Friday, June 14, 2024


Dhaka Tribune

Summing it all up

How reliable is the GDP as a metric?

Update : 11 Mar 2023, 11:44 PM

This will sound very weird, and possibly even entirely inappropriate given that there are thousands still missing and tens of thousands already known to be dead, but the earthquake in Turkey will grow their economy.

No, this does not then lead to a recommendation that we should try to have more earthquakes in order to become richer, not at all. Instead, it's a commentary upon the mistakes we make when we try to measure the economy and how rich we are. 

Our standard measure of the economy is the gross domestic product which is final production (so, not including things we make which then go into other things) at market prices of goods and services. Another way to think of it is value added within the economy. The close relation, gross national product, is the value that accrues to people within the economy on the same basis.

Normally, these are very, very similar. 

We have estimates of the costs to Turkey with regards to the earthquake: “$84 billion (€80 billion), about 10% of Turkey's gross domestic product. About $70.8bn is from the damage to homes, $10.4bn from the loss of national income, and $2.9bn from the loss of working days.” Let's just accept that as reasonable, even if we know that it's not accurate. 

But I'm saying that the earthquake will grow the economy. Yes, there's that loss of national income (which is really a loss of GDP) so how can it rise? And this is our basic problem with using GDP as a measure of the economy. GDP is what it is, it's very useful as what it is but it's not, by any means, the be-all–end-all. 

We all know that it doesn't include work done for money in the marketplace. So, all that domestic work such as cooking, cleaning, caring -- largely, as we know, done by women -- doesn't get included. As long as we know this, when we consider GDP, that's fine. 

But the most important thing, in the political policy sense, that's lacking from GDP is that $70.8bn loss from the homes falling over. Because GDP is gross. But what value was added this year? The true determinant of our wealth is the net figure -- what was added is useful to know but we also want to know what value was lost.

If we look at company accounts we want to see the profit and loss, because of course we do. That tells us what the company did this year. But we also want to see the balance sheet -- what happened to the capital of the company this year. Sure, it's very interesting to know that more shirts and trousers were made, but if the factory fell over we'd like to know that too you know. 

GDP is, in this analogy, like the profit and loss account of the factory -- entirely ignoring everything that is happening on the balance sheet. What this means is that the destruction of that capital, all those houses, is entirely ignored in GDP. What we do get, though, is the activity of rebuilding all those houses in the near future. 

Logically, too, building houses adds value. As GDP is the measure of value added, then building houses must be counted in GDP. So, Turkey's GDP will rise as a result of all the activity to recover from the earthquake. But Turkey will still be poorer, at the end of this period, than if the earthquake didn't happen. Because without the destruction and the loss, and the replacement of all the houses, everyone could have done something else. They'd have then had both the houses and that “something else.”

The problem isn't GDP, it's not remembering what GDP measures: The value added in this period of time. It's like the difference between wealth and income. Wealth is the great big pile of stuff we've got, income is the extra we got in this year. If we want to know what our national income was, GDP (or the above GNP) does that just fine. But if we want to know what the national wealth is then we've got to use a different measure -- the national wealth, obviously.

Or, if we want to know what the change in national wealth was then we should use net domestic product (NDP), not gross. If we do that, then Turkey has lost $70.8bn in NDP from those houses falling down. That's the correct measure of wealth to be using.

The importance of this isn't just about earthquakes. It's also true of pollution. The original loss from pollution isn't in the GDP but the value added from cleaning it up is. The loss is in the NDP. The mining of minerals, the exhaustion of a deposit of fossil fuels. The value from the mining is in the GDP, But the loss from emptying the deposit? That's only in the NDP. 

We can use many different measures here. National or domestic (what comes to the people in the country, or what happens in the country), product or income, or net and gross. We use GDP just because it's the easiest of them all to calculate. We should be using NDP (or NNI even) but that's really, really hard to calculate except two or three years down the line.  

In terms of what we can work out, in any useful time, we're stuck with GDP. But we've got to remember, always, what it actually is. It's not, at all, how rich we're getting. It's our income this year, which is an entirely different thing.  

Tim Worstall is a senior fellow at the Adam Smith Institute in London.

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