GDP is one of the most universally recognised terms in economics.
Even outside people with an interest in the subject most
adults would be able to tell you that GDP is a measure of how large an economy is.
They might not be able to tell you how it’s calculated
or even what it stands for but they would get at least that part right.
And you know what, that’s probably all they need to know, it might be all economists need
to know about the figure, because it might be the extend of what this figure can tell us.
Gross Domestic Product is a measurement of production
in an economy, the idea is that the more stuff that is being created and transacted
the wealthier the economy is and while this isn’t necessarily wrong it’s not the whole story.
The tachometer is a measurement of your car’s performance. Higher revs on the dial, normally
mean your car is going faster, but there is actually no way to know without other information,
like if that car is in gear or even if that car has wheels on.
This might be a bit of a rough analogy but in a world where people are becoming
hyper focused on GDP figures and what they mean for everybody amidst the chaos of 2020
it’s important to remember to check the other indicators.
Something to keep in mind amongst all of this is that GDP is a macro-economic measure,
it looks at the whole economy as an aggregate or a total collective.
Sure the figures might not look great, but ask yourselves watching,
did your lifestyle become 33% worse when a 33% drop in GDP was recorded?
For most of you watching I would imagine the answer is no,
which might start to raise some eyebrows as to just how useful this measure is at
telling economists whats really going on in the nations they are studying.
So
What are the limitations of GDP
Are there better figures to look at to get an idea of how prosperous an economy is?
And how could focusing on something outside of pure productive capacity be good for our economy.
INTRO ADD
Now alot of people might say that GDP is just fine,
it’s a quick snapshot of information that serves it’s purpose.
But “just fine” probably isn’t the term we want to hear when we
are looking at figures that will dictate the policies of nations around the world.
If a doctor was to say that a metric was just fine for determining the health of their patients
you might be looking to get a second opinion, and in many way
the stakes are higher for national economic policies.
We have seen before in videos on this channel that a small rise in unemployment
can lead to hundreds of thousands of deaths,
and that seemingly benign policy mistakes can make the difference norway and venezuela.
So if we wanted something better than “just fine” we first need to understand the
Limitations of GDP
Part of GDP’s charm is that it is relatively simple to calculate,
it’s a calculation of output in an economy which is also a calculation of consumption.
GDP equals consumer spending plus government spending plus investments plus net exports.
The idea here is that if we look at the total value of all these figures
it should add up to the total value of all the “stuff a given economy is making”
If an iphone roles of a production line, it is either getting purchased by a consumer
or it is being exported. If a plumber provides 10 hours worth of work on a project
it’s normally being paid for by a household or a government municipality.
Even if something gets produced and doesn’t get sold, it will normally be counted in business
inventory as an investment in the hope that eventually it will be sold a lot to a consumer.
The reason we use consumption metrics to calculate GDP is that it’s just a lot
easier. Hypothetically record keepers could sit at the end of every production line,
and monitor every service provider out there an tally up all their final outputs
but it’s a lot easier to look at revenue figures.
Now this is one of the first issues with GDP, it's a bit rough…
If a planks of wood are sold to another business along with some screws and paint,
and that business then turns around and builds a table, only the table is supposed to be counted
towards GDP figures, because those other items are all component parts of a final product.
What's more is if that table then gets sold to someone who uses it for 3 years
and then sells it to a second hand goods store which sells it all over again that second sale
is not supposed to count, because it did not technically reflect new output.
Now while these figures are not supposed to be counted in theory, they often times are, and
sometimes that’s because the lines between final product output and components can be very blurry.
Consider this, when a car is assembled, the engine itself is not counted towards
GDP because it is included in the productive value of the entire car.
But if let's say that engine breaks down after a few years and you need to pay a mechanic to buy a
new engine from the manufacturer as well as pay for their labor, does that coun’t towards GDP?
A new engine could cost thousands of dollars, and the mechanic is probably going to charge
a pretty penny for their time in the shop as well but after all is said and done, nothing new
has been created, the world doesn't have an extra car so it’s not technically any better off.
So I put it to you, should these repairs count towards national GDP figures. Feel free to fight
to the death in the comments section and the best answer gets featured in our next video.
All of this besides, confusion about what should be included in GDP
is not as big of a problem as what specifically is not.
The informal economy by some estimates makes up over 60 percent of the worlds workforce.
These are businesses and individuals that do not get counted in normal economic activity reports
either because their figures are hard to track down.
This might be because they are engaged in illegal activities like selling contraband,
but most likely it’s because their operations just fly under the radar.
Someone selling bananas in rural africa is likely not reporting financial figures back to the
government and so these types of operations don’t get included in GDP when they actually should be.
Infact even those illegal ventures technically
should be counted towards GDP, but of course they are not.
This can give developing nations unfavorable looking metrics simply because there economy
tends to be less formal. Cash businesses and unreported services are a way of life in a nation
like the Democratic Republic of the Congo, but are not nearly as important in lets say switzerland.
The final big factor that GDP figures completely ignore is foreign operations.
The world is becoming an increasingly interconnected and interdependent entity. Global
supply chains are now a staple of global business to the point where you would probably be hard
pressed to find a modern product in your home that was made exclusively within your home country.
If a computer is assembled from foreign component parts this is technically fine,
because those components would be counted in net exports, so its not like the figures would be
thrown off or anything, but rather it just misses a lot of wealth that is being produced abroad.
