What's Wrong With GDP?

By Ricky Lee and Diane Hu

GDP, or Gross Domestic Product, is the most widely used metric for economic activity today. Formalized by Simon Kuznets in a US Congress report in 1937, and officially endorsed as the standard tool for measuring an economy’s production levels following the Bretton Woods conference in 1944, GDP is calculated by every sovereign state in the world. It is a familiar term even to those who have no interest in the academia of economics, and for good reason; GDP is intuitively-defined, has been extensively studied and reevaluated, and is calculated largely via the same, reliable methods across the globe. That said, however, its respected status as the gold standard of metrics has belied numerous faults and oversimplifications, many of which are only beginning to be part of political and socio economic dialogue today.

In 1934, Kuznets remarked that “the welfare of a nation can scarcely be inferred from a measure of national income.” The shortcomings of GDP have been well documented, with a myriad of anecdotal pieces to illustrate its failures. For instance, consider the following classical example: the government paying people to dig holes in the ground and fill them back up would result in an increase in GDP. Worse, if these people were putting radioactive waste in these holes, there could be negative externalities associated with this type of economic activity. GDP does not capture these externalities or ineffective types of economic activity in its final measurement of production.

Even in measuring economic production within a region, as GDP is expected to calculate properly, there have been many observed biases. As the metric does not measure home production, due to challenges in valuing activity without a market, wealthier countries disproportionately outperform poorer countries because the participants and players in less wealthy countries experience more household production. Another effect that may distort measurements is the proportionately larger underground economies of poorer countries, which are also not captured in GDP, as it is difficult to measure production in these less visible markets.

Furthermore, the exclusive, undivided attention we give to GDP hides our failure to understand wealth and income inequality. GDP per capita fails to assess the income of the average person, and even metrics describing the wealth of the median fail to capture disparities for the rest of the population. Cost of living adjustments are not made for comparisons in social and economic welfare across regions, considering the Balassa-Samuelson effect, which explains higher consumer prices in wealthier nations through productivity differences between the production of tradable goods in different countries.

Despite all its limitations, it would be correct to claim that many metrics are not all encompassing, so it would be unfair to expect the same of this particular metric. It is also true that there are few metrics that are objectively and universally considered the best in analyzing whatever they claim to analyze. A metric can be useful without being entirely comprehensive in analyzing economic activity, and it would be folly to claim that GDP has misguided economists for decades.

The problem with GDP, then, is how it is used. GDP has its uses; this has been universally established and accepted. It is that it currently resides in colloquial speech as a measure that completely captures a country’s growth in every domain. In short, we claim to understand total progress and assess the effects of our policies solely on GDP, when it has been demonstrated in countless papers, articles, and other media that this interpretation is erroneous. Politicians refer to GDP growth as an indicator of improvement and progress due to their policies; for example, US Presidents often put pressure on the Federal Reserve to lower interest rates to boost investment and GDP, when this might create unwanted inflationary pressures. With our misguided efforts, we become more and more blind to social problems plaguing people from all backgrounds and walks of life across the world.

As Robert Kennedy put it in his famous election speech in 1968, “it [GDP] measures everything in short, except that which makes life worthwhile.” Our project hopes to introduce another metric, with a well-documented framework to the dialogue. In introducing credible, rigorous alternatives, perhaps we can steer our discussions to capture change overlooked by GDP, benefiting those who have long suffered from neglect and misunderstandings of economic progress.