GDP - what is it and is it fit for purpose?
Measuring economic growth: Is GDP sustainable?
It is a mainstay of political slogans, dictates whether finance ministers sink or swim, and is parroted by the press as the ultimate metric for the health of our economy. Yes, Gross Domestic Product (GDP for short) is perhaps one of the most influential statistics in the public domain. If GDP is rising, it generally means more jobs, wealth, investment and higher living standards – and falling GDP means quite the opposite. Hence, GDP has become something of a fixation among governments – with GDP growth stated by many as their primary policy goal. But what does GDP measure, how did it come to be used, and is it really the best metric for economic performance?
GDP and its great deal of problems.
In 1937, Simon Kuznets presented the original formulation for calculating GDP, and since the Bretton Woods conference of 1944, GDP has become the standard tool for sizing-up a country’s economy. But what exactly does is measure? Well, there are three ways of calculating GDP:
- Measuring the total value of goods and services produced in an economy
- The total income from profits and wages
- The total expenditure in the economy
All three methods should yield the same result.
Whilst that may sound simple enough, since its conception, GDP has had its critics. The main problem is that GDP only values monetary output. This presents some interesting quirks. For example, unpaid work in the home is not accounted for in GDP figures; the economist Diane Coyle quips that: “If you employ someone to clean your house, it adds to GDP. Except if you marry them, then it doesn’t.” Likewise, work done by volunteers does not add to GDP. In fact, the chief economist of the Bank of England estimates an additional £234bn a year could be added onto the UK’s GDP if the positive social value of volunteering was fully accounted for. On the other hand, events with negative environmental and social externalities can actually contribute positively to GDP figures. For example, the Exxon Valdez oil spill in 1989, one of the largest environmental disasters in US history, actually led to an increase in US GDP because of the additional money spent on the clean-up effort.
One economist, Moses Abramowitz, argued that “we must be sceptical of the idea that changes in welfare can be gauged from changes in the growth of output” and even Kuznets himself cautioned that whilst GDP may have been suitable for measuring demand and supply capacity during wartime, it was hardly an adequate measure for overall economic welfare. In fact, if we take GDP figures at face value, the last 50 years have been an incredible success story – according to McKinsey, the world economy is 6 times larger and average income per capita has tripled over that period. However, these figures don’t tell us about the impact of widening inequality, stagnating incomes, or the negative effects of economic growth on the climate. By using GDP as the ultimate measure of economic performance, these important issues have been somewhat overlooked by governments.
Would using a different measure change anything?
Whilst economic growth is clearly important as a vehicle for wealth creation and helps improve lives by lifting people out of poverty, adopting GDP as the fundamental measurement of growth encourages a consumption-led growth mindset, which desperately needs to be challenged in the light of a climate emergency and broader social issues. Rather than fixating on economic growth, Kate Raworth, an Oxford University economist, argues that governments should use a range of metrics to assess whether a country is operating sustainably – meeting the needs of their populations but not exceeding these needs by so much that they cause irreversible environmental damage. Promoting alternative measures of growth, such as the Genuine Progress Indicator (GPI), which considers environmental externalities, can re-frame how the situation is viewed and how decisions are made. Framing information in a way that captures environmental externalities, and the wellbeing of an economy means government and business decision making will be focussed not only on consumption-led wealth creation, but also the wider social impact of policy and actions.
Furthermore, adopting a more nuanced range of measurements and shifting focus away from wealth creation towards wellbeing and environmental sustainability could have positive externalities and benefit the economy in numerous ways. A 2017 study by researchers at the University of California found a positive correlation between HDI – a measure of economic wellbeing - and health. Healthier workers will not only be more productive, but also happier. Likewise, if a government is being judged on GPI, it would have a greater incentive to invest in eco-friendly projects, potentially leading to a greater pace of innovation in green and tech industries where focus is needed. In the UK there is debate around the government’s decision to invest £165m in a new coal mine in Cumbria. The government argues it will create jobs and boost the local economy – which it would as measured by GDP – but if the government were using GPI, for example, the negative environmental externalities (the project will result in an estimate 400,00 tonnes of co2e emissions) would discourage investment in a project that is clearly environmentally damaging.
It may seem radical to ditch GDP; after all it is engrained in policies, performance targets, how debt is measured and for international comparison of economic performance, but Diane Coyle says: “People have forgotten that it isn’t a real thing, it’s a construct.” Hence, constructing or adopting a new set of metrics that better suit the needs and challenges of today is not impossible, and could have positive economic and policy implications, leading to a renewed focus on issues that matter, such as the environment, how wealth is distributed, and social value created.
What are the alternatives to GDP?
Measuring the health of an economy is essential if a government is to introduce impactful policies. If GDP is not effective, what can be used instead? Here are three examples of alternative measures economic growth:
1) Human Development Index (HDI): This metric was developed in 1990 by Amartya Sen, who won a Nobel prize for their work on this. He said he set out to “create an index as vulgar as GDP but more relevant to our own lives.” According to the World Health Organisation, “HDI is a summary composite measure of a country's average achievements in three basic aspects of human development: health, knowledge and standard of living.” Critics argue the metric is too slow to respond to short-term changes in an economy and the assumption that wealth increases wellbeing is questionable.
2) Gross National Happiness (GNH) Index: Bhutan use this approach to measure the wellbeing and happiness of their population and use it as a guiding measure for policy decisions and government plans. It maps 9 broad domains, including education, health, living standards and ecological diversity.
3) Genuine Progress Indicator: GPI is similar to GDP but accounts for externalities such as pollution, thereby providing a full view of the health of a nation. However, calculating these externalities is just as subjective as the initial GDP figures, prompting questions about its effectiveness.