Companies like Apple, GM, Tesla, Amazon, or pretty much anything else on the s&p
500 for that matter have operations outside the USA that bring in profits.
Since these are not happening within a nations borders, they would not be counted.
The opposite is also true. If a nation is filled with foreign corporations then
any work those corporations do would count towards that nations GDP, but if the profits
from those operations are then sent back overseas to the corporations home country
the people of the operating nation might not feel much of the benefit outside of maybe some jobs.
This becomes particularly important when you start to consider natural resources.
Major international resource companies like Shell, BP, Rio Tinto have operations all over the world.
These operations involve digging stuff out of the ground and selling it off to the highest bidder
on the international market. The operations in the countries being mined will be taxed,
and they do create jobs but oftentimes the spoils are reserved primarily for the company.
This type of exploitation doesn't just aflict undeveloped nations either,
Australia has one of the largest mining industries in the world, when the government pushed to
introduce a resource tax to be compensated for the resources these companies were extracting they
were beat back down by one of the most expensive lobbying campaigns in the nations history.
But the good news was that atleast Australia still got to count
all of these operations in their GDP figures. So Yippee I guess.
Now there is a metric called GNP or gross national which is supposed to account for this.
What this figure does is stick a 5th variable onto the calculator
net foreign income, represented by Z. this means accounts for the balance
of foreign income payments to an from businesses operating in that nation.
Or put simply if a foreign company is operating in a country and generates 10 million dollars
worth of output, but then sends 5 million dollars of that back to its home nation it would count as
10 million dollars by GDP figures, but only 5 million dollars via GNP figures.
Now you might be thinking well great there is the solution right there, lets just use
GNP figures instead. But unfortunately they are probably even more flawed.
It is difficult to use these figures to tell anything because suddenly they are influenced
by foreign exchange as well as the health of other economies. The performance of these other
economies may not be truly indicative of the performance of the base nation.
It would almost be like a doctor doing a checkup on a patient by taking the blood
pressure of everybody in the room and then averaging out the results.
Alright so GDP is easily skewed by reporting stuff that shouldn’t be reported, and by not
reporting stuff that should be reported, it doesnt account well for our moden globalised
world and it overlooks internal factors that may hurt the actual wealth of people within a nation.
But perhaps the biggest limitation is has is what it assumes about living standards.
It doesn't stop to ask.
What about the waste?
The assumption is in economics that a higher GDP is a good thing, year on year growth
in GDP figures means that more stuff is been produced and making people wealthier on average.
Sure it might be making a select group of people a lot richer and not really changing anything for
everybody else, but that's a separate argument entirely. But GDP doesn’t really discriminate.
A billionaire buying their third yacht is just as good as 500 families buying their first home
as far as GDP is concerned. Now you might think this is a major limitation of GDP and
some would argue that it is. But you know what
it’s probably just fine so long as people realise that it is an aggregate figure.
In this example living standards have increased,
they have just increased massively for one person rather than little bit for a lot of people.
But let’s steer well clear of that argument to look at a more
universal shortcoming. Which is that of waste.
Economist assume that the more stuff we have
the better our living standards are. It’s up to the market to decide what those things are
but a nation with a 100,000 gdp per person adjusted for purchasing power parity is going
to have better living standards than one with a gdp of 50,000 per person.
Now some will argue that more stuff isn't necessarily the be
all and end all but even ignoring those damn hippies, waste becomes a very big problem.
Consider two nations, they both have 10 million residents and are similar
in almost every other way. Nation 1 has a GDP of 100 billion dollars per year,
whereas nation 2 has a GDP of 200 billion dollars per year.
Nation 2 would be the wealthier nation, pretty simple.
But consider this, nation 1 turns almost all of its productive potential towards building
long lasting durables, things like very reliable cars, brick homes, those appliances
from the 1960’s that still work to this day as well as a selection of industrial goods.
Nation 2 on the other hand focuses more on the production of consumables, gadgets,
single use items, homes that will be out of style within the decade and
cars that are only reliable for as long as the average lease contract.
Well in this instance long term it would be hypothetically possible that nation 1
would have more collective wealth if given long enough to build up a collection of good
sustainable, reliable items.
This might be an extreme example but consider the dichotomy of Japan and Qatar.
Qatar has one of the highest GDP per capita’s in the world at $69,000 usd
as of 2019. Japan’s GDP per capita is still good, but a lot more modest at $41,000 per year.
Despite having less than 2 thirds of the GDP the average net worth
of a japanese citizen is more than double that of the average qatarie, coming in at
$154,235 per person, compared to qatars $62,239.
An economy literally fuelled by oil and obsessed with blingy things
may look great in terms of GDP figures, but who is truely better off?
Final Thoughts.
GDP is a figure that people know and therefor it is a figure that people care about, gini
co-efficients and niaru statistics aren’t going to make headlines like a 33% drop in GDP will.
Recessions are defined by GDP figures so policy makers are almost strongarmed into making that
look as good as possible, even if it comes at the detriment of the economy in the long term.
Things like collective net worth of individuals within an economy might tell us a lot more about
genuine prosperity, rather than how much stuff we are chruning through.
or if nothing else it might be a figure to consider in conjunction with GDP.
To stress the analogy, a speedometer to the GDP
tachometer to let the people driving the economy really know what’s going on.
Either way if you want to do your part for collective net worth figures of your economy,
you better start investing, fortunately this is made easy
With acorns.