GDP -- does size matter more than essence?

| Updated: February 22, 2022 21:24:38

Workers are at a site of expressway construction in Dhaka. Mega infrastructure projects become critical to boost the GDP growth in Bangladesh. 	—Xinhua Photo Workers are at a site of expressway construction in Dhaka. Mega infrastructure projects become critical to boost the GDP growth in Bangladesh. —Xinhua Photo

GDP (Gross Domestic Product) serves as a gauge of an economy's overall size. GDP measures the total market value of the output of all goods and services produced in the country in a given year. Also, when compared with previous periods, GDP can indicate whether the economy is expanding  by producing more goods and services, or contracting due to less output. Economic growth rates are very closely monitored by public policy makers and officials, businesses, and the public alike  because of their importance both for economic and political reasons as well as to make informed decisions.

Economic growth rates  are reported as  percentage and reported rates are usually based on real GDP which is nominal GDP (measured in current market prices) adjusted to eliminate the effects of inflation. The  GDP growth rate  is expressed as a single figure  by compacting all economic activities in a particular period of time, usually one year.

It can be measured either by the sum of what is purchased in the economy using the expenditures approach or incomes earned on what is produced using the incomes approach.

Looking from the expenditures side which is the most widely used approach to measure GDP, we breakdown the number using the macroeconomic textbook formula where GDP equals private consumption (C) + investment Expenditure (I) + Government Expenditure (G) + Net Exports (X-M).

It must be noted that GDP only measures the "size of the economy". This is why Simon Kuznets who developed the measurement of GDP in the 1930s was quite clear that his measure has nothing to do with wellbeing. 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. 

But how the "size" is interpreted remains the core of the debate on GDP.  Kuznets' view is contested by some and  they argue that the size of a country's GDP matters because GDP measures a country's production of goods and services which is equal to income. Income is generally considered as an indicator of the quality of life (QOL), so there is positive correlation between income and the QOL.

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, public 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. GDP has, indeed,  been turned into the principal guide for countries to formulate economic policies with the singular focus on economic growth as measured by GDP.

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, therefore national wellbeing,  despite not to do so by no other than Simon Kuznets himself.

Kuznets also feared that the simplicity of GDP might be prone to misuse. The reason being GDP is a gross number expressed in a single figure. It includes everything that a country produces, goods and services including armaments, financial speculation and advertising along with wastes, environmental  pollution and degradation, depletion of finite resources etc.  GDP does not take into account its own costs of continuing growth.

We are indeed led to believe that GDP can perform miracle. Growth as a metaphor for prosperity has become deeply embedded in our collective psyche. This is because growth has become shorthand for higher living standards. Such a view naturally leads to  believe  in the all important dictum "only size matters" which underlies and determines our understanding of GDP.

Despite the apparent scientific approach, the calculation of GDP relies on a number of restrictive assumptions which preclude many activities such as unpaid work at home, charities and voluntary work, leisure time, underground economy, i.e. all non-market transactions and illegal activities are excluded. More importantly GDP fails to capture such as wellbeing, environmental accounts and distribution of income and wealth. Robert Kennedy commenting on GDP once famously said, "it measures everything in short, except that which makes life worthwhile".

GDP measures the extent of economic activity. It is simply the sum of the value added for all industries. At current prices, Bangladesh GDP now measures about US$416.00 billion making it the 37th largest economy  in the world with per capita income US$2,591. The US has the largest economy in the world with US$22.9 trillion followed by China with US$16.8 trillion.

While GDP measures aggregate production enabling us to gauge the size of the economy but does not measure how that aggregate output is shared. The global economy is estimated to be worth about US$80 trillion a year-- that is about US$10,500 for every person on this planet. But in 2019 per capita income in Bangladesh was US$1,855, India US$2,099, China US$10,262, Russia US$11,585 and the US US$65,298.

The average figures mentioned above do not tell us the degree of income inequality in society. In the contemporary global society the principal cause of social dislocation and social inequality is income inequality. GDP completely fails to  say anything about income distribution, so averages are misleading.

