The failures of GDP
In the history of measurement of economic development, nothing beats GDP's supremacy. The obsession is now leading the world into mayhem while the time is ripe to get over with its hangover.
A brief history of GDP
In the history of measurement of economic development, nothing surpasses GDP’s stronghold on global economies. The single statistical measure obtained through a complex process of compressing large data of economic activities is touted 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 fight back with the effects of the great depression and when 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, great depression was continuing to disrupt industrialised nations and the clouds of a second world war were looming large.
The western economies were facing devastation and a statistical measure and relevant data to understand the health of 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.
What Kuznets and Keynes developed eventually became the most fundamental benchmark of economic performance and policy making and has reigned as a superior measurement of economic 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 of those situations even managed to spiral 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 used as the central stimulants to GDP growth and to bring economy back into its virtuous cycle during recession. The virtuous cycle or circular flow of economy has been about more economic output – produced by workers for firms and used by consumers. Wages, investment and spending complete the cycle and are fuelled by fiscal and monetary policies.
As GDP is composed of many economic activities which are closely intertwined, these policy stimuli also make fixes when and where needed. Economists identify problems by keeping a constant watch over GDP’s quarterly and annual records and extrapolate the data for future estimates to inform investors, producers, consumers, workers and governments.
But GDP isn’t only about diagnosis and making fixes. The real objective is to expand economic output or GDP itself – more innovation, more production, more choices, more consumption. In this pursuit of more of everything, industrialisation, consumerism, finance and technology have become pivotal in keeping the circular flow afloat and in virtuous path.
In specifics, the race for growth induces governments to allow greater competition among firms which encourages firms to innovate regularly to stay ahead. In turn, firms make profits, government make revenues and people get more choices to meet their needs and wants while living standard improves only so much.
GDP’s influence on trajectory to today’s digital or information age from the age of manual labour is massive. No wonder, for all these possibilities which was mainly predicated on a single measure, US Bureau of Economic Analysis heralded it as one of the greatest inventions of the 20th century.
What doesn’t GDP tell us?
The period post-world wars and great depression saw great devastation, and scarcity and thus priorities were different back then. The backdrop suited best for GDP making it a desirable measure and also a driving force for countries to pursue greater material wealth and outpace each other.
The world has evolved to a great extent today while GDPs’ relevance has diminished after decades of prominence. The circular flow of economy is limited to accumulation of material wealth and ignores the costs at which it is derived. Wealth is not all that human wants or values.
Two quotes stand out in this context.
Mr Kuznets, the brain behind the GDP, had warned at the onset that national accounting of income [GDP] should never be considered a measure of economic wellbeing.
In 1962, Kuznet reiterated what he expressed at the beginning by writing,
Six years later, Robert Kennedy put it excellently in his election speech in 1968,
Their concerns have become widely legitimate today because inequalities, ecological disasters, depletion of resources, climate change, global warming and social unrest are today’s realities. None of these issues are factored in by the GDP. It’s limitation in telling the ground zero situation has failed its significance.
Rivers and oceans are facing existential threat with industrial and human waste and plastic invasion; airports and cities that generate employments are built at the expense of millions of trees that sequestrate carbons for us and keep temperatures at check; the air we breathe is becoming more toxic; the rich are getting richer across the world while poors are struggling to live a dignified life despite over timing; medical care is unaffordable and our children may never experience universities while our system is failing the poors; mental illness is on the rise; earth is becoming hotter and our natural stock of capital such as water, oil, minerals, forest, soil is depleting faster than we could imagine.
At the end of the day, chances are high that you’d still hear that your economy is doing fine or facing recession and that your government is doing everything at its disposal to maintain or revive growth.
Despite frantic calls by the critics of GDP, global leaders and economists have seemingly turned blind eye to these deepening crises. Take for instance, the 2007/08 financial crisis. The whole financial system ignored the financial bubble that preceded the crisis because it was creating unrealistic wealth that was amassed by few. However, the pretexts such as ‘too big to fail’ and ‘systemic risk’ was used as a cover to plan a trillion-dollar bailout package out of taxpayers’ pocket, despite the risk of setting future precedence for reckless risk-taking or moral hazards. Rest, as we know, is history.
Such shortcomings have been wide open but taken for granted. Economists, politicians, journalists and financial analysts are enamoured of GDP, pursue it with desperation and debate about it with great enthusiasm. It’s always in the news and social media is buzz with its figures and fluctuations.
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.
On the contrary, the obsession with GDP and its misinterpretation that it measures economic and human wellbeing is something disturbing. It’s unsuitability as a policy objective for wellbeing is bound to lead to wrong policies and results that are undesired.
In light of GDP’s limitations, economists have argued for a reformed or corrected GDP or a whole new indicator to supplant the GDP. Others suggest a whole new set of indicators that includes the measure as well.
The quest has resulted in some unique outcomes, but still experimental.
Decades ago, Bhutan came up with a happiness paradigm - Gross National Happiness - that it established as its government’s 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 listening.
Since 1990, UNDP has been publishing an annual composite index, Human Development Index, comprising life expectancy (health measure), literacy rate (education measure) and per capita income (GDP-based) based on the works of economist Mahbub Ul Haq and Amartya Sen. Although Haq knew HDI’s limitations, he wanted to bring some focus to human element that was missing in the GDP.
In 2009, Joseph Stiglitz, Amartya Sen and Jean-Paul Fitoussi came together at the behest of the then French President to think about alternative to GDP and came out with a framework consisting of several elements of wellbeing, which formed as a groundwork for OECD in developing its own comparative measure of wellbeing OECD Better Life Index.
Earlier, China came out with the concept of Green GDP in 2004 that would factor in the environmental consequences but retracted the step later due to political concerns and how it reflected on the performance of some of its regions. In recent time, UN has come out with sustainable development goals while, India recently launched Ease of Living Index to measure a holistic view of its cities.
The task at hand is colossal because the philosophical premises, local context and minute details of calculation technique has to be precise for wider acceptance. More importantly, GDP is handy to use and deeply embedded in our policy making, budgeting and investment decisions and the choices we make as economic actors.
Meanwhile, earth’s resources are depleting faster and climate risks are mounting. This makes the concerns, conversations, and achievements inadequate and too slow despite coming from industrialised countries.
Initiatives from industrialised countries is crucial here because even if Nepal and Bhutan chart their own ways, they will have to face climate consequences out of India and China’s industrial ambitions. That’s just one example.
In present state, it makes more sense to work with imperfect measures than waiting for the arrival of the right one. Broad indicators and granular data are already available on poverty and inequality, environment, conservation and depletion, crime and employment, hunger and mortality and health and education to formulate policies accordingly.
It is better if we are open to the idea that we may never achieve even an approximate measure of human wellbeing. It is because humans are a complex being and their well-being is a complex construction that depends on a complex interaction between several human and non-human elements. All the while, humanity is looking at much complex global problems that warrants an immediate sense of urgency.
(Please find the second part of this article here)
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