As technology ushers in changes to global economic and social systems, how are the metrics we have used historically to measure national economic performance, metrics designed primarily for the industrial economies of the early-mid 20th century, holding up? Is the ubiquitous gross domestic product (GDP) measure even steering us in the right direction in an increasingly digital and global economic system?
We know measurement of economic performance is vital. Investors must assess economic risk and opportunity to guide their capital allocation decisions. Policymakers must formulate and revise policies and regulations, the consequences of which have potentially life-altering effects on careers, communities, and lives. We often draw inferences then about which are ‘good’ investments and ‘good’ policies by considering their relationships to economic growth (i.e. GDP). But, if our metrics of performance are flawed, so too may be the inferences and decisions that we draw from them.1
Empirical evidence and common sense already tell us that what GDP is not; it is not a holistic measure of national prosperity. So, what is the value of GDP in modern economic systems if it can show us whether an economy is growing faster or slower but not if the basic needs of a country’s population are better met, making people healthier, happier, and yes, more productive?2 Let’s also not lose sight of the fact that a singular focus on GDP risks obscuring pathways to economic and environmental sustainability.
In this article we will look closer at cross-country panel GDP data and alternative measures of socioeconomic development to analyse whether national accounts are as obsolete as is commonly thought of late.3
A Short History and Definition of GDP
The economist Simon Kuznets is often described as the ‘father of GDP’. In fact, in 1971 Kuznets received the Nobel Prize in economics “for his empirically founded interpretation of economic growth.” But Kuznets was not the first to design a measure for the size of an economy or to estimate GDP at the national level. We need to go back further in time and introduce you to Sergey Prokopovich.
In the middle of World War I, Russia was not doing well on the war front. The Czar, or perhaps it was his advisors, came to a painful realization: investing everything in the military would mean nothing to eat at home. The Czar appointed a commission to answer two questions: What would it take to win the war, and could the country afford the required level of investment without collapsing the economy?4 A commission led by Sergey Prokopovich developed the basic concepts of national accounting and calculated GDP (initially it was called national income) for the Russian Empire for 1900 and 1913. His results were published in 1918 after the Great October Revolution of 1917.5
The Commission’s report was read by the young Kuznets with great excitement. In 1921, Kuznets enrolled at Columbia University and got a job at the National Bureau of Economic Research in New York. By 1929, he was working on his doctoral dissertation, seeking to develop economic accounts for the United States following the ideas initially developed by the Czar’s commission.4
Around the same time, the US stock market collapsed and the US government was looking urgently for someone who could define the magnitude of the recession. Enter Kuznets. He headed to Washington to develop the United States’ first official national accounts. Kuzent’s work was published in the late 1930’s and marked the introduction of “Gross National Product” into standard economic analysis.4
Fast forward to WWII. Across the pond, Churchill was facing the same question as the Czar during WW1. Richard Stone, a Royal Air Force officer, leveraged Kuznet’s work to address Churchill’s questions about military and economic tradeoffs and to later lay out a system of national accounts for the United Nations, the very system that became the basis for the Standard National Accounts now used by most countries.4
The combined contributions of economists from Russia, the United States, the United Kingdom, and the United Nations thus laid the foundation for GDP to become the primary measure of a country’s economy in the post Bretton Woods (1944) period. GDP measures the monetary value of final goods and services—that is, what final users actually purchase—produced in a country, along with some nonmarket ‘production’, such as defense or education services provided by governments,6 during a specific period of time (say a quarter or a year). It factors in the difference between the value of total output and the value of the intermediate inputs in the production process. This difference is termed ‘value added’ and is essentially corporate profits, wages and taxes, i.e. a measure of the value of income generated by the economy.
What’s wrong with GDP?
Criticism leveled at GDP is hardly new. Even in 1934 in presenting GDP to the US Congress, Kuznets disapproved of its use as a general indication of welfare. However, as long as the goal of raising the basic level of well-being remained a priority for policymakers, the use of GDP to measure economic development did not cause alarm.
