Common Sense vs. GDP Sense

When students are first introduced to the Gross Domestic Product (GDP), most do not find any real reason to suspect why using this metric could be a wrong or even a dangerous decision. The definition seems fair enough! GDP measures production activity and the country that produces the most must ideally be doing well, isn’t it?

Well, to assume that all the production being undertaken in a nation is because of worthwhile economic activity is an underlying assumption behind this conclusion. However, as we shall know that this is far from reality. Using the GDP as the sole measure of a country’s progress can bring about dire consequences. This article will briefly list down a sample list of consequences. Detailed discussion on these issues will be undertaken in other articles within the module.

So, here is a list of some of the most common issues that face a country when GDP is used as a barometer of progress:

Issue #1: GDP Disregards Debt

The first and foremost flaw in the GDP system is that GDP disregards debt. As we stated above, the GDP is a measure of the production that is taking place within a nation’s boundaries. Now, since what the producer’s produce is what the consumer’s consume, another way to state the same would be that GDP measures the consumption in a given economy in any given year.

Now, regardless of whether we consider the production or consumption perspective, it must be noted that GDP fails to account for where the money came to produce or consume in the first place.

Let me explain this with an example. If we know 2 people, Mr. A and Mr. B and Mr. A spends within his means i.e. from the money he has earned, whereas Mr. B borrows money on credit cards to fund his spending, who would you call financially prudent?

The GDP system ignores prudence. It ignores how the production activity was funded and on what terms. It simply measures the spending. Whoever spends more wins! GDP fails to consider the fact that the person (or economy) may have borrowed money on horrendous terms and a bleak financial future awaits them. At the present moment, a higher spending means a higher GDP.

Issue #2: GDP Disregards Destruction

Another major flaw with the GDP system is the fact that it does not differentiate between money that was spent for productive purposes or for destructive purposes. Therefore, in this sense, many economists have argued that the GDP system implicitly encourages war.

Many people observe that America was able to come out of the great depression thanks to the spending push it got from World War-2. However, less known is the fact that GDP always rises in countries which are at war. The GDP growth in Afghanistan was close to 40% during the recent war. Also, the GDP growth in Iraq was in mid 20%’s during the war.

The reasoning behind this is fairly simple. War destroys entire countries. First an obscene amount of money is spent on bombing the country and destroying the entire infrastructure i.e. roads, rails, bridges, communication networks etc. Later an even bigger amount of money is spent in rebuilding the same infrastructure.

Therefore, in terms of GDP, which measures spending, a huge spurt is seen. However, when we see the real life of the citizens, almost nothing has changed on ground. A higher GDP does not translate into a higher standard of living or more prosperity for these people.

Issue #3: GDP Does Not Differentiate Between Wasteful and Useful Expenditure

A third major flaw in the GDP metric is that GDP calculates the total expenditure and considers the higher expenditure as being the higher GDP i.e. better for the economy. The GDP system does not differentiate between wasteful and gainful expenditures.

This makes GDP particularly liable to manipulation. The biggest reason being, that governments can simply start expenditure programs which do not add any value and increase the GDP in the short run. In the short run, it may appear to be a good state of affairs to be in. However, in the long run it is certainly harmful for the economy. Wasteful expenditure must be avoided and the limited natural resources available must be rationed appropriately.

Issue #4: GDP Does Not Consider Qualitative Factors

Another very important flaw in the GDP system is that GDP does not consider the qualitative factors of life. For instance, a country with a high healthcare expenditure on a government or an individual level is facing a crisis. If GDP were the correct barometer, it would warn governments about these crises being perpetuated. However, higher healthcare costs mean higher expenditure which translates into higher GDP. The GDP system therefore implicitly encourages poor health, well being and happiness of the people.

It is no irony that the nations considered the most developed in the world, have the highest healthcare costs and the maximum number of people facing life threatening medical conditions.

Issue #5: GDP Does Not Measure Household Services

Lastly, GDP does not consider household services to be of any value. If you pay a maid a certain amount to cook your food, that gets added to the GDP. However, if your wife renders the same service and there is no monetary payment being made, then there is no addition to the GDP.

Ideally this should not be the case. The production of food has taken place in both scenarios and hence both should get added to the GDP. In many countries where wives provide household services because of cultural norms, the GDP is artificially deflated and does not provide a true measure of the economic activity which is taking place.

Thus, the GDP system is highly flawed. Economists all over the world have realized its flaws and hopefully soon governments all over the world will give impetus to the idea of finding an alternate metric which truly explains the underlying state of affairs.

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