How do we measure economic growth?
The Learning Economics Series
All of us hear about economic growth and how good our economy is doing compared to other countries, or not. But what is this magic number called GDP?
How GDP is calculated
Gross Domestic Product (GDP) is a single number measuring the “health” of the economy. You can calculate it by adding up one of the following three for everyone in the country
The total value of goods and services (‘output’) produced;
Everyone’s income;
Or what everyone in the country has spent.
source: Munich Business School
All of that is getting summed up and every quarter we measure how much it is growing or not compared to the previous quarter or last year. ONS is responsible for measuring it by collecting data from people and businesses. Of course not all the three ways get the same result, that’s why ONS is revising the number regularly when they have new data and evidence, as well as they are trying to balance the estimates from the different methods.
Strengths of GDP
The main benefit is its own simple nature, it is a single number which, if it is going up the economy is doing better, if it is going down the economy is not doing well. This is very useful as policy makers have only one number to consider when they think about the economy and it is easy to be understood without any major knowledge of economics or mathematics.
Secondly, you can compare how well a country is doing compared to another one, by simply looking at the GDP growth numbers. Or by converting it into dollars after adjusting for inflation within the country to compare GDP in the same currency for all the countries.
Lastly, it is accepted by almost every country with very similar methodology, which makes international comparisons very easy to make and countries to share best practice on how they measure it.
What are the limitations of GDP ?
So great, we have a number, we can make decisions easily, we can understand it. But is it perfect?
GDP has a lot of limitations, one of the main ones is that it doesn't measure non-marketing goods, which are goods that you don’t pay for or services that you aren’t getting paid for. In a previous blog we spoke about unpaid work, GDP doesn’t include the values of childcare or driving around if you are not paying or getting paid for it.
Secondly, GDP methodology was mainly established after the Second World War. Of course it has been revised and changed over time, but we face a technological revolution with the majority of us having access to the internet, mobile phones and AI these days. The fact that the technology is improving and we have to do a lot of our services from our phone such as finances etc.creates issues in measuring GDP, also new professions (tik-tokers, influencers, instagramers etc) create a lot of revenue that probably surveys haven’t found a way to capture yet.
Thirdly, does the fact that a number grows mean that all of us have the same growth in our personal finances? Not always, GDP doesn’t take into account inequality and poverty, the fact that in our lives income and wealth are not distributed equally among the citizens.
Last but not least, the fact that GDP grows doesn’t necessarily mean that is a good thing, producing more products may have a negative impact on our environment for which GDP doesn’t account for. Also, having more money or spending more money doesn’t mean that we are happier, or our mental health is better.
GDP is a great concept, simple and easy to measure the progress of our economic output, however it should never be used as a measure of well-being or social progress. In the next blog we are going to look at the different measures that economists and policy makers should take into account when focusing on decision around well-being and economic equalities
Disclaimer: the blog will focus on explaining economic concepts, theories and books. It will not comment on current events during the pre-election period.