In recent decades, the situation has changed. There is more and more evidence that economic growth is not necessarily a path to improved or sustained well-being. The data show a clear remarkable acceleration of the global average per capita GDP since the end of the 19th century, rising nearly 5 times globally over the course of the 20th century. But only now have we come to appreciate the devastating consequences of this growth for the natural capital of the planet and income inequality suffered among populations worldwide, as illustrated in the charts below.
The US is a classical example of inequality of economic growth. Between 1980 and 2016, per capita income of the wealthiest US citizens more than doubled (at constant 2010 US$), while per capita income of the country’s poorest barely changed. In other words, knowing that the US GDP per capita was expected to grow by 1.5-1.7 percent in 2019 did not help us to understand how, if at all, this positive growth would change the life of the ordinary American.
Rising inequality and environmental constraints on the back of strong economic growth prompted the French government in 2008 to create a special commission on the measurement of economic performance and social progress (CMEPSP), generally referred to as the Stiglitz-Sen-Fitoussi Commission. In September 2009, the Commission submitted a report with guidelines for the creation of a set of indicators to provide a more comprehensive understanding of economic performance and changes in quality of life.1
A key takeaway from the work of the Stiglitz-Sen-Fitoussi Commission was the recognition of the multidimensional nature of well-being. In the simplest terms, the Commission found that the creation of a single indicator of well-being is likely impossible.1 In practice, a collection of measures, as is being attempted, for example, via the UN Sustainable Development Goals, is required.
Let’s check in with what the data show in terms of GDP and well-being, setting aside for a moment income inequality and environmental consequences of growth.
Our comparison across a broad collection of countries shows that GDP growth is a strong predictor for quality of human capital, labor vulnerability, health status (except countries that become “rich” rapidly due to external factors), and subjective measures such as happiness, at least until per capita income reaches $50,000 (2010 prices). In general, beyond that point, income growth does little to improve the well-being dimensions we examined.
Income inequality and (especially) environmental sustainability relative to GDP are entirely different stories. The data show that economic growth in developing and developed countries is absorbing more and more natural resources, depleting natural capital, and polluting the environment. And, by the way, it’s not moving the needle on the uneven distribution of income either.
Whether we like it or not, for now GDP remains the measure of choice. It’s a deeply entrenched, institutional metric that represents the status quo of political and economic thought and understanding.7
The benefits of using GDP (for now) greatly outweigh its limitations. GDP covers the performance of the whole economy in a single figure. And, thanks to the efforts of the UN and other international institutions the methodology behind GDP is accepted and identical across the globe, so that quarterly updates from national governments can continue to serve as important fodder for investors and decision makers.
Other measures of economic performance and well-being as highlighted in this article are important, yes, but should be considered in addition to GDP, especially while the validity and continuity of these newer measures remains uncertain.
In the end, the art and science of economic measurement is not at a stand still. The spread of digital technologies combined with alternative data creates opportunities for the implementation of cutting-edge ideas to improve national accounting and GDP measures and governments around the world are already dabbling in these new approaches. Who knows, maybe it will not be long before every transaction in an economy will be scored good or bad for the economy based on its contribution to building social and natural capital, offering a whole new perspective on economic conditions across our world.2
- Joseph Stiglitz, Amartya Sen, Jean-Paul Fitoussi, 2009. Report by the Commission on the Measurement of Economic Performance and Social Progress. Link
- Pooran Desai, May 2018. GDP is Destroying the Planet. Here’s an Alternative. WEF. Link
- Joseph Stiglitz, November 2019. It’s time to retire metrics like GDP. They don’t measure everything that matters. The Guardian. Link
- Clopper Almon, 2018. Why Are Input-Output Tables Important? Studies on Russian Economic Development. Volume 29, Issue 6. Link
- Sergey Procopovich, Moscow 1918. Experience of Calculation of National Income for 50 Provincies of European Russia for 1900 and 1913. Link
- Tim Callen, 2018. Gross Domestic Product: An Economy’s All. IMF. Link
- David Dawkins, August 2019. GDP Is Broken – Meet The Leaders Trying To Fix It. Forbes. Link