Post No.: 0263
‘Gross domestic product’ (GDP) is the market valuation of all the final goods and services produced within a given time period in a country. It’s highly debatable as an adequate measure of an economy – never mind the happiness and health of a country. For example, it doesn’t care about inequality, thus a country with a few large producers and therefore only a relatively few super-rich and powerful organisations, but everyone else struggling, can have what seems like a strong GDP, especially if certain jobs are outsourced or automated i.e. large producers don’t necessarily guarantee proportional job creation.
GDP also includes all positive values, thus expenditure on wars, fixing/cleaning the destruction due to natural disasters or pollution, and wasteful projects, are included as ‘good’ production i.e. the ‘broken window fallacy’, or failing to account for opportunity costs.
Government expenditure is included too, hence the government can (and often does) borrow money to boost GDP, but at the same time this funding has to come from somewhere thus this strategy increases national/government debts, and potentially crowds out private investment. The definition of a ‘recession’ is a bit arbitrary too (two successive quarters of negative real GDP), thus, as above, what a government can do to try to avoid a recession is borrow even more.
Government borrowing, like consumer or business borrowing, isn’t always bad, and leveraging can sometimes even be optimal when borrowing conditions are favourable. But it’s about the ability to service those debts rather than using borrowing as a short-term fix with long-term consequences. And the thing about national debts is that they get passed onto future leaders and generations to sort out if they get out of hand! (Although this could be said about corporations too, which also sometimes become ‘too big to let fail’ and so get bailed out by the public.) This is especially true in countries like the USA, where no President can remain in office for currently more than two terms anyway.
GDP figure manipulation is possible via central bank monetary policies (e.g. interest rate manipulation, quantitative easing) and governmental fiscal policies (e.g. public borrowing), all without necessarily tackling the underlying root causes for a downturn in economic expenditure, production or income. GDP doesn’t take into account the future environmental state or indeed any future state, hence, like company accounts, can be manipulated to show short-term gains to citizens (essentially ‘the shareholders of a country’), at the expense of any hidden long-term hazards.
GDP focuses us on spending, including domestic spending, when really it requires selling and exports (more exports compared to imports), tourism, innovation and/or somehow finding new valuable raw material resources that’ll ultimately generate genuinely new money within a country. A better measure is therefore ‘Gross national income’ (GNI), which is the GDP plus the net flow of income from foreign countries. But still, like GDP, it doesn’t account for factors like inequality, the environment, freedoms, well-being, security, political stability and more.
It shouldn’t be about bluntly throwing money at problems – it should be about tackling the root causes of problems, such as a trade deficit (exporting one’s way out of a recession; albeit, logically, not every country in the world can simultaneously have a positive trade balance) or corporation taxes and/or fuzzy red tape that are too discouraging for entrepreneurship. Now corporation taxes and some bureaucracy are necessary (e.g. to prevent fraud and to pay for public infrastructure projects that’ll aid business creation, which is more efficient than each company needing to build or hire its own roads, bridges, airports, etc.). So it’s about finding the right balances.
Spending over saving (to counter the ‘paradox of thrift’, which argues that saving more will purportedly result in less total savings) is also only useful as a short-run strategy. And theoretically, as long as the saved money is held in banks then increasing savings should mean that the banks will have more money to lend, and this should result in more investment and spending anyway (but the problem is if the banks aren’t doing their proper job to lend). Also in theory, low demand should mean reductions in prices, and this should result in increases in demand, as per the classical microeconomic model of supply and demand. However in reality, we see that prices of things are sticky (‘sticky prices’ or ‘nominal rigidity’) and don’t change as dynamically as the model suggests (e.g. even when demand decreases, the prices of goods and services don’t tend to change perfectly (or in some cases at all) in line with that lower demand i.e. the reality often doesn’t match the on-paper theories in economics!)
GDP for measuring the state of an economy is like using ‘body mass index’ (BMI) for measuring the health of a person – it’s easy to measure and to generate a number, and it’s hard to find a substitute metric that’s just as easy to generate but more informative. But it’s fraught with extreme over-simplicity, to the point that it can at times be misleading.
Why subjectively choose GDP (and a particular method of measuring GDP) as the ‘objective’ measure of an economy anyway? It’s logically not an objective measure but a subjective one – like any measure that attempts to reduce a complex, multi-dimensional thing into a single number. So don’t be fooled into thinking that if something has been reduced to quantitative rather than qualitative data then it automatically makes a measure objective. (This applies to other scientific areas too.) Such things have fooled the financial sector because it thought that reducing risk to numbers and equations meant that ‘1 in 20’ chance catastrophic events shouldn’t be worried about (and then the 2007/2008 Financial Crisis happened).
