Since its introduction in the 1930s, GDP has been the go-to figure for policymakers and economists alike. Its beauty lies in its simplicity, a single figure which tells you how well countries are doing and how much better off we are now compared to people in 1960. But is it really that simple? Can the complexity of today’s economies be encapsulated in one number? Or have we just traded off accuracy for convenience and simplicity?
Voices are starting to resonate that GDP might not be the all-encompassing measure signifying a nation’s development as previously thought. Arguably, the superficiality of GDP, often regarded as its greatest advantage, is at the same time its greatest weakness. However, it need not necessarily be a problem if the metric were used as originally intended. To gain a better understanding of this issue, one needs to look back and briefly analyze the great desideratum of the early 1930s for a user-friendly and single-dimensional economic metric that gave rise to GDP.
The whole concept of measuring the aggregate economic activity stems from the Great Depression and the 1929 collapse. The U.S. Senate commissioned the creation of an economic measure that would be able to predict and estimate the aggregate losses sustained during these crises. Harvard economist Simon Kuznets took over the project and developed a measure that would evaluate the country’s state of affairs from the vantage of productive capacity. A few years later, a similar concept began to be developed across the pond, in the UK, by John Maynard Keynes. He argued that the paucity of aggregate measures made it almost impossible to determine the UK’s war machine capacity.
Eventually, it was the Keynes’ understanding of GDP that had become the new standard of economic measurement. In short, GDP is nothing more than a product of depression and war. And it does exactly what it was designed to do — it measures the productive capacity of a country.
So … where’s the catch?
The problem arises when we start using GDP in ways for which it was never supposed to be used. For the last decades, increasing GDP has been the paramount objective of governments around the world. This blind fixation on economic growth had caused GDP to become a synonym of progress and well-being; put simply, what was once merely an indicator, is now perceived as an end in itself.
However, it would be feebleminded to conflate the overall well-being of people with purely economic aspects, such as income. Many institutional economists have rightly pointed out the concomitance of the economic and non-economic when evaluating human progress and development.
GDP utterly disregards the social aspects of our everyday lives. As Robert F. Kennedy put it, “It measures everything in short, except that which makes life worthwhile.”
It measures the aggregate value of production. It doesn’t care about the negative externalities that this production causes. On the contrary, it seems to flourish while environmental degradation and resource depletion are on the rise.
If excessive production pollutes a local ecosystem and the government or any other organization spends money on services to clean up the mess, the overall effect is a net gain in GDP. The same holds true for natural disasters, which are well-known GDP boosters. If a country is struck by, say, an earthquake, the GDP indicator only takes into account the investments needed to mitigate the damage; the losses sustained are irrelevant.
Following this logic, certain natural disasters would actually be good for the economy and the well-being of people, as they increase gross domestic product and thus supposedly “make people richer.” This is exactly what happened in China in 2008 when an earthquake hit the Sichuan Province, killed more than 85,000 people, and increased Chinese GDP by 0.3%.
It is this limited purview of GDP that fails to reflect the big picture which makes this metric unsuitable for measuring the overall well-being of people. Nevertheless, it was never meant to be a measurement of human progress nor welfare; it was only a flawed perception of policymakers that GDP could ever reflect the societal well-being.
The distorted view on reality…
Things such as prostitution and drug trafficking, jointly referred to as the “shadow economy,” also play an important role when determining GDP growth. In 2014, when the UK included illegal activity in its GDP for the first time, it instantly overtook France as the fifth largest economy in the world. Although it would be quite hard to convince someone of illegal drug dealing as welfare-enhancing, by conflating GDP with well-being it’s done indirectly.
Criminality and full penitentiaries also increase GDP in the short term, as the government has to pay for extra security. The U.S. prison system itself is a producer of an estimated turnover of $74 billion — more than the GDP of 133 nations.
The deeper we dig, the more obvious it becomes that the GDP’s predilection for the economic largely disembodies the metric from reality. If a local store or restaurant improves its services, GDP will not notice. However, if the store burned down, the owner would have to invest extra cash in its reconstruction; this would subsequently stimulate GDP growth. An even “better” scenario would be if the entire neighborhood caught fire, as this would require an even larger investment.
This represents one of the main shortcomings of GDP — not counting in the asset destruction. This conceptual paradox implies that GDP decreases with increasing quality of durable products. The increased durability of goods results in less frequent replacement and thus lowers overall consumption. As David Pilling, author of The Growth Delusion, put it, “GDP might prefer a plane crash — so that it can build a new plane.”
Furthermore, many policymakers oftentimes confuse GDP with an indicator of progress and thus, ipso facto, conflate growth with economic development. However, this is far from the truth. The process of growth is all about replication, whereas development is of qualitative nature — it entails the process of structural transformation. The society underwent such a structural change when production shifted from manufacturing to services. GDP is a product of the manufacturing age; it is good at measuring the value of tangible goods but clumsy with services.
Moreover, as digitalization continues to spread across the globe, GDP quickly becomes more and more anachronistic. Economies are now much more interconnected and complex than in the 1930s. We can book a flight online, buy groceries on Amazon, or watch live news wherever we are. Our convenience has gone up, but GDP doesn’t show you that change. We can now do almost everything online without having to pay anyone to do it for us, and what’s more, many online services are provided free of charge (Wikipedia, Gmail etc.). Since they are free, in GDP terms, they have zero value.
The rising need to move beyond GDP
Times have changed and GDP is now lagging behind, slowly becoming less and less representative of modern economies. Although it was developed to measure productivity, it has been naively conflated with well-being and progress.
Nevertheless, it would be unfair not to mention the benefits that the systemic use of GDP brought to society. It undoubtedly deserves its fair share of credit, and if used as originally intended, it can still be a valuable tool for policy-making.
Nonetheless, GDP is not a compass. It doesn’t show the direction of travel, it only measures the speed. If you were in a taxi and told your driver that you think you might be going the wrong way and the response would be — “then let’s go faster” — you would probably think the driver is a freak, and you would want to get out. Yet this is what happens every time we let GDP guide our policies.
What we need is a dashboard of measures to complement GDP in order to ensure a more comprehensive and holistic outlook on development and well-being that is not purely limited to economic aspects. Recognizing this need is the first step towards a better future.
The AEC’s fundamental goal is to promote a free, responsible and prosperous society. Through education and improving public understanding of key economic questions, the AEC promotes the idea of a free market economy and the ideal of a free society.