Gross Domestic Product- An analysis

Sumeet Choudhary PGP27185 (Sec-A)

Contents:
1. 2. 3. 4. 5. What is GDP? Why is GDP used? Criticism of GDP Alternate measures Impact on Businesses

What is GDP?
The monetary value of all the finished goods and services produced within a country's borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory.

GDP = C + G + I + NX where: "C" is equal to all private consumption, or consumer spending, in a nation's economy, "G" is the sum of government spending, "I" is the sum of all the country's businesses spending on capital, "NX" is the nation's total net exports, calculated as total exports minus total imports. (NX = Exports - Imports) Its development in the 1930s, when the U.S. government was looking for new tools to measure national income and output more accurately, has been described as one of the most important advances in macroeconomics.

Why is GDP used?

GDP is commonly used as an indicator of the economic health of a country, as well as to gauge a country's standard of living. An increase in the GDP of the country is considered as growth of the economy itself. GDP is important for three reasons: 1. Most important, it is used to determine if the countrys economy is growing more quickly or more slowly than the quarter before, or the same quarter the year before. 2. GDP is also used to compare the size of economies throughout the world. 3. It is used to compare the relative growth rate of economies throughout the world.

Criticism of GDP:
GDP is used extensively by economists worldwide as the only and true measure of the health of an economy. Its importance as an indicator for the standard of living has limited utility. Herein, over the years criticisms of GDPs utility as a measure of an economys health and wellness are coming to the forefront. Supporters of GDP counter that a shift to alternative measures of national and societal progress is not possible, as GDP; even in its flawed form is the best measure of economic progress. Some criticisms of GDP as a true measure of the economic health and wellness of a nation: GDP doesnt account for household domestic and volunteer work. Child-rearing and housekeeping is deemed valueless under the GDP regime. Any unpaid volunteer work is seen as not benefiting the economy. Doesnt take into account the black market arena where any money spent is not registered, thus unaccounted for in the GDP realm. Bartered services are also not accounted for in the GDP equation. GDP doesnt measure quality of life or quantify human happiness. Sustainability of growth is not accounted for by GDP. A nation may have had a temporary bump in its GDP by misappropriating investment or by over-exploiting natural resources. An oil rich nation can have high GDP without industrializing, unable to sustain high growth statistics once the natural oil and gas resources are depleted. A economy dependent on mass consumerism for economic sustenance, the repetitive purchase of poor quality, cheap low-durable goods by consumers over time, more so than high-durable goods may lead to higher GDP that is the result of waste and inefficiency. In majority of cases, waste and inefficiency are associated with production of and the consumption residue of low quality-durable goods. An economy experiencing a stock bubble or a housing bubble with a low personal savings rate statistically appears to grow faster due to higher consumption, basically a nation mortgaging its future for current growth. The measure doesnt account for disparity in incomes between the rich and poor. Transfer pricing skews national GDP and is performed by corporations to escape or minimize taxes. Corporations use transfer pricing to manipulate inner prices as to show low profits in high

tax arenas and high profits in low tax arenas. This action will deflate GDP in one nation at the expense of another and vice versa. GDP doesnt measure inputs used to produce the output. Herein, an increase in GDP may not reflect the true underpinnings of the output. For it is, if people worked twice the number of hours and the GDP doubles as a result, it doesnt mean that people are better off as they have less time for rest and recreation. The mean wealth not median wealth is reflected in the GDP. Nations that have distorted income distributions may have a comparatively high per-capita GDP while most of its citizens have comparatively low income levels because of the concentration of wealth in the hands of a few members of the population. These reasons also indicate that it is very much possible to maintain a high growth in GDP even if the common man of a nation gets poorer. A study To put things clearly into perspective recently French President Nicholas Sarkozy asked his top economists to review the adequacy of GDP as an indicator of the current standard of fiscal well-being. The panel, chaired by two Nobel economists, Joseph E. Stiglitz of Columbia University and Amartya Sen of Harvard University, concluded that G.D.P. was insufficient and that measures of sustainability and human well-being should be included. An excessive focus on GDP metrics contributed to the onset of the current financial crisis, according to the report submitted by the panel. Economists noticed that policy makers cheered rising economic growth while other data, like those that showed the increasing and unsustainable indebtedness of households and businesses, were overlooked. It was concluded that there are many aspects of our society that are not covered by GDP. Stiglitz noted that recent US Census data showed that over the years 2000-08, Americas median household income fell about 4 percent. But over the same period, he said, GDP, the number on which the media and government were focused, was rising. The study also revealed that there isnt a single indicator that can encompass everything but we need to complement it with other indicators that can provide other measures of well being. Stiglitz also noted that one of the most glaring problems with using economic growth as a proxy for wellbeing was the fact that it excluded the damage to society and ultimately to the economy of environmentally non-sustainable activities. For instance, developing countries may be encouraged to allow a foreign mining company to develop a mine, even though the country receives low royalties, even though the environment may be degraded, and even though miners may be exposed to health hazards, because by doing so G.D.P. will be increased.

Alternate measures
Despite the limitations of GDP, it is widely used as an indicator economic health and wellness of a nation and its society. However, there are alternative measures of welfare available such as, the Genuine Progress Indicator (GPI), Index of Sustainable Economic Welfare (ISEW), Sustainable National Income, Gross National Happiness (GNH), and Human Development Index (HDI). As an alternative to the developed worlds pursuit of GDP, the Himalayan kingdom of Bhutan has chosen to focus on gross national happiness complete with the 4 pillars, the 9 domains and the 72 indicators of happiness. China has recently tried to use a measure known as green GDP an index of economic growth that factors in environmental consequences. The United States Congress has also commissioned research on green accounting measures.

Impact on Businesses
Change in the measure of wellness of economic health of a nation will force businesses to revisit their outlook towards the way they look at their contribution towards its stakeholders and towards society as a whole. As of now corporates look at businesses as sources of profit based on which they evaluate their performance as well as performance of their employees. In case a nation redefines its criteria for development business houses will also be forced to include more diverse factors and will have to take into account their impact on their surroundings. Once this happens businesses will have to take responsibility for their actions and will have to be more accountable to the society. For example, if GNH is used nationwide, corporates will also face pressure to include criterias to measure happiness of their employees and work towards it. Theyll have to ensure that their actions are not only aimed towards increasing profitability for equity holders but are also in line with the happiness goals of the nation.