Finance

GDP: Gross Domestic Product Fails as an Indicator of Economic Welfare - Part 1

Why Using GDP is a False Growth Benchmark of Health and Wellness of an Economy

Written by Gaurav Bhola, MSM, Managing Editor & Community Manager on September 14, 2007 4:21 pm EST

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Conceivably there is no other headline that captures the essence of the Gross Domestic Product or GDP better than the Reuters headline after the catastrophes of hurricanes Katrina and Rita.

The disasters ravaged the citizens of our country, over 850,000 homes damaged, thousands of people becoming refugees, devastation of over 1.3 million acres of forests, avoidable deaths of 1,836 men, women, and children, and more unthinkable residual destruction.

Herein, the above catastrophes profoundly illustrate the fallacies of using GDP as an indicator of economic health and wellness. Pragmatic economists for decades have been shouting from the rooftops that the GDP is an inadequate reflection of the true economic welfare of America and Americans. American government officials and politicians always talk about economic progress; their solutions for sustainable and consistent growth of the economy come in various hues. However, there is one common theme, one commonality in their arguments; they always cite the Gross Domestic Product or GDP as the only measure of economic progress. Unfortunately, the GDP is not the universal indicator of growth as the above officials make it to be. The lackadaisical use of US GDP by politicians and government officials as the one size fits all benchmark of economic health and wellness is a disservice to the American public. Alas, the public is not provided the true picture of economic progress. Herein, I will endeavor to clarify GDP and offer some alternatives for benchmarking economic health and wellness.

The GDP is used to define the market value of services and goods produced within US borders irrespective of nationality during a period of time. This differs from Gross National Product or GNP which is the total value of all final services and goods produced by Americans irrespective of their location globally. Hence, GDP and GNP are almost similar and yet wholly dissimilar; GDP (or GDI - Gross Domestic Income) focuses within the region in which income is generated and GNP (or GNI - Gross National Income) measures accrual of income to a region. The GDP reflects the economic production within the US. The most common method of estimating production is the expenditure method.

This approach evaluates the amount that government and people expend on finished goods, investment for business in plants and equipment, and net exports of America. However, GDP counts only final services and goods while certain things are not counted towards GDP:

sales between companies
savings & financial investments
level of utility the public gets from consumption and production
- doesn’t measure the effects to the public or environment’s well-being as a direct result of a financial transaction

So, GDP counts many transactions as benefits to the current economy at the expense of future growth.

Henceforth, GDP is a national average which ignores the importance of the distribution of income or economic wealth. Here are some examples of what GDP doesn’t measure:

Simply doesn’t distinguish between financial transactions that diminish the well-being of people or environment.
Simply doesn’t distinguish costs from benefits, presupposes that every financial transaction profits people and environmental well-being.

A Look through the GDP Prism

GDP: Income Includes Depletion of Natural Capital

GDP treats natural capital depletion as income, unlike in accounting where it is measured as depreciation of an asset. This is counter intuitive as this would mean there is an inverse relationship with regards to depletion of natural resources and GDP count; hence, as more natural resources are used up, the GDP will increase.

GDP: Crime and Natural Disasters are Viewed as Economic Benefits

Crime is counted as a benefit to the economy from the GDP prism, since crime spurs consumption of security items, repair or replacement of property, and spending on crime prevention security services. Damage caused by the recent natural disaster Hurricane Katrina through the GDP prism injected billions of dollars into the economy and is seen as an economic benefit, completely ignoring the negative impact upon people and the environment.

GDP: Ignores Income Distribution

The GDP doesn’t take into account the distribution of income, as all tides don’t lift all boats. During two decades of GDP increase by over 50 percent between 1973 to 1993, wages declined by 14 percent. Also, in 1980, the real income of the top 5 percent of the households rose by 20 percent. The GDP increase was presented as a benefit to all Americans, it benefited a select few.

GDP: Overlooks the Disadvantages of Financing the Economy through Debt

America borrows money mainly from abroad to sustain the economy. The main avenue for economic sustainability is by procuring cash through debt, by sale of our US Treasuries. This activity contributes to the GDP; alas, the debt has to be repaid. Americans mainly go into debt for consumption not capital investment. Herein, this national and personal debt must ultimately be repaid; this downside of excessive debt is not reflected in the GDP.

GDP: Disregards Non-financial Services

The GDP doesn’t include any services of non-financial transactions such as volunteer work, elderly parental care, child care and such are not measured. Remember only monetized services are measured for the GDP. Herein, as non-financial services are replaced with more monetized services, from the GDP prism it is seen as economic progress.

GDP: Goes Up with Rise in Environmental Pollution

The Environmental Protection Agency’s multi-billion dollar Superfund Clean-up Program of waste and toxic sites will take over 3 decades to complete, during which time the economic activity generated and expenditure for the clean-up will be added to the GDP. The initial economic activity used to generate the waste was added to the GDP, the ensuing clean-up will again add to the GDP. Thus, polluting the environment is seen as an economic benefit through the prism of GDP.

Consequently, the GDP is used whimsically by government and political officials to portray an unrealistic view of the health and wellness of America and Americans. There are measures available that can reflect the true picture to the American public. After all, we and our children have a stake in the wellbeing of our nation in all spheres; thence, we desire and deserve information critical to the wellbeing of present and future generations of Americans.

Part 2: Coming soon

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4 Responses to “GDP: Gross Domestic Product Fails as an Indicator of Economic Welfare - Part 1”

David Says:
September 14th, 2007 at 5:26 pm
The site looks great. Your content is awesome. I see very few people on the web that communicate as much quality information at this pace. Thanks for sharing and good luck in ‘08!
mary robinson Says:
September 21st, 2007 at 4:05 pm
Your site is awesome. Your insight regarding GDP vs GNP is enlightening. Keep these discussions coming.
Xhilda Says:
September 24th, 2007 at 7:56 am
very enlightening. never seen it from that perspective.
jinky celis Says:
March 27th, 2008 at 10:18 am
can i request a estimated GDP of US economy as of 2007?tnx and im hoping for your reply.