Why GDP (Gross Domestic Product) is a Poor Measure of Wealth and Prosperity

The Gross Domestic Product (GDP) is a measure of economic activity for a country as a whole.  GDP, and related figures like per capita GDP or inflation-adjusted GDP, are frequently referenced in economics and news sources, especially in the context of development economics, and especially in news sources discussing economic downturns or booms.  GDP is so dominant that the general term “growth” is usually implicitly assumed to mean growth of GDP.

Economics, contrary to popular belief, is not the study of money or financial systems per se, but rather, the study of resource use and distribution in human society.  Definitions of economics, including those in most mainstream economics textbooks, emphasize economics as the study of the choices people and groups of people make, particularly in contexts involving scarce resources.

If economics is to retain its place in academia and society as a legitimate social science, the economic discourse needs to stay true to its broader definition, and needs to encompass the study of all resource distribution, not just that included in the money economy.  This blog post will provide a compelling argument that GDP is not only a poor measure of wealth and prosperity–but in fact, that it is not even a measure of wealth and prosperity at all.  And, as such, the equating of GDP with wealth and prosperity by economists is not only wrong (and has negative impacts on society through its influences on policy), but also serves to discredit the field of economics by studying only the money economy and not the distribution of resources as a whole.

What does GDP measure and what does it not measure?

There are many different ways to calculate or measure GDP, but they essentially measure the same thing.  This exposition of GDP is necessarily an oversimplification, but I believe that it captures the essence of the concept (to economists reading this, if you have suggestions of how to make this section more accurate, let me know).  The simplest way of understanding GDP is as the total of all production (both goods and services) in an economy that is associated with transactions in which money changes hands.

Except in certain organized business barter transactions which are counted as income for individuals or corporations, GDP generally does not include transactions in which no money changes hands.  The following table helps to illustrate what is and is not included in GDP.

GDP Includes:	GDP Does Not Include:
Farmers producing & selling crops (even if the crops later rot or spoil–so long as they are sold)	People growing food in their own garden, for their own consumption, gifts, or donation to charity
Buying a meal at a restaurant (regardless of whether or not you eat it)	(excluding ingredient cost) Preparing a similar meal at home
Hiring a babysitter or paying a daycare center for child care	Caring for your own children or those of a friend or relative free of charge
Hiring a contractor or skilled tradesperson to do repairs or improvements on your home	(excluding supplies) Working on your house yourself, or doing similar work for a friend as a favor
Buying a new suit (regardless of whether or not you ever wear it)	Giving a used suit to a friend, or donating it to charity, instead of throwing it out

It is also worth noting how GDP counts goods or services when they are sold and resold.  Shipping and storage of goods are almost always counted in GDP, as these are considered services that are produced.  So a product that is sold directly to the end user, at the point of production, will result in less of a contribution to GDP than a product which is produced, shipped, stored in a warehouse, and shipped again to the same end user for the same price plus shipping costs.  Also worth noting, a new product that is resold at progressively higher prices will result in a greater contribution to GDP than the same good which is only sold once at the lower price.

Already, we see a disconnect between what economics is supposed to study (the distribution and use of resources), and what GDP measures (the amount of money changing hands in association with sale and purchase of new goods or services).  But there is another, deeper shortcoming with GDP that is easily illustrated by looking at what happens to GDP in the case of a car accident.

The Example of a Car Accident:

Let us look at what happens to GDP when a gruesome car accident, like the one pictured below, happens:

It is likely that people are seriously injured in an accident of this scale.  In these cases, an ambulance would come and take people to a local hospital, where they might be given medical attention.  Suppose both cars are totalled.  Between health insurance, car insurance, out of pocket expenses, a lot of money changes hands–and unless the cars are junkers and the injuries superficial, the amount of money is probably on the order of several tens of thousands of dollars, possibly more if the injuries are severe.  If someone hires a lawyer and sues, even more money is likely to change hands.  Also, public or government services (and thus taxpayer funds) are probably involved in the emergency response, further adding to the total cost.

This cost is not theoretical.  A 2008 report put out by AAA (the American Automobile Association) estimated the annual cost of car accidents in the U.S. as $164.2 billion dollars.  This is a substantial amount of money–to put it in perspective, it is over 1.2% of the current U.S. National Debt [Source], and about 1.1% the amount of 2008 GDP in the U.S. [Source]  Now, here’s the kicker:

Most of this money is included in GDP. The main exception would be if the people purchase used cars as replacements.  But the medical care, any car repair work, and new cars purchased, and any legal fees, is all included in GDP.  Furthermore, the incremental rate by which everyone’s insurance premiums go up to pay for this accident results in more payments to insurance companies, which is also included in GDP.  The net effect of the accident is to produce a substantial increase in GDP.  Most alarmingly, the more destructive the accident, the greater the increase in GDP.

The net effect on society and on people’s lives is that resources have been destroyed or used up–the cars, the resources of emergency response personnel, the medical resources used to treat the people involved in the crash, and the quality of life (and possibly work productivity) lost while these people recover from their injuries.  This highlights the ultimate failing of GDP: GDP does not measure the destruction or loss of wealth or resources.

One More Piece of Evidence that GDP is Not an Indicator of Wealth & Prosperity:

Especially in an area like macroeconomics, I think it is always valuable to look at something from different perspectives.  So far, we’ve been talking about the individual contributions to GDP from various small incidents and economic activities.  What does the picture look like when we look at the GDP of a country as a whole?