GDP is a flow measure of income only taking into account the value of goods and services produced in given year i.e., the past one year. It does not measure wealth. In fact, the rising wealth inequality is now being identified as the principal contributing factor to growing income inequality leading to the concentration of income and wealth among the one percenters, leaving 99 percent of people resentful at how the 1 percent is making good.

GDP focuses on total output alone and can not measure a nation's development or its citizens well-being.  It does not answer the question of economic growth for whom and at what costs or whether the country's growth is sustainable or not.

Yet "size" matters in most economies because there is a general perception that a higher income (a larger GDP) is correlated with a higher standard of living, therefore a higher quality of life. But empirical studies indicate that beyond a certain level of income, additional increases in income no longer correlate with higher quality of life.

Fast growth as measured by GDP has been considered a mark of  success in its own right, rather than a means to an end regardless of the costs of infinite growth. GDP does not calculate its own costs of infinite growth. As for GDP now, certain questions must be addressed: Growth for whom and at what cost?

Economies around the world have become structurally dependent on growth, so much so that without GDP growth figures in the Wall Street will become totally directionless, necessitating a country like the US to publish quarterly GDP growth figures to help business and public policy planners.

Governments and central banks also  totally rely on GDP data to formulate their policies to further stimulate growth. After the WWII, the Marshal plan relied on GDP to design the European economic recovery program and the United Nations also use GDP as the principal economic indicator. 

GDP has been very successful in drawing attention of public policy makers and from their perspective the "size" matters where bigger GDP is always better. But GDP fails as one size fits all measures of national  progress or welfare of the citizenry.

More importantly, whether economies around the world can continue to grow for ever is now open to debate. The debate primarily rests on the argument that growth by definition is impossible to sustain for ever given our planetary constraints, and therefore the only solution is 'degrowth'. This concept of degrowth focuses on sustainability, wellbeing, deceleration and in particular  reduction of production and consumption in developed countries.

We have so far completely relied on the growth models and GDP as the barometer of success.  But that has been under challenge since the late 1960s as many economists began to question the over-reliance of governments and their agencies on narrow, exclusively GDP-based measures of economic welfare. In search for a wider measure of welfare, various alternative measures have been suggested.

In 1972, Yale Economics Professors William Nordhaus and James Tobin introduced their "Measure of Economic Welfare" (MEW) as an alternative to GDP that attempted to remove defence expenditures and commuting costs which do not contribute to welfare and added imputed values of leisure and  non-market work that are excluded in GDP. MEW  can be also seen as a forerunner to create an Index of Sustainable Economic Welfare (ISEW) which is derived by adjusting GDP further by taking into account a wider range of harmful effects of economic growth  as well as excluding defence expenditures.

Another alternative indicator, the Genuine Progress Index (GPI)  has achieved some recognition as reflected in at least one US House Representative introducing recently a bill in support of GPI in an attempt to overhaul GDP. It is based on 26 economic, environmental and social indicators, all expressed in dollars to produce a single figure like GDP.  Also, another widely used indicator is the Human Development Index (HDI). The index is based on three broad indicators - life expectancy, adult literacy and per capita income. More recently, another indicator has been added- a measure of inequality.

In February 2008, French President Nicholas Sarkozy assembled a group of three eminent economists to form a commission headed by Joseph Stiglitz with Amartya Sen and Jean Paul Fitoussi as members to look  at alternatives to GDP. They produced a report titled "Mismeasuring Our Lives: Why GDP Does Not Add Up" (now published as a book by The New Press). They recommended that  policy makers pay less attention to GDP and pay more attention to distribution, quality of life and sustainability. They also recommended that no single indicator should replace GDP rather recommended a dashboard of indicators to describe a nation's wellbeing.

The critique of GDP primarily rest on that, it is only one indicator  but however ingenious it might be it tells us something.  The solution is also not to find another better indicator to replace GDP. The way forward is to use other indicators along with GDP to encompass issues that are of vital importance to society such as measures of wealth and income distribution, equality, leisure, wellbeing, net domestic product adjusted for environmental costs to begin with. Therefore, the alternative indicators suggested above need serious consideration because they go far beyond the narrowness of a nation's GDP value.

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