GDP and Economic Indicators

Gross Domestic Product (GDP), GDP per capita, investment, inflation, unemployment and many other statistics are well established economic jargon. In fact, the layperson uses such economic jargon regularly without necesssarily understanding what it means. Business and economic news flaunt many of these statistics reported in detailed reports produced by international agencies and exerts without appreciating what they imply.

Unemployment is perhaps the most common statistic to comprehend since it is a binary condition; you have a paying job or you don't. Other statistics such as GDP or inflation are less understood by many, layperson and some experts alike at times! The next few paragraphs will help shed light on one of those often debated economic indicators and how we should think about it.

What do we need economic indicators?

Economies are like the human bodies, they have vital signs which indicate their health. Much like the human body economies also have baselines that would suggest good health. However, these baselines may differ depending on the type of economy and its structure. Generally speaking, there are key measures to reflect these baselines. For economies, these are often summarized in output, employment and prices. Many would approximate these by using GDP, Unemployment and Inflation. Although it is not a comprehensive picture, but these economic indicators give a snapshot of an economy's health.

Although it is not a comprehensive picture, but these economic indicators give a snapshot of an economy's health.

Measuring the health of an economy is not just a statistical practice however. The need for practical economic indicators is to ascertain what type of policies - if any- are required to ensure the economy is where it needs to be. Thus, the availability of economic indicators that reflect the true nature of the economy is essential.

Which economic indicators are best?

Having taught macroeconomics for more than a decade, I often relied on a the firm belief that the complicated systems of national income accounting are sufficient to answer the question above. However, in a more recent experience teaching Development Economics, it was clear that the question of 'What is economic progress?' is a difficult question to answer using one metric or another. Moreover, it was important to appreciate that the use of economic data and indicators was subject to the purpose of measurement. Therefore, traditional economic measures become problematic when used in unconventional ways to measure desired outcomes.

... it was important to appreciate that the use of economic data and indicators was subject to the purpose of measurement.

This has lead to my reflection (and many others I'm sure) on the use of GDP as a measure of well-being and progress. However, before I address that issues, a brief view of GDP is called for.

So what is GDP?

It would be fair to say that GDP is not a universal measure for progress and development. In fact it wasn't designed as so in the first place.

In the simplest terms GDP is a bunch of receipts, a lot of them in fact. It is a measure of all recorded transactions in an economy. In the same token, it is all the spending on those transactions. Moreover, and perhaps more importantly, it is all the income generated from those transactions. Therefore, GDP is not simply output, but spending and income at the same time. It is also value added of all the production processed within the economy. This implies that GDP is particularly useful to our understanding of the behavior of economic participants be it consumers, businesses and governments.

This implies that GDP is particularly useful to our understanding of the behavior of economic participants be it consumers, businesses and governments.

What GDP does not do?

Like your typical shopping receipt GDP does not necessarily indicate the quality of the goods or services bought. It only reflects the cost of purchase. In other words, GDP is a very defined metric, not a strict measure of well-being or happiness.

In other words, GDP is a very defined metric, not a strict measure of well-being or happiness.

Why do we use it?

GDP has proven to be a versatile measure when used in the way it was meant to. It tells us how well the economy overall performed compared to pervious years. GDP per capita, a derivative of GDP measures the average income per person in the economy. A loose measure of well-being and progress that often stirs more debate about its usefulness when considering income distribution and inequality. However, it has been shown that improvements in GDP and GDP per capita have had positive associations with other socio-economic indicators for many economies.

... improvements in GDP and GDP per capita have had positive associations with other socio-economic indicators for many economies.

One of my favorite data driven comparisons and visualization websites gapminder.org illustrates this fact beautifully in their bubble graph shown below when comparing per person GDP (measured at PPP) with life expectancy. The positive association can be observed over more than 200 years of data.

Negative consequences?

Despite the strong positive correlation and causation between GDP and GDP per capita and some socio-economic indicators, there are less desirable outcomes. Take materials footprint per person used in the production process in association with higher per capita incomes, the story is grim. (Visualized by gapminder.org below) On a per person basis, more raw materials are consumed in richer economies (measured in PPP) to maintain the level of production. The same trend is also observable with respect carbon emissions per person.

Despite the strong positive correlation and causation between GDP and GDP per capita and many socio-economic indicators, there are less desirable outcomes.

There are many positive associations of GDP with socio-economic outcomes. However, what is clear a measure such as GDP cannot be designated as the only measure of well-being and economic development.

Alternatives?

Despite calls for abandoning GDP as an measure of economic advancement, there are many arguments for maintaining it as a useful economic barometer. GDP has many uses especially when understood for its diverse uses of output, spending and income properties. However, GDP alone isn't enough to tell the full story. There is a need to strengthen GDP to encompass the negative externalities such as income inequality and degradation of the environment.

There is a need to strengthen GDP to encompass the negative externalities such as income inequality and degradation of the environment for example.

Green growth is perhaps one approach championed by many international organizations such as the World Bank Group and OECD. (see https://www.greengrowthknowledge.org) Other approaches to encompassing a broader view of the socio-economic elements of well-being include the World Bank Group's Human Development Index (HDI) and the Human Capital Index both focused on the human element of economic and social development.

A broader perspective is presented by the Social Progress Index (SPI) by the Social Progress Imperative (https://www.socialprogress.org). While not fully applicable in all countries for data availability and other limitations, SPI has a broad perspective of development. The list of alternatives also includes the World Happiness Index (https://worldhappiness.report) which survey's individuals about their happiness levels and their current socio-economic conditions.

Many of the alternatives to GDP as a measure of well-being are hybrids of economic and social indicators that seek to capture a diverse picture of the economy and its outcomes. Incidentally, many also include GDP per capita as a sub-measure of economic performance.

Should we abandon GDP?

There is no shortage of suggestions of why GDP does not work and why it should be abandoned. However, as an economist, I understand the limitations of any measure exotic or bland as it may be. In adopting useful economic measures and indicators we need to answer the three questions:

• What are we measuring?
• Why are we measuring it?
• How do we measure it?

Economies are complex and when we seek to understand their complexities data is important. GDP like any other metric is limited by its design. It must be complimented with an array of other measures that provide us a complete picture.

Should we abandon GDP yet? The short answer ... No!