By Asim Hussain*
GDP is an important economic idea; it is often discussed in the media, it is seen in all kinds of textbooks, and spoken about by politicians. But what is GDP? GDP is the market value of all final goods and services produced in a country within a given time frame, and GDP per capita is GDP divided by the population to find out the value per citizen. It is calculated by finding out what households, governments, and firms spend in the market; after all, what they are buying must have been produced by someone.
GDP is great to measure the aggregate value of goods and services being produced within a country and sold on the market. But although it’s is an amazing measuring device, GDP is often criticized because it only measures aggregate market activity and doesn’t measure anything that can’t be counted in terms of market prices. For example, Moore McDowell, Rodney Thom, Ivan Pastine, Robert Frank, and Ben Bernanke criticized it in Principles of Economics (3d European ed., McGraw Hill) for various reasons. In this article I plan to explain those reasons from an Austrian perspective. Here are some of the things GDP doesn’t count.
Quality of Life
GDP is not very good at measuring quality of life, because it values marketable goods and services and not factors that determine quality of life, such as safety, work-life balance, and life satisfaction of the citizens, all of which, according to the Organisation of Economic Co-operation and Development (OECD), determine the quality of life. In figure 1 below, the x axis is the GDP per capita measured in USD and the y axis is the OECD’s quality of life rank (a lower number is better).
Source: OECD data (gross domestic product [GDP] [indicator], 2017; accessed Nov. 13, 2020), https://www.oecd-ilibrary.org/economics/gross-domestic-product-gdp/indicator/10.1787/dc2f7aec-en; and OECD Better Life Index data (2017; accessed Nov. 13, 2020), http://www.oecdbetterlifeindex.org/#.
As we can see, a high GDP per capita does not necessarily imply higher quality of life. For example, Luxembourg has a high GDP, but there are countries such as Canada and Norway which have a higher quality of life. If GDP were good at measuring welfare, then the countries with more GDP per capita would have a better quality of life, which as we can see from the graph is not the case. Indeed, as philosopher Marcus Aurellius wrote, “The happiness of your life depends upon the quality of your thoughts.” Even if we disagree as to the OECD’s rankings, we can nonetheless see how GDP fails to account for many measures of quality of life, such as personal safety, the local climate, and other measures.
Economic Inequality and Poverty
Another reason GDP is criticized is that although it is great at measuring aggregate consumption, unless we collect additional data GDP does not tell us whoconsumes all these goods. A GDP of $50,000 does not imply that every citizen consumes $50,000 worth of goods. Half of the people could consume $80,000 whereas the other half consume $20,000. In France, for example, although the disposable income is $31,304 the top 20 percent of the population earn around four times as much as the bottom 20 percent.
GDP is not a measure of welfare: things that increase consumer welfare that are not sold in the market (i.e., leisure time) contribute nothing to the GDP even though they contribute to our welfare. Furthermore, GDP growth might come as a result of less leisure time, because there might be a situation where in order to increase goods produced in an economy the workers will have to labor for longer hours. Furthermore an increase in GDP won’t always trigger the “income effect” of longer leisure hours, because the marginal value of goods in the economy is lower than the marginal value of leisure.
Thirdly, each country takes a different amount of leisure time; for example, UK workers spend 14.4 hours in leisure time per day in contrast to French workers who spend 16.4 hours in leisure per day.
An Increase in GDP Is Not an Increase in Economic Activity
GDP is derived from what is bought and sold on the market. This means that an increase in GDP does not always mean an increase in economic activity, because economic activity could be shift from being created by labor bought on the market to coming from nonmarket labor. Let’s illustrate with an example. Say that Robinson Crusoe cleaned his house with his own labor. Then one day Crusoe hired a cleaner to clean the house while he rested. Although there will be an increase in GDP equal to what Crusoe paid for the cleaner’s services, as you can clearly see there has not been any increase in economic activity. In this example the service of cleaning the house has just been transferred from Crusoe to the cleaner. In both scenarios the house will be cleaned by someone.
Data Collection Is Often Incomplete
GDP is not always accurate because it doesn’t include unreported income, which be anything from taxi drivers not reporting their income to selling narcotics, because the people providing those services—whether drug dealing or delivering pizza—pay a price for reporting their income, from jail time to taxation.
The goods and services produced through illegal activity, counted through illegal transactions (i.e., buying narcotics) on the shadow economy, as a percentage of GDP total no negligible amount. Although many may think that this number might be small, in places such as Greece the shadow economy is estimated to account for 21.5 percent of GDP according to the Institute for Applied Economic Research at the University of Tübingen in Germany.
Moreover, in order for a country to have an accurate estimate of GDP, researchers need reliable national income accounts. In not-so-developed countries, with unreliable national income accounts, compiling GDP is often like trying to figure out one’s speed without a speedometer. But even if market activity could be measured, it would still tell us nothing of the many forms of nonmonetary value that affect a person’s quality of life.
Source: This article was published by the MISES Institute