GDP as a Tool of Economic Misdirection: Moving ‘To and Fro’ on the Growth Bar?

Are we really where we predicted? Or are we here because we overestimated? You, me or a few economists are not alone in thinking of GDP as a miscalculated benchmark for national economic well-being. Adjudged as one of the greatest inventions of the 20th century, it has long been a closely-watched tool for politicians, economists and journalists alike. But for nearly as long as GDP has been revered, it has faced strong criticism too. And rightly so because it captures what economic historians call a “somewhat arbitrary slice of reality.”

Gross Domestic Product (GDP) is the total monetary or market value of all the finished goods and services produced within a country’s borders in a specific time period (usually a year). As a relatively broad measure of overall domestic production, it works as a comprehensive scorecard of the country’s economic health. This definition excludes a lot. To name a few, we can look at the following qualitative parameters:

1) Services have replaced goods, freelancers and agencies are a growing share of the workforce, and value is increasingly derived from intangible assets like design, branding and software.

2) Unpaid labour like parental housework and childcare does not figure in, nor does volunteering.

Many loopholes exist, but let’s focus upon one in particular: inequality. In recent times, income inequality has shot almost everywhere globally. As per the data summarised by the World Economic Forum, one scenario exists wherein growth is uneven between the poorest 50%, the middle 40% and the richest 10%. While earners at all income levels receive some benefit, nearly half of the population saw about half of the 5% GDP growth for the total economy. On the other hand, taking another stance, 90% of the population sees none of that growth. In fact, incomes for the bottom 50% actually contract. Still, GDP growth looks strong, let’s say, at 5.5%.

Rich get Richer: Production Factor and Financial Imbalance

One aspect to ponder upon is that a growing fraction of innovation is not measured at all. In a world where houses are private suites and private cars are Uber/Meru taxis, where a free software upgrade renews old computers, and Facebook, Instagram and YouTube bring hours of entertainment to millions at no price at all, many suspect GDP is becoming an ever more misleading measure. Unfortunately, nothing is perfect. And GDP is no exception.

As much as GDP is widely used as a measure of output, or even as a measure of a country’s well-being, GDP has irrefutable limitations. Conventionally and quite literally, GDP calculates only output that is bought and sold. I have strong reasons to believe that it is a fairly limited approach. First, market transactions are taxable and, therefore, of interest to the exchequer, an important consumer of GDP statistics. Second, they can be influenced by policies to manage aggregate demand. Third, where there are market prices, it is fairly straightforward to put a value on output. This convention means that the so-called “home production”, such as housework or caring for an elderly relative or children, is excluded from GDP even though such unpaid services have considerable value. Fourth, despite the convention, a lot of what is included in GDP lies outside the market economy. Many government services are provided for free, and for decades the value given to such output was simply the cost of provision. It is fairly recently that statisticians have started to measure some bits of public sector output directly, for instance, by counting the number of operations performed by health services or the number of students taught in schools.

Is Price Parity causing a Hindrance?

Adjusting for the ever-rising increase in prices over a considerable period of time (inflation, yes) has further complicated the situation. Then comes the adjustments for changes in quality. This year’s iPhone might cost more than last year’s, but if so- it is because it is capable of rendering more. If statisticians focus only on changes in price, they will *overstate the true inflation rate *by missing improvements in performance.

With the advent of newer technologies some physical marketable products have turned into digital services, the value of which is harder to track. It seems likely, for instance, that more the physical copies of books are being read to than ever before, but revenue for publications has shrunk by a significant margin from its peak. (Thanks to e-books and kindle?) Consumers once bought newspapers and maps and paid middlemen to book holidays. Now they do much more themselves, an effort which doesn’t show up in GDP.

These problems do not invalidate or negate the use of GDP but given the significant increase in technological change, they seem likely to grow much more than before, and solutions to them are both hard and imperfect. Measuring the consumer surplus from new or free products relies on calculated assumptions; estimates vary considerably depending on which ones are used!