The failures of GDP

A brief history of GDP

In the realm of economic development measurement, GDP’s influence is unmatched. The single statistical measure obtained through a complex process of compressing large data of economic activities is hailed as the world’s most powerful statistical indicator of national development and progress — certainly so when it was conceptualised by economist Simon Kuznets in the 1930s while developing national income accounts framework to understand and combat the effects of the Great Depression. John Maynard Keynes later modernised it by equating national income with the sum of spending made by consumers, firms and government and net exports of the country.

When GDP, or national income accounting, was conceived, global problems were unlike today, largely dominated by wars. First world war had recently ended, the Great Depression was continuing to disrupt industrialised nations and the clouds of a second world war were looming.

The western economies were facing devastation while a statistical measure and relevant data to understand the health of the economy was missing. Thinking about right policies to build back economies and meet the demands of war financing was a herculean task for economists and governments.

Kuznets and Keynes’s framework became a foundational benchmark for economic performance, enduring as a key measurement of development ever since.

In more than eight decades of its use, economies around the world, mainly industrialised, have come to face many dire circumstances. Some spiralled into a long-term downturn. But GDP allowed economists to make rapid policy changes to bring the economy back in track. Reconstruction post WWII, energy crisis in seventies, Asian financial crisis and other financial crises that rose in the nineties and the 2007/08 global financial crisis were all discussed and fixed within the GDP paradigm.

Policy responses within the realm of fiscal and monetary regimes such as tax cuts, interest cuts and quantitative easing have been central stimulants to GDP growth, aiming to restore the economy's "virtuous cycle" of output, wages, investment, and spending, especially during the period of recessions. Policymakers closely monitor GDP's quarterly and annual records to diagnose economic conditions, introduce policy stimuli to make fixes when and where needed and guide future estimates to inform investors, producers, consumers, workers and governments.

But GDP's primary goal isn't merely diagnosis and fixes; it's about expanding economic output—fostering more innovation, more production, more choices and more consumption. This drive for growth pushes governments to foster competition among firms, leading to regular innovation, profit generation, and increased choices for consumers and improved living standards.

The shift from the era of manual labour to the digital age can largely be attributed to GDP's influence. No wonder, for all these possibilities which were mainly predicated on a single measure, the U.S. Bureau of Economic Analysis heralds it as one of the greatest inventions of the 20th century. 

What doesn’t GDP tell us?

The period post-world wars and the Great Depression saw great devastation and scarcity. Priorities were different back then. As such, nations focused on material wealth accumulation, making GDP a desirable measure driving to outpace one another. However, as the world evolves, GDP's relevance as a measure of progress has diminished, revealing its limitations.

Two quotes as warnings stand out in this context:

Mr Kuznets, the brain behind the GDP, cautioned at the onset that national accounting of income [GDP] should never be considered a measure of economic well-being.

In 1962, Kuznet reiterated what he expressed at the beginning by writing,

Robert Kennedy echoed this sentiment in 1968, famously stating during his election speech:

These concerns resonate strongly today, as issues like inequality, ecological destruction, climate change, and social unrest persist—none of which GDP accounts for.

Rivers and oceans are under existential threat from industrial and human waste, along with plastic pollution. Airports and cities that create jobs are planned at the cost of millions of trees that absorb carbon and help regulate temperatures. The air we breathe is growing toxic. Wealth inequalities persist while the poors struggle for a dignified life, often working long hours. Large population still struggle for basic necessities like affordable healthcare and education. Mental health issues are rising, the planet is getting hotter, and our natural stock of capital—water, oil, minerals, forests, and soil—are depleting at an alarming rate.

Despite these challenges, the narrative often remains that the economy is thriving or facing recession, while governments tout their efforts to sustain or revive growth.

While these escalating crisis still lack focused solutions. For instance, during the 2007/08 financial crisis, the financial system ignored the bubble that had formed, creating unrealistic wealth for a select few. Instead, concepts like “too big to fail” and “systemic risk” were invoked to justify a trillion-dollar taxpayer-funded bailout, despite the risk of fostering reckless risk-taking or moral hazards in the future. Rest, as we know, is history.

These shortcomings are well-known yet often overlooked. Economists, politicians, journalists and financial analysts remain enamoured with GDP, pursuing it with fervour and engaging in passionate debates. It dominates the news with its figures and fluctuations.

A case for alternate measures

In all fairness, GDP, in itself, is not bad because it does give a good account of what it measures — the economic output. It is a great source of economic knowledge and serves best to macroeconomic policy making. But its unsuitability as a policy objective for wellbeing is bound to lead to wrong policies and results that are undesired.

Critics of GDP argue for a reformed metric or a whole new indicator to supplant the GDP or a whole new set of indicators that better reflect human and ecological well-being.

This quest has led to some intriguing and useful outcomes. Some remain experimental. Some are already pursued.

Decades ago, Bhutan came up with a happiness paradigm Gross National Happiness - and established it as its ultimate goal. It covers equitable distribution of socio-economic development, good governance and cultural and environmental preservation. The happiness philosophy that received endorsement from the UN General Assembly in 2011 is presently propagated internationally and people are taking notice.

Since 1990, UNDP has been publishing an annual composite index, Human Development Index (HDI), comprising life expectancy (health measure), literacy rate (education measure) and per capita income (income measure) based on the works of economist Mahbub Ul Haq and Amartya Sen. Although Haq recognised HDI too had its limitations, he wanted to highlight the human element that was absent from the GDP.

In 2009, Joseph Stiglitz, Amartya Sen, and Jean-Paul Fitoussi were tasked with developing alternatives to GDP, resulting in frameworks that assess various well-being factors. It formed a groundwork for OECD in developing its own comparative measure of wellbeing: OECD Better Life Index.

China briefly explored a Green GDP concept to account for environmental costs but later retracted due to political concerns and how it reflected on the performance of some of its regions. Recent initiatives like the UN's Sustainable Development Goals and India’s Ease of Living Index to measure a holistic view of its cities reflect a growing recognition of the need for broader indicators.

However, the challenge remains significant. The complexity of human well-being and the intricate factors that influence it complicate the quest for a comprehensive measure. Furthermore, as the world faces urgent challenges, the reliance on imperfect measures may be more pragmatic than waiting for a perfect solution.

Data on poverty, inequality, health and education, environmental degradation, crime, employment, hunger and mortality is already available to help guide policies. It’s essential to acknowledge that a perfect measure of human well-being may never exist, given the complexity of human existence [their well-being is a complex construction] and the myriad interactions between several human and non-human elements at play.