Financial and Monetary Systems

A partial defense of gross domestic product

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Financial and Monetary Systems

Gross domestic product is simultaneously an overly hyped and overly maligned statistic. While reports of the quarterly GDP reports get play in the financial press, some researchers claim that the measure needs to be abandoned in favor of some better measure of economic prosperity. The proper course seems to be somewhere in between these two poles. To paraphrase the late economist Arthur Okun: GDP has its place, but it needs to be keep in its place.

GDP is the most widely cited measure of market output and economic growth. The statistic adds up the value of all final goods and services produced within a country during the course of one year. In short, it measures the value of annual output in an economy. The encompasses all the money spent by consumers, invested by companies and households, and expended by governments plus the value of goods and services exported to foreign purchasers minus the value of foreign goods and services imported into the country.

The U.S. Bureau of Economic Analysis and other statistical agencies do a good job of calculating GDP, though there are statistical issues from time to time and improvements can be made. As Matthew Yglesias at Vox argues, GDP measures what GDP is supposed to measure. But it doesn’t count everything that counts. The rate of growth of GDP, for example, doesn’t give us any information about the recipients of these gains. A three percent annual growth rate might be flowing proportionately to everyone or disproportionately up or down the income ladder. Furthermore GDP as currently constructed neither counts the nonmarket work done in the household nor does it factor in environmental effects. So looking at GDP is definitely important for understanding the economy even though it’s far from sufficient.

But this doesn’t mean that we should throw GDP out the window, and arguments such as one made by University of Pretoria political economist Lorenzo Fioramonti in Foreign Policy go just a bit too far. Take for example his use of Greece and similar countries where income levels would be higher if informal markets and community services were counted as income. He argues these higher income levels mean that the governments of these countries should be able to spend more. The problem, of course, is that governments can only tax market income so they can only pay for this spending or pay back creditors for the borrowed money with funds raised from market income—unless these government start taxing informal markets or some other aspect of prosperity.

Gross domestic product is far from perfect. But its imperfections don’t require scrapping the entire idea. GDP simply needs to be just one of several measures we look at when we consider the state of the economy.

This article is published in collaboration with The Washington Centre for Equitable Growth. Publication does not imply endorsement of views by the World Economic Forum.

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Author:  Nick Bunker is a Policy Analyst with the Washington Center for Equitable Growth.

Image: Pedestrians cast shadows on the crosswalk near the headquarters of the Bank of Japan. REUTERS.

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Financial and Monetary SystemsEconomic Progress
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