Finance

GDP: Gross Domestic Product Fails as an Indicator of Economic Welfare Part 2

Written by Gaurav Bhola, MSM, Managing Editor & Community Manager on March 3, 2008 4:06 pm EST

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Gross Domestic Product has been incorrectly used as an economic indicator of the economic health and wellness of a nation and its citizens since World War II. GDP is used extensively by economists worldwide as the only and true measure of the health of an economy. As it has abroad, so has it at home, ill-served the American people by giving them a false sense of economic security. Its importance as an indicator for the standard of living has limited utility. Herein, over the years criticisms of GDP’s utility as a measure of an economy’s health and wellness are coming to the forefront.

As economics is not an exact science, cause and effect cannot be measured properly and results can vary according to innumerable variables, some of which are too difficult to quantify. Hence, economists rely on a few quantifiable variables and extract from it, implications for the larger picture. Economics is more art than science. Can a lone Gross Domestic Product measure reflect progress and public welfare? Can GDP, a shorthand tool for the well-being of a country be an accurate assessment of the standard of living of its citizens? Supporters of GDP counter that a shift to alternative measures of national and societal progress is not possible, as GDP, even in its flawed form is the best measure of economic progress.

Gross Domestic Progress is the sum market value of all final goods and services produced within a given nation in a given period of time.

In the mid 1990s, Senator Byron Dorgan (D-ND) asked his congressional colleagues to re-evaluate the GDP. He thought if GDP was going up and America was doing so well, then why were Americans working more and more for less and less. He questioned the merits of GDP as a true economic indicator.

Ever since World War II, growth statistics based on GDP have been extensively used as an appraisal of the health and wellness of society. The use of GDP as society’s economic health indicator was not the original intent of the creators of GDP, Simon Kuznets being the principal architect. He stated almost forty years ago:

“The welfare of a nation can scarcely be inferred from a measurement of national income… Goals for more growth should specify of what and for what.”

Unfortunately, the U.S. and the world didn’t heed his warnings and GDP has become the de facto measure of progress that it was never meant to be. These are some criticisms of GDP as a true measure of the economic health and wellness of a nation:

• GDP doesn’t account for household domestic and volunteer work. Child-rearing and housekeeping is deemed valueless under the GDP regime. Any unpaid volunteer work is seen as not benefiting the economy.

• Doesn’t take into account the black market arena where any money spent is not registered, thus unaccounted for in the GDP realm. Bartered services are also not accounted for in the GDP equation.

• GDP doesn’t measure quality of life or quantify human happiness.

• Sustainability of growth is not accounted for by GDP. A nation may have had a temporary bump in its GDP by misappropriating investment or by over-exploiting natural resources. An oil rich nation can have high GDP without industrializing, unable to sustain high growth statistics once the natural oil and gas resources are depleted.

• A economy dependent on mass consumerism for economic sustenance, the repetitive purchase of poor quality, cheap low-durable goods by consumers over time, more so than high-durable goods may lead to higher GDP that is the result of waste and inefficiency. In majority of cases, waste and inefficiency are associated with production of and the consumption residue of low quality-durable goods.

• An economy experiencing a stock bubble or a housing bubble with a low personal savings rate statistically appears to grow faster due to higher consumption, basically a nation mortgaging its future for current growth.

• The measure doesn’t account for disparity in incomes between the rich and poor.

• Transfer pricing skews national GDP and is performed by corporations to escape or minimize taxes. Corporations use transfer pricing to manipulate inner prices as to show low profits in high tax arenas and high profits in low tax arenas. This action will deflate GDP in one nation at the expense of another and vice versa.

• GDP doesn’t measure inputs used to produce the output. Herein, an increase in GDP may not reflect the true underpinnings of the output. For it is, if people worked twice the number of hours and the GDP doubles as a result, it doesn’t mean that people are better off as they have less time for rest and recreation.

• The mean wealth not median wealth is reflected in the GDP. Nations that have distorted income distributions may have a comparatively high per-capita GDP while most of its citizens have comparatively low income levels because of the concentration of wealth in the hands of a few members of the population.

Despite the limitations of GDP, it is widely used as an indicator economic health and wellness of a nation and its society. However, there alternative measures of welfare are available such as, the Genuine Progress Indicator (GPI), Index of Sustainable Economic Welfare (ISEW), Sustainable National Income, Gross National Happiness (GNH), and Human Development Index (HDI).

Part 3: Coming soon

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