What does GDP Stand for? What does it capture? What are its strengths and weaknesses as an indicator of economic activity?
HASS/Business school Pre Entry Access Course Economic Essay
Juan Carlos Sanjuan Zamudio
Tutor: Ms. Jacqueline Gildea
This essay explains the strengths and weaknesses of the GDP as an indicator of economic activity. It describes the meaning of the abbreviation and what it measures. It explains when it was created, why and where. The objective of this piece of work is to introduce the reader to the fascinating world of economics through its most important abbreviation.
One of the most common uses of its shortened form by economists is GDP, “which stands for gross domestic product” (Callen, 2008, p.48). It is an economic indicator created by the United States of America as a result of the Great Depression of the 1930's. Prior to the economic developments that happened during that time, the States did not have proper measures to manage their economy efficiently. The results of their efforts created the efficient innovations that made a more stable economic environment (Survey of Current Business, 2000). In fact, “depressions that were recurring problems before World War II became a thing of the past. The business cycle was not eliminated, but its severity was curtailed” (Survey of Current Business, 2000).
The GDP “is usually calculated by the national statistical agency which compiles the information from a large number of sources. In making the calculations, however, most countries follow established international standards. The international standard for measuring GDP is contained in the System of National Accounts, 1993, compiled by the International Monetary Fund, the European Commission, the Organization for Economic Cooperation and Development, the United Nations, and the World Bank”. (Gallen, 2008, p.48).
The analysis of the word GDP can be broken down into three words, each having its own special meaning. Firstly, domestic, means that it is a domestic product, and more specifically that, “the exclusion of income generated by overseas assets explains why it is called “domestic” product”. Gross refers to a gross of depreciation. What that means is that, “the term “gross” refers to the fact that there is no deduction to reflect the depreciation or wearing out of fixed assets”. Product refers to an item which, “can be calculated at market prices or factor costs”. “GDP can be calculated by adding the sales values of all finished goods produced during the year, which is the same as totalling expenditure on finished goods, as explained above. This sum will produce a figured called “GDP at market prices”. “As the measure is expenditure based, it is not affected by the problems of double counting income tax payments that are simply transfer of income within the economy. However, it is affected by expenditure taxes, such as VAT, and subsides. Market prices include these taxes and subsidies” (Kaplan Publishing, 2008, p.191).
After this essay disclosed the meaning of this well-known abbreviation, it is convenient to explain what it captures. “GDP measures the monetary value of final goods and services—that is, those that are bought by the final user—produced in a country in a given period of time (say a quarter or a year). It counts all the output generated within the borders of a country” (Gallen, 2008, p.48) “and excludes any income generated by assets held by the country´s residents abroad” (Kaplan Publishing, 2008, p.191). “GDP is composed of goods and services produced for sale in the market and also include some nonmarket production, such as defence or education services provided by the government” (Gallen, 2008, p.48). In fact, “GDP aims to best capture the true monetary value of our economy”. (Khan, 2014)
This important economic indicator does capture the economic value of the economy of a country. As it is stated in the title of one of the articles from the Bureau of Economic Analysis U.S. Department of commerce, “GDP: one of the Great Inventions of the 20th century”. It is indeed a great invention with the following positive points:
•GDP is the best known abbreviation in economics. “This is the mother of all economic indicators and is the most important statistic to come out in any given quarter” (Bauhmol, 2008, p.107)
•It gives the size of an economy and how it is performing. “An increase in real GDP is interpreted as a sign that the economy is doing well”. “When real GDP is growing strongly, employment is likely to be increasing”. (Gallen, 2008, p.49)
•As it is a worldwide indicator, international organizations like the IMF calculate and publish global and regional measures of real GDP growth. “These give an idea of how quickly or slowly the world economy or the economies in a particular region of the world are growing”. (Gallen, 2008, p.49)
•Since the creation of the economic indicators, the GDP being the most important of them, the recessions have been shorter and shallower. (Bauhmol, 2008, p.108)
One of the more relevant quotes the researcher of this essay founds about the strengths of the GDP as an economic indicator is in the book Economics by Nobel Laureate Paul Samuelson and his co-author William Nordhaus in the 15th edition of their textbook where it states, “Much like a satellite in space can survey the weather across an entire continent so can the GDP give an overall picture of the state of the economy. It enables the President, Congress, and the Federal Reserve to judge whether the economy is contracting or expanding, whether the economy needs a boost or should be reined in a bit, and whether a severe recession or inflation threatens”. (Survey of Current Business, 2000). This quotation is important because it gives to the reader an idea of what is the GDP, for what it is used and why the government use it.
