Gross domestic product (GDP) is by far and away one of the most commonly referenced metrics when we talk about the economy. It is frequently referenced in news reports and is used by government officials to make policy decisions in public life.
When times are good, government officials and policy makers love nothing more than touting positive GDP trends as proof they are doing a good job. When the trends are negative, they often use the figure as justification for making tough policy decisions, such as cutting public funding.
Given that GDP is such an important metric and is referenced so frequently, this raises an important question: Is it accurate and can we trust it?
What is GDP?
Before we discuss the limits of GDP and question just how accurate it is, we should first get a solid understanding of what is GDP.
In short, GDP is a measure of a national or regional economy’s total output in a specified timeframe. It measures the total monetary value of the goods and services produced within defined national borders over a set time period, which helps to illustrate the productivity of that economy.
Although it is a quite limited way of measuring the productivity and total value of an economy, it is nevertheless an incredibly popular metric among policy makers and economic analysts. Generally speaking, it is believed to be one of the most comprehensive measurements of an economy’s health.
But how is GDP actually calculated?
How is GDP calculated?
Firstly, GDP is always measured over a defined time period. This is often done on an annual basis and compared over time; however, quarterly calculations are also incredibly popular in the financial world. Quarterly GDP calculations allow analysts in the public and private sectors to track the health and performance of an economy on a more gradual basis.
Secondly, there are also various types of GDP you can measure. This includes nominal GDP, real GDP, GDP per capita, GDP growth rate and GDP purchasing power parity. Each of these calculations attempts to capture a slightly different view of the value of the economy.
In terms of how it is actually calculated, there are three primary methods: the expenditure approach, the output or production approach and the income approach.
The problems with GDP
Although GDP is, as the definition states, an attempt to measure the broad scope of economic activity of a country’s economy, this is in many respects what makes it such a problematic metric to use.
In particular, some have argued that by focusing on GDP as the sum of economic activity, you miss out on everything else that might be important to citizens in a country. This includes things such as social welfare, levels of inequality, healthcare outcomes and other quality of living metrics. For this reason, Robert Kennedy famously criticized GDP as measuring everything “except that which makes life worthwhile”.
Other things GDP misses out on, and which are particularly important given the climate crisis we find ourselves in, is the environmental impact and sustainability of that economy. GDP focuses narrowly on the total value of economic production, rather than its impact and consequences. In this sense, by focusing on GDP, we might overlook the industrial impact of the type of economic activity GDP captures.
For these reasons alone, of which there are many others, GDP is arguably the wrong tool for measuring what matters. Although GDP might be able to accurately measure the size and health of an economy, with high GDP generally being associated with better living standards, this might not always be the case.
What about the GDP statistics released by countries and governments around the world, can they be trusted to paint an accurate economic portrait of the health of that economy?
Are country’s GDP statistics accurate?
As we have seen, measuring GDP is a useful, but ultimately a limited way of charting economic growth. This is even more true for certain types of economies than it is for others.
Ireland, for example, tends to post massive GDP per capita figures given how many multinational companies base their operations in the country. However, this figure does not necessarily correspond with the level of economic activity going on there given that so much manufacturing takes place overseas. This is also true for Luxembourg, which is a tiny country that is used as a hub for global intellectual property.
Population size also has a big impact on the level of GDP growth that is reported. For example, countries such as Ireland and Luxembourg tend to post massive GDP per capita figures. However, this is helped by the fact that their populations are relatively small to begin with!
The same is also true of countries with massive populations. China and India, for example, are some of the biggest economies in the world. However, when combined, they also account for roughly 36-37% of the global population alone. In this sense, once you calculate GDP on a per capita basis, they tend to perform poorly.
In these examples alone, we can see how GDP often only tells us half the story.