opportunities. Overall, the benefits of growth do not look like shared by the poor and very low income wage earners like RMG workers.

It is now clearly evident that focusing exclusively on GDP and economic gains to measure development ignores the negative effects of economic growth on society as measured by GDP, such as environmental degradation and income inequality.

If we continue to follow the path of infinite economic growth as measured by GDP  using finite resources that the planet provides us to feed, cloth and shelter, economic activity will collapse pretty quickly. Environmental degradation is a significant externality that the measure of GDP has failed to reflect. The production of more goods definitely adds to Bangladesh's GDP irrespective of environmental damage suffered because of it.

While no country is immune from the climate crisis as manifested in global warming and climate change, it is a developing country like Bangladesh that is recognised as one of the most vulnerable  countries to the impacts of climate crisis. This is primarily due to its unique geographic location. A report by the Environmental Justice Foundation provides an analysis of the situation facing Bangladesh. The report describes Bangladesh as exceptionally vulnerable to climate change. The country's low elevation where two thirds of Bangladesh is less than five meters above sea level, high population density and inadequate infrastructure,  all these put the nation in harm's way.

The report further adds that the Bangladesh economy is heavily reliant on farming. By 2050, with a projected 50cm rise in sea level, Bangladesh may lose approximately 11 per cent of its land, affecting 15 million people living  in its low lying costal region. The process of salination has been exacerbated by rising sea levels seriously impacting health and crop output. But more alarmingly, it is also estimated that a three-foot rise in sea level would submerge almost 20 per cent of the country and displace more than 30 million people. In fact,  the actual rise in 2100 could be significantly more.

But there are also other immediate concerns for developing countries like Bangladesh arising out of climate crisis. According to the IMF research findings, a country's vulnerability or resilience to climate change can have a direct effect on its credit worthiness, its costs of borrowing, and  ultimately the likelihood  that the country might default on its sovereign debt.

Now, time has come to acknowledge the limitations of GDP by looking at negative effects of economic growth on society such as environmental degradation and rising income inequality. Also, economic growth, by definition, is impossible to sustain forever given the planetary resources limit. Therefore,  the goal of an economy is to be geared towards sustainably, improve human wellbeing and the quality of life that can be supported by the ecosystem.

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