GDP: an indicator with many limitations

GDP or gross domestic product has established itself as the economic indicator most used by economists to measure wealth and, therefore, economic growth. However, are we talking about a reliable indicator to measure growth? Does this indicator contemplate new trends in production, such as sustainable?

The first economic indicator that comes to mind when we want to observe or analyze the economic growth of a country, or a specific territory, is the gross domestic product (GDP or GDP for its acronym in Spanish). In essence, we are talking about an indicator that reflects the monetary value of all the final goods and services produced by a territory in a certain period of time. Therefore, for an economy to grow, that is, for GDP to increase, we must know that it is necessary for production to increase.

However, how does an economic indicator like GDP fit into a scenario where reuse and recycling is increasingly common among consumers? How can we correctly measure the economy with GDP, if the world is increasingly aware of the importance of producing in a sustainable way? How will we know whether or not an economy grows in a globalization that is committed to curbing mass production?

And, as we said, GDP is an indicator that measures production, so production must be increased so that the GDP figure increases. However, a large majority of countries in the world have committed to sustainable development goals that are directly confronted with this indicator and its formula for measuring growth. Well, we must know that GDP, despite being the best indicator to measure economic growth to date, ignores key aspects such as those mentioned, among which sustainability, recycling and the quality of manufactured products stand out.

In other words, GDP measures, for example, quantity, but does not measure quality. His way of measuring wealth requires more goods and services to be able to say that the economy “grows.”

For this reason, there are many economists who, in the face of this new scenario, open the debate on whether GDP is the correct indicator to measure the economy, or we should bet on other indicators that take these aspects into account. A debate that, among other things, shows us that GDP, the indicator most used by economists around the world, is an incomplete indicator.

Let’s see more!

The origins of GDP: How, when and why this indicator was born

“To go back to the origins of GDP, we must travel to the times of the Great Depression, when the United States was still dragging the devastating effects of the crash of 29.”

As we explained previously, to this day, GDP has become the king of economic indicators. It is the magnitude that all economists, journalists and politicians use to assess the good or bad performance that a certain economy shows. In addition, because GDP can be measured in different ways, it also allows us, through GDP per capita, to compare the economic situation of two or more territories.

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However, how did GDP come about? Who created this indicator? Why has it been used for so many years in economic diagnostics?

To go back to the origins of GDP, we must travel to the times of the Great Depression, when the United States was still dragging the devastating effects of the crash of 29.

The then US President, Franklin Delano Roosevelt, was looking for a way to measure the impact that the crisis had caused on the US economy. However, the Government already knew that unemployment had risen in a terribly worrying way, in the same way that it was aware of the collapse that the stock market had experienced. However, it was the year 1932 and Roosevelt needed an overview, a global perspective that would allow him to diagnose the global impact of that terrible recession; to date, the most catastrophic.

To do this, Roosevelt turned to the economist Simon Kuznets, a Russian-American economist, who taught at the Warthon School of the University of Pennsylvania, John Hopkins and Harvard University. Thus, Kuznets and his team traveled across the country to find out about the spending, production and consumption of American companies.

Kuznets’ goal was to measure the “added value” of production. To do this, it was necessary to add the value of production in each of its different phases. Thanks to Kuznets, in 1934 GDP was already available as an economic indicator.

GDP: Does Quantity Only Matter?

“In other words, it does not matter to produce better, but to produce more”

When talking about gross production, we must point out that there is no distinction between high-quality production and low-quality production. Thus, GDP does not take into account carbon dioxide emissions, the dumping of plastics into the sea or the effects of deforestation. If production increases, the polluting effects of the use of fossil fuels do not matter, nor is the indiscriminate felling of trees taken into account. Therefore, in terms of GDP, the economy simply grows, but it does not indicate how it grows, as well as whether the growth that is taking place, in the future, could be creating a major economic crisis.

Let’s look at the Great Recession fueled by a housing bubble. Despite the fact that a crisis of historic dimensions was brewing, GDP continued to grow, as production continued to increase.

In other words, it is not important to produce better, but rather to produce more, thus forgetting the negative effects of economic activity, also known as externalities; in this case negative.

Likewise, it is worth highlighting the example of those countries that, by not increasing their production, focus on sustainable production of high value-added goods and in which the resources used are used more efficiently. Given that this country has not focused on increasing its production, but has focused on producing more efficiently and sustainably, this country may not be growing as much if we look at its GDP, but it could be experiencing greater development.

Once again we are faced with a complicated dilemma, a confrontation between economic growth and sustainable development that is gaining more and more adherents among academics every day. Doubts assail us. Should we sacrifice economic growth to guarantee a future for future generations? Is economic growth the priority?

Be that as it may, the debate is more alive than ever, since what has been commented allows us to affirm – this time with reasons – that GDP is an incomplete indicator.

GDP: an incomplete indicator

“And the fact is that GDP was a reflection of economic activity, but it was not born as an indicator to measure well-being, as many economists claim.”

It should be noted that it was Simon Kuznets himself, before academics did, who was very critical of the indicator that he himself had created. According to this, GDP was only focused on quantity, but not on quality. Therefore, we should be aware of the need to continue developing indicators that, such as the Human Development Index (HDI), implement new variables that should be taken into account to correctly measure growth and development.

And the fact is that GDP was a reflection of economic activity, but it was not born as an indicator to measure well-being, as many economists claim.

However, with the world plunged into World War II, economists of the stature of Keynes argued that what was important was production and not a measure of well-being. With factories turning to the production of tanks, guns, airplanes and ships, well-being seemed to take a back seat. Hence, the GDP was consolidated. And even more so after the war, with a devastated Europe in which the United States, as the country that financed reconstruction, needed to know how each country was progressing economically. Later, after expanding its use in forums such as the UN, GDP became a standard indicator to measure economic growth at the international level.

It is for this reason that, to this day, GDP has established itself as the main economic indicator. When one listens to economic analysis on television or we read newspaper articles, one assumes that increasing our wealth, our prosperity, necessarily goes through an increase in GDP. Also in high political spheres or in institutions such as the International Monetary Fund, constant references are made to the need for GDP to grow to speak of economic growth.

However, the great consequence of this, that is, of using GDP growth as a synonym for prosperity, means leaving aside aspects such as sustainable development, the reduction of pollution or the number of hours a worker spends in their work. company. All this means that increasing production is the big goal. Therefore, it is clear that the GDP, although it is very useful, is an incomplete indicator, as we said, which arises in an industrial era little committed to the effects of pollution and the non-reuse of resources.

For this reason and in conclusion, despite its wide use as a reference indicator, it needs to be updated and adapted to the new context. A context in which mass production and sustained growth are ideas that are already beginning to disappear from the minds of economists.

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