September 4, 2017    5 minute read

GDP Figures: Flawed Indicators for Measuring a Country’s Economy?

Imperfect Calculation    September 4, 2017    5 minute read

GDP Figures: Flawed Indicators for Measuring a Country’s Economy?

Gross Domestic Product (GDP) figures are widely considered to be the best indicator of an economy’s health and prospects. GDP growth figures decide elections, influence investor decisions and determine the borrowing capacity of a country. The release of these figures by countries, especially economic powerhouses such as US and China, are closely watched and often regarded as the most important days in the market.

Furthermore, the capital flows and fortunes of developing and frontier markets are heavily influenced by their real GDP growth figures relative to market estimates. However, the measure faces fundamental barriers that prevent it from accurately describing a country’s economic performance and thus begets the question of whether its increasing importance and influence on a country’s future is justified.

Technological Advancements

Innovation is the driver of productivity growth, which in turn drives economic growth along with changes in the labour force. Innovation in the last decade has been concentrated in the technology sector, which has spearheaded the ascendance of The Information Age. However, as Adam Saunders of MIT’s Sloan Review wrote – “You can see the influence of The Information Age everywhere, except in GDP statistics”. Many goods and services that used to be added to GDP as market-based final sales are now available for free or at a significant reduction in price. Examples include newspapers, books and music. Encyclopedia Britannica had annual revenues of $1.2bn, adjusting for inflation, in the 1990s compared to Wikipedia’s current annual revenues of $50mn.

Recorded music sales used to have annual revenues of around $20bn but the online streaming behemoths that currently dominate the music industry, Spotify and Pandora, generate a combined annual revenue of just $7bn. GDP calculations have still not managed to account for these changes and a possible explanation for the subpar economic growth over the past few years could be that they are reflecting these advances in consumer technologies, as opposed to poorer global economic prospects.

Quality and Variety of Goods and Services

GDP, which purely measures expenditure changes, is unable to account for quality improvements and increases in variety – two key factors that are imperative to the growth of an economy. Quality improvements, in particular, have strong effects on a country’s economic health and often serve as a reliable indicator of future demand. A country that constantly improves the quality of its goods and services, while maintaining their price levels, may not immediately see a change in its GDP figures but will undeniably enhance its economic prospects, because an innovation trend is evidently present. Increases in variety are also important as they have been shown to improve the competitiveness of an economy by preventing monopolies and concentration of pricing power, thus encouraging companies to continuously invest in R&D.

Informal Economy

The Informal (or shadow) economy in a country consists of activities that occur “off the books” – they are not officially reported and usually involve cash transactions. These activities range from smuggling, drug trafficking and other illegal work, to babysitting and other harmless household work. While economists are unable to agree on the exact size of the global informal economy, the general estimated size is around 10% in developed countries and a significant 33% in developing countries. Since the government has no official records, they are unable to tax these activities and accurately account for their size or productivity improvements in GDP figures.

Fake Data

The unique trait of the Chinese economy to produce growth in even the darkest of circumstances has made global market watchers sceptical of the legitimacy of their data. Many major economists and research agencies, such as Capital Economics, suspect the Chinese economy is actually growing at a rate between 4–4.5% rather than the 6.7% growth rate published by the Chinese government in 2016. These suspicions are accentuated by the fact that prominent Chinese officials, such as the provincial governors of Lianoning, Jilin and Heilongjiang, admitted to faking data in 2015.

However, concerns of fake data are not limited to the Chinese economy. India’s official economic growth of 7% during October-December 2016, wherein demonetization occurred, has also sparked widespread debate and scepticism over the legitimacy of the data. The disruptive effects of demonetization, which wiped out 86% of the circulating currency notes, has been well documented – the inability for citizens to obtain cash for daily use, cessation of work due to long queues at ATMs and unprecedented business uncertainty. The most surprising aspect of the GDP data released by India’s CSO (Central Statistics Office) was the increase in private consumption by 10.1% over the quarter, as it came at a time when even basic consumption needs were unsatisfied.

Conclusion

Ultimately, the flaws of GDP have been acknowledged before, and those described in the article are by no means exhaustive. Most economists are cognizant of GDP’s many drawbacks but a new, better measure that accurately captures the economy’s health is yet to be proposed. GDP has historically been very useful to shape policy and predict future global trends, especially when utilized in conjunction with other measures. However, with the global economy adapting to The Information Age and the proportion of intangible goods steadily increasing, the current method of measuring GDP needs to be changed and improved. Until that occurs, it would be prudent to reduce the emphasis placed on GDP figures in politics, news and investment decisions as well as its role in shaping the future of the world.

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