If GDP confuses you, here’s some much-needed clarity

Although it wasn’t created to measure progress, a country’s gross domestic product (GDP) quickly became the single measure that defined progress. Economist Diane Coyle has written a nice essay in Aeon magazine that explains GDP and its limitations, while putting it in historical context. Here are some highlights:

  • GDP is the sum in a given time period of everything produced in the economy with a monetary value, which should add up to the same figure as the incomes earned by every person and company, and the same as the total spent by everyone. In practice, these separate sides of the accounts are rarely equal because of the difficulty of getting all that data.
  • GDP was first developed in 1934, and it soon became the main tool for measuring a country’s economy.
  • Most people complain about GDP because it doesn’t measure non-monetary costs, which include environmental damage and social welfare. That is why a national disaster (or war) spurs faster GDP growth, but the loss of life and assets will not be included.
  • GDP is meant to measure market activities and, by definition, housework is not in the market; but there’s no market price for government activities either, and they are included.
  • While changes made to it later introduced hedonistic factors to include innovation, the list of products are severely limited.
  • Initially GDP didn’t count financial trading, but now it does. This leads to situations where, for instance, the biggest contribution from the financial sector to the UK economy occurred in the final quarter of 2008, which is when the financial crisis started.
  • GDP served as a decent measure when economic activity and social welfare went hand in hand, but now the gap between the two is widening.

In the end Coyle suggests that GDP is a flawed but useful number. That is why it must not be scrapped or changed. Instead newer measures for uncounted things need to be given more importance such as OECD’s Better Life Index.

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