Gross Domestic Product (GDP) is one of the few economic concepts that almost everyone recognises. It was originally designed by Nobel Laureate US economist Simon Kuznets in 1937 in response to demands by the government following the Great Depression. In 1944, it became the standard tool for measuring a country’s economy by bodies such as the International Monetary Fund (IMF).
But by 1968, its shortcomings had become apparent, with the American politician Robert F Kennedy lambasting the perverse outcomes he saw flowing from the way it was defined. “It counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage,” he said. “Yet it measures neither our wit nor our courage, neither our wisdom nor our learning, neither our compassion nor our devotion to our country; it measures everything in short, except that which makes life worthwhile.”
Half a century on and a growing number of economists believe GDP’s shortcomings go beyond that: in today’s post-industrial age, most economic activity takes place in the services sectors rather than in factories where output can easily be counted. Here’s what the experts we spoke to think of GDP.
Matthew TaylorMatthew Taylor, chief executive of the Royal Society for the Encouragement of Arts, Manufactures and Commerce (RSA), says it fails to capture the quality and experience of consumption that are increasingly key to understanding post-industrial societies.
GDP neither accounts for pollution and other environmental impacts nor incorporates changes in the value of assets, such as the depletion of resources or loss of biodiversity, Matthew says. “Neither the unsustainable consumption of the Earth’s resources nor the pollution and degrading of its life-sustaining eco-systems are counted as costs for GDP.”
But Matthew doubts GDP will be dethroned anytime soon because of the linkage between economic output, tax and public services. “To really wean ourselves off GDP, we need a deeper economic transformation,” he says.
Diane CoyleDiane Coyle, professor of economics at the University of Cambridge and author of
GDP: A brief but affectionate history, tells
The Review that the limit of GDP as a measure of economic welfare is that it largely records monetary transactions at their market prices. Calculating GDP involves assessing the value of the goods and services produced (nominal GDP) before adjusting it to take account of prices (real GDP).
This has left GDP ill-equipped to capture the impact of technological innovation that has seen the quality of services improve as their prices have fallen. “GDP has never captured well the effects of substantial new innovation,” says Diane.
“Many people contribute free digital work such as writing open-source software that can substitute for marketed equivalents, and it clearly has great economic value despite a price of zero.”
Lord O’NeillLord (Jim) O’Neill, a former UK Treasury minister and chief economist at Goldman Sachs Asset Management, agrees, saying: “It is difficult to measure the service sector as well as capturing nominal versus real GDP with many prices shifting sharply in technology-influenced areas.”
He is dubious about replacing GDP with an alternative, saying it is more important to improve how GDP is calculated.
David PillingDavid Pilling, author of
The Growth Delusion and Africa editor of the
Financial Times, says GDP fails to capture the “balance sheet” of human, financial and physical capital. As an aggregate number it conceals differences between different groups within a country that may be experiencing very different levels of economic activity.
“If higher GDP means more money to spend on the things we want, that’s great,” David says. “But higher GDP ought not to be the goal.”
Gian Maria Milesi-FerrettiGian Maria Milesi-Ferretti, deputy director in the International Monetary Fund’s research department, says: “I can see reasons why you would make the measure more attuned to the changes in the way production takes place. It is not a static measure and statisticians agonise over ways to capture phenomena that were not relevant years ago. Sometimes GDP is given short shrift in a very superficial way as something left untouched since the 1930s.”
The full version of this article appears in the Q4 2018 print edition of The Review. All members, excluding student members, are eligible to receive the quarterly print edition of the magazine. Members can opt in to receive the print edition by logging in to MyCISI, clicking on My account, then clicking the Communications tab and selecting ‘Yes’.
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