It’s not perfect, but it’s the best one we have
It’s entirely possible that Gross Domestic Product, GDP, isn’t a very good method of working out how a country is doing. It most certainly shouldn’t be the only target, every economist will agree with that -- a dictatorship does not justify the absence of civil liberty by pointing to economic growth however much they might try to. However, GDP does have the one saving grace as a measure which is that it might well be the best measure we’ve got.
This came up in a recent discussion by the Power and Participation Research Centre, PPRC. This idea of just adding up everything that is produced and declaring that to be the aim and goal -- its increase -- doesn’t sound much like the way to create a better society. Such things as the potability of water -- not just the availability of it but its quality as a drinkable liquid -- or even the behaviour of crowds at a bus stop might be useful measures of how life is working out. All of which is true.
GDP is not just what is produced though. Everything that is produced is also something that is consumed, somewhere. And everything paid for something is an income to someone, somewhere. So, in the GDP equation, production is equal to income, either of which are also equal to consumption. The three totals don’t always agree with each other for the simple reason that people lie at times, especially about taxes. But in our definition, they always will reach the same number.
Thus GDP can be counted as all production but it also means the incomes of everyone. Further, since your real income is what you can consume, that must also be the same. A rising GDP simply does mean that the population as a whole is getting richer. As that’s what we desire an economic system to achieve, GDP is a reasonable enough target to have. Maybe as one of many, but still reasonable.
There are undoubtedly faults with GDP. The most obvious being that it doesn’t measure things which are not part of the money economy. One reason for this is that it’s a great deal easier to measure transactions than it is to apply a value to something that doesn’t use money as the intermediary. The other is, well, just what is the value of something like childcare, or mother cooking for the family? Yes, of course these have a value, but what is it?
Some go further and say that as GDP doesn’t include the distribution of incomes -- how many are rich, how many poor -- then we should include that. But that is to start off on a dangerous path. For there are those who say that a more equal country is a better place. But is it? That’s not an objective fact. How many bales of jute were made is objective.
That the country is more equal is not objectively better, it is a subjective, opinion-based, statement. This being true of near all other measures that we might use. There are those who say that free at the point of use health care is a mark of a better country -- Singapore doesn’t have that and it strikes most as an entirely fine place to live. And so on, far too many of the things that people would add into their one pure measure of how the economy is doing are political demands and or desires they’re trying to smuggle in.
On the other hand, there are entirely valid economic complaints. One often used example is the idea that a pollution spill, say an oil spill, is not counted in GDP, but cleaning it is. This is true by the way. The reason being that another way of defining GDP is the value being added in the economy. Cleaning up an oil spill is adding value -- that’s why we clean up oil spills -- so that should be included in adding value. The problem is that the spill itself is not included and that is a problem.
The best way of understanding this is to think of company accounts. We’ve the profit and loss part, which details the events of this year. Then we’ve the balance sheet which has all the capital structure, the assets of the company, and so on. Our oil spill is a damage to the capital assets of the country. Our clean-up is on that profit and loss part of the country. And GDP is that profit and loss part only.
It just doesn’t include the capital assets, nor the liabilities, of the country. So, what we’re saying when we talk about including the pollution incident is that we want to have a balance sheet for the country. And we should too. People are doing a lot of work on this too. The problem is that it’s not an easy thing to compile.
The biggest problem being time. To calculate GDP, we can get a good idea within a month of the end of the period. The UK produces monthly GDP accounts and they arrive some 30 days after the end of the relevant month. Near all countries produce quarterly GDP and that arrives about 30 days after the end of the quarter.
But if we were to prepare a national balance sheet it would take 18 months to two years after the end of the period to produce it. There’s no real way around this either, because we have to wait for all of the company accounts to work out some part of that balance sheet. That’s just where we get important parts of our information from.
Which leaves us back with GDP. It’s certainly not perfect and there are minor ways in which it can be made better. But the big complaints about it fail because they miss the strengths of GDP. We can calculate it pretty quickly and it’s also entirely objective, not subjective. Both of which are pretty useful for something we’re going to use as a target.
Tim Worstall is a Senior Fellow at the Adam Smith Institute in London.