I think one of the most compelling points about GDP is that countries with higher per-capita GDP do not necessarily have a higher quality of life.  Wikipedia has a useful list of countries by per capita GDP (in U.S. $), which has three different sources (IMF, World Bank, and CIA Factbook).  Depending on the source, Sudan’s per capita GDP is between $2,380 and $2,201.  Compare to Eritrea, whose GDP is listed as $624-$700.  If GDP is even a crude measure of prosperity, then since Sudan’s GDP is over 3 times as high as Eritrea, the Sudan should be much better off.  Public health data suggests the opposite.  Their HIV prevalence rate is similar [Source], but Sudan has about twice the rate of infant mortality rate [Source], and life expectancy in Sudan is lower by more than 10 years [Source].  The genocide and violence in Sudan is another issue; although Eritrea has had its share of violence and strife, the magnitude of violence there does not approach that in the Sudan.

This was just one example; perusing other figures show similar results, even among wealthier countries.  For example, the U.S. has an embarassingly high infant mortality rate, 46th worldwide, placing it below Cuba, even though it ranks 6th or 8th in per capita GDP.  One of the reasons that GDP fails to correlate tightly with public health measures is that per-capita GDP is an average, and thus does not capture distribution of wealth.  In the U.S., the infant mortality rate is high because the wealth is concentrated in the hands of a few; the contributions to high infant mortality come from poor subsets of the population living at an economic level comparable to that in many developing countries.

A quick summary of some of the shortcomings of GDP:

• GDP only counts activity that happens inside the money economy.  Many of the most important types of economic activity (including food production, education, raising children, even transportation) happen both inside and outside the money economy, and these are not included in GDP.
• GDP aggregates figures based on price, not value.  Sales of the same goods or services at a higher price contribute more to GDP, even though they contribute equally to the wealth available in a country.
• GDP measures only production, and does not measure the destruction, loss, or using up, or squandering of wealth or resources.  GDP is thus measuring only “half the equation” (less than half when considering the first point above) when it comes to what is affecting the total amount of wealth in a country.
• Per-capita GDP measures only average prosperity and does not address disparities in wealth, income, and resource distribution.

Considering these shortcomings, the practice of equating wealth or prosperity with GDP is completely indefensible.  Wealth, loosely speaking, is the total of all resources belonging to a country, individual, group, or region.  Using common sense, we can say that a change in wealth is equal to the amount of wealth being created and the amount being destroyed or used up.  Using this concept as a starting point, we can make a simple equation for the true nature of wealth:

Change in Wealth = GDP + (Production of Wealth Not Included in GDP) – (Destruction and Loss of Wealth) +/- (Flow of Wealth due to Imports & Exports)

How big are each of these terms?  I don’t know…but depending on how you value them, they could be huge.  Many of them probably cannot be easily quantified with a dollar value.  But the lesson is the same…GDP does not measure wealth.  It is not even a crude measure of wealth.  GDP is only one of several factors determining the rate of change of wealth within society, and it is not necessarily the biggest factor.

What happens when you focus on Raising / Maximizing GDP?

The answer is simple: GDP increases, often at the expense of other things (the other terms in the equation above).  The net effect is a miserable failure from a sustainability perspective.  Look at U.S. society and you see a compelling example of the failure of this policy.  The U.S. economic policy in recent years, through both Republican and Democratic administrations, has been a focus on growth of GDP as an indicator of economic health.  The effects of this policy are inescapable, in virtually every aspect of our society:

• Compared to past generations, both parents are more likely to work full-time, and people work longer hours, leaving less time for spending time with family–instead things like childcare have moved into the money economy.
• The retail sector of our economy is focused on reselling goods through multiple layers of distribution at progressively higher prices.  The emphasis is on the price, not the value, and the highest profits exist for the people who are able to sell the cheapest goods at the highest markup.
• Our economy is based on continually buying new things rather than buying high-quality goods and properly maintaining and repairing them.  Repair industries have suffered greatly–the dominant practice is to throw out and replace anything that breaks or wears out.
• Transportation and shipping of goods has become a huge part of our economy.  Rather than goods being produced locally, we import a huge amount of things from overseas, including China, and even within the U.S., we are less likely to purchase locally-produced goods and purchase things from local stores.  Even our food supply has become based on shipping things from overseas.
• Our society remains stuck trying to prevent or fix environmental problems through a regulatory approach.  Rather than people having natural incentives to preserve and protect the environment, the incentives are for people to exploit or use up as many natural resources as possible, in order to generate profit.  Corporations are thus constantly fighting for as lax regulations as possible, and finding ways to evade existing laws.

Is this the way it needs to be?  Not at all.  Can you imagine a society which has none of these problems?  I can.  I believe that we can achieve such a society–and can do so quickly, within significantly less than a person’s lifetime.  Furthermore, we must do so quickly, as the society we are living in is completely unsustainable in every sense of the word.

People often tell me that Americans are short-sighted.  I don’t believe this.  I think that we’ve just been given the wrong incentives.  Most Americans, liberal and conservative, care deeply about future generations. It simply does not make sense to me that people don’t care or don’t think in the long-term.  Most people I know do–but I think that most people I know are also operating within social and systems that produce incentives for short-term thinking.

People live paycheck-to-paycheck because they’re in debt and need to make a series of monthly payments on loans.  They got in debt because everything in our society makes it easy to get and stay in debt and hard to stay out of debt.  People make short-sighted decisions in their jobs because their jobs are structured to create incentives for this behavior.  CEO’s are fired if they don’t deliver consistent quarterly profits–they’re not judged by their commitment to long-term prosperity of their company.  And many people work long hours because their jobs require them to do so, and they’re afraid that they’ll get fired if they don’t.  High unemployment makes people even more strongly locked into this type of work life.  And people make choices in their daily lives to buy products that are made in ways that are damaging to the environment, not because they don’t care about the environment, but because these goods are cheaper and more widely available.

Why is our society structured this way?  Because we have designed our economy this way. All the problems given as examples above are examples of things that boost GDP without creating real wealth.  These problems are an inevitable result of a