Despite all the arguments and quotes in favour of the GDP as an indicator of economic activity. It is known that there are actually some individuals who challenge it, such as Firamonti, the author of a book entitled, “Gross Domestic Problem” and the government lead from the French president Nicholas Sarkozy seem to be worried about the GDP as an indicator of wealth and well-being. All the concerns held by these people about the GDP might be seen as weaknesses. It has the following points:
•It “is not a measure of the overall standard of living or wellbeing of a country”. “For example, increased output may come at the cost of environmental damage or other external costs, such as noise. Or it might involve the reduction of leisure time or the depletion of non-renewable natural resources”. ”The quality of life may also depend on the distribution of GDP among the residents of a country, not just the overall level.” (Gallen, 2008, p.49)
• There are a few complications in calculating this data. The first, being that most of the economies are not a close economy in the sense that most of them trade with other countries. (Kaplan Publishing, Understanding economics, pg 190). An additional point is that, “the government, it takes income of tax-paying factors of production, and pays benefits to non-productive individuals in the economy, increasing their income. If we counted these latter “transfer” incomes as income, there would be double counting, since they come from the taxes paid out of the incomes of productive people.” (Kaplan Publishing, 2008, p.190).
•It is worth saying that the business cycle of economic growth is theoretically supposed to continue indefinitely. “However, as a practical manner, this system is susceptible to breaking down once in a while as a result of outside shocks, like war, or in an event of a serious imbalance, such as an accumulation of excess inventories or an outbreak of inflation. Fortunately, such events are rare.” (Bauhmol, 2008, p.108). As far as this essay is concerned, the problem might be that in period of crisis the unemployment can be very high, affecting millions of individuals with series consequences that arises during unemployment.
Despite the weaknesses of the GDP and the attention given to finding economic alternatives and variables to it, it does not seem to be the end of the GDP. The ONS agree that the variables will supplement rather than replace GDP (Khan, 2014) and the French committee concludes that, “Serious alternatives to GDP are around the corner. However, it seems desirable to abandon the preconception that one can find a unique consensual measure of well-being, and necessary to accept that there will not be a single alternative”. “Total income or consumption remains a relevant component or determinant of social welfare that should appear in informative decompositions – provided the other components are displayed as well” (Fleurbaey, 2008, p.40). “The United Nations computes a Human Development Index, which ranks countries not only based on GDP per capita, but on other factors, such as life expectancy, literacy, and school enrolment.” (Callen, 2008, p.49)”. For these reasons, the GDP will remain one of the major economic indicators of our time as it was in the past century, perhaps with the addition of other components. Regardless, it may sound reasonable that the actual economic system should improve to avoid periods of crisis like the one we are living now.
- Bauhmol, B. (2008) The secrets of economic indicators. 2nd ed. Upper Saddle River, New Jersey: Prentice Hall.
- Callen, T. (2008) What is Gross Domestic Product? Finance & Development, 45 (4), pp.48-49. Available at: http://www.imf.org/external/pubs/ft/fandd/2008/12/pdf/basics.pdf [Accessed: 15/11/2014].
- Fleurbaey, M. (2008) Beyond GDP: Is There Progress in the Measurement of Individual Well-being and Social Welfare? Available at: http://www.stiglitz-sen-fitoussi.fr/documents/Beyond_GDP.pdf [Accessed: 15/11/2014].
- Khan, M. (2014) What does the GDP really tell us about economic growth? The Daily Telegraph. Available at: http://www.telegraph.co.uk/finance/economics/11159277/What-does-GDP-really-tell-us-about-economic-growth.html [Accessed: 15/11/2014].
- Survey of Current Business. (2000) GDP: One of the Great Inventions of the 20th century. Available at: https://www.bea.gov/scb/account_articles/general/0100od/maintext.htm [Accessed: 15/11/2014].
- Understanding Economics. (2008) 1st edition. Berkshire : Kaplan