The limitations of GDP

Gross Domestic Output (GDP) — the single statistical measure obtained through a complex process of compressing large data of economic activities is considered the world’s most powerful statistical indicator of national development and progress.

The statistical measure was conceptualised by economist Simon Kuznets in the 1930s while developing national income accounts framework to understand and fight back against the effects of the great depression.

Later economist John Maynard Keynes modernised by equating national income with the sum of spending made by consumers, firms, and government and net exports of the country.

Remember the equation Y= C+I+G+NX, where,

Y= Total Output (or GDP measured in total value of output)
C= Consumption 
I= Investment
G = Government Spending
NX= Net Exports [Export (X) – Import (M)]

When GDP, or national income accounting, was conceived, global problems were unlike today, largely dominated by wars. The 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 large.

The western economies were facing devastation and a statistical measure and relevant data to understand the health of the economy was missing. Thinking about the 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.

However, GDP is limited to the accumulation of material wealth and ignores the costs at which it is derived. 

Two quotes stand out in this context.

Mr. Kuznets, the brain behind the GDP, had warned at the onset while developing the framework 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:

“Distinctions must be kept in mind between quantity and quality of growth, between costs and returns, and between the short and long run. Goals for more growth should specify more growth of what and for what”

Six years later, Robert Kennedy put it excellently in his election speech in 1968:

“GDP measures everything in short, except that which makes life worthwhile.”