Lots of governments of different countries have been accused of artificially trying to boost their own GDPs – GDP has been like a gamified score on a scorecard for decades, just like school ratings and league tables (for the schools themselves rather than for the pupils) have been gamified in a competitive environment, leading to strategies such as cheating on pupils’ actual education just in order to chase the numbers that schools and teachers are rated upon. Chasing such numbers becomes vanity (like turnover as opposed to profits or cash). Read more about gamification in Post No.: 0197.
Governments can be accused of pandering to the super-rich because they can almost single-handedly boost GDP figures. Helping one super-rich group and their corporate interests will boost a country’s GDP far more than helping a group of poorer people, hence GDP hides inequality and even injustice. (This is another way the already-rich find it easier to get richer.) Building new infrastructure via government borrowing can absolutely help a nation’s economy, but doing so when the demand or need for such infrastructure isn’t present yet, just to boost GDP growth figures, is a risky strategy (e.g. China). GDP growth targets can be dangerous.
So GDP is often flaunted for vanity. A country can look wealthy but can actually be gambling – some of the ‘richest’ countries based on GDP have the biggest and longest-running government debts, which aren’t included in GDP figures because it only measures flows, not stocks. This may or may not turn out fine for them in due course. And if (or when) an unexpected economic crisis arises, then the lucky generations are those that benefited from the build up of a large national debt and the unlucky generations are those that have to live through austerity and struggle to build property assets during their prime working years, even though they had nothing to do with causing the crisis i.e. the punishment is unequal and unfair. This also highlights the tension or dilemma between attempting to cut government spending and avoiding austerity during recessions.
Vanity does typically fool others though, such as the average person. And if everyone trusts a number, we collectively fool each other and ourselves. With physical vanity – we ought to know that a face full of botulinum toxin doesn’t genetically improve a person for the sake of sexual selection, yet many people still find people with Botoxed faces more mate-worthy than people at equivalent ages with equivalent lifestyles but without the injected toxin. (We should rationally prefer selecting the genetic material of a person who doesn’t risk needlessly inserting needles and toxins into his/her face from a true survival fitness perspective!) People are generally superficial creatures who generally trust in surfaces over what’s deeper inside (despite what most claim). People even think they’re being smart by making ‘if it looks like a dog and smells like a dog then it’s a dog’ (it could be a young wolf!) or ‘there’s no smoke without fire’ (smoke machines!) inductions (which they mistakenly believe are deductions). People tacitly collude in superficiality, both via trusting other people’s fakery as well as conducting in fakery themselves. Human instincts are good at finding patterns, but patterns can be spurious, coincidental or, in these cases, faked, and so a perceived pattern doesn’t necessarily mean the truth.
…Erm, that was a slight detour. Sorry. Woof.
There are lots of other limitations of GDP, such as failing to account for many intangibles (some free things give us a lot of joy, benefits and utility), the cost of living, efficient versus inefficient production and the effects of innovation (e.g. manufacturing old technology light bulbs versus new technology light bulbs) i.e. not all that’s produced is equal and not all production increases wealth (e.g. rebuilding after a conflict). Unpaid work isn’t captured (e.g. families raising children or caring for their elderly) – as if these aren’t important work in a country (women, traditionally, are therefore most neglected when GDP maximisation is the goal). Corporations shifting profits to foreign jurisdictions with lower tax rates also distort GDP.
GDP is too oversimplistic for gauging the well-being of a nation. There’s a strong correlation between GDP-per-capita and happiness, particularly when adjusted for inflation (real GDP, as opposed to nominal GDP) and the cost of living – because poverty is obviously stressful. Yet the correlation only appears up to a limit (albeit the data is mixed on that, or this limit hasn’t been reached yet).
It also critically doesn’t measure or account for the costs to the natural world. It assumes these resources are free, but how can they be free if they’re limited (e.g. trees, fishes, air quality)? GDP only accounts for human inputs/outputs such as labour, consumption and government spending. It treats natural resources as if unlimited and costless. The Consumer Price Index (CPI), Human Development Index and any other current mainstream and globally relied-upon economic measure fails to account for environmental costs too.
Therefore some countries have started to supplement with different measures. The Happy Planet Index and measures like the Genuine Progress Indicator (GPI), for instance, include metrics for well-being, environmental and social costs to some degree – but nothing so far is as universally quoted as GDP, or fully accounts for the environmental costs of limited resources. No metric will be perfect or objective, but some capture the complexity of reality and what we care about, or need to care about, more than others.
In the field of macroeconomics, there’s a growing trend for more countries to consider ‘happiness economics’ because GDP is a crude measure of the total condition of a country. And we cannot expect GDP or GNI to grow forever – a never-ending growth in the global economy is never going to happen simply because the planet has limited resources, so we’ll need to reach for the stars one day, but that’ll come too late if we don’t look after this planet better and account for our environmental costs.
Woof. Full-time economists may be able to explain things better but the main point is for sure – what we use to measure the scores becomes what we aim for, so we need to change what we measure so that we aim for all the important things we should care about.