Economies all across the world today measure their performance and their worth through their GDP or the Gross Domestic Product. It is widely believed to be the most accurate measure of economic performance for a country in today’s world. Everyone from politicians to economists to the commoners has heard of GDP and how it represents the strength of the economy. But not all are fully aware of what the GDP exactly is, how it’s calculated, what it represents, and most importantly, is a genuine representation of a nation’s economy.
GDP, unlike other economic measures, is very straightforward to calculate. The formula for GDP is C+I+G+NX=GDP, in this case (C) stands for total consumption in the economy by individuals and organizations, in other words, any kind of spending or economic activity which is done by the people or organizations.
(I) stands for private investment in the economy such as banks providing credit or industries setting up more productions plants and infrastructure, it can also be Foreign Direct Investment or FDI coming in from other countries. (G) stands for total government spending in the economy done to spur economic growth and create infrastructure and other social amenities. (NX) stands for net exports, which is the total number of exports minus the total number of imports which can be positive or negative depending upon the export to import ratio of a country.
Therefore, it is clear that spending is done by the consumers in the economy which is regulated in turn by demand, private investments such as credit extensions and setting up of businesses, overall government spending on the people of the country as well as the imports and exports contribute to the GDP of a country.
Problems with GDP
But there are many reasons why GDP is not necessarily a good measure of the economic performance of a country. Many experts and even countries are today claiming that a newer better method of determining the health of the economy is necessary.
One of the problems with measuring GDP and the rate of GDP growth is that it does not take into account inflation. Due to the fact that GDP = C+I+G+NX any increase in the price of any of these variables due to inflation will result in a higher economic growth reflected in the GDP figures, despite the fact that no actual growth or increase in productivity, performance, efficiency, or standard of living is recorded.
In other words, just because the value of money has depreciated, and more money is required to buy the same good or services means that according to the GDP figures this inflation has been misrepresented as growth due to the manner in which it is calculated. A richer nation that spends more and has greater rates of private investment and government spending can actually have less GDP than a nation that is embroiled in hyperinflation.
This means that there are two different types of GDP figures real GDP which is calculated in constant prices and nominal GDP which is calculated in current prices. Real GDP is the actual growth and is a much more accurate representation of the health of the economy as it is compensated for the rise in inflation. It is calculated using constant prices in which a year is chosen as the base year and for the next years, the output is measured using the price level of that base year. This excludes any change in inflation and enables a comparison of the actual goods and services produced.
While nominal GDP is not compensated for the changes in price level and uses current prices which are nothing but the price level currently which would be influenced by inflation over the years compared to the base year used by constant prices.
- Population Impact
Another problem with the GDP is that of population size in the nation as well as the distribution of the nation’s wealth. A larger population will mean that the actual per capita GDP of the country is much lower than that of a less populated country, which means that per capita GDP is a much more precise indicator of the quality of life of a country, and yet it might still not be accurate enough due to the wealth and the income inequality in a particular country.
In the year 2019, the top 10% in India earned more than 56% of the wealth generated in the country due to bad wealth distribution. This means that even though the GDP per capita grew by five times from 2000 to 2019, the actual concentration of wealth is with the rich of the country. Therefore, the GDP would be unable to provide a correct picture.
- Resource Allocation
There is also a question of resource usage efficiency and its wastage. All countries have to use the finite resources of the planet to produce their goods and services, but this is done at different rates of efficiency in other words some countries can have a greater production from the same number of resources than other countries due to the better efficiency of their technologies. Thus, nations would have to spend more and use more resources to produce the requisite amount of goods.
This might not be reflected in the GDP as it eventually leads to greater spending, albeit at the cost of wasting resources, and would result in a relatively less standard of living for the people.
In conclusion, it is clear that the GDP is not necessarily a perfect measure of a nation’s growth and may not be able to accurately record the people’s standard of living. It is after all the object of the state to provide economic growth which in turn would lead to a better standard of living for the people, but due to a multitude of reasons such as inflation, population, income inequality, etc., it is difficult to see GDP as something which can provide an all-encompassing figure.
And yet nations rely on it in spite of the fact that there are other measures such as GNP and happiness index and many others, most suffer from similar or other problems as GDP does. It certainly doesn’t matter to the extent we give it significance India’s economy today is around $2.6 Tn, when some people speak of a $5Tn economy it seems strange as a simple change in the value of the Rupee against the Dollar from Rs.72 to Rs.36 will turn India’s economy overnight into a $5 Tn plus economy. Therefore, it is more important to look and many other nuanced figures in the economy to understand its performance than just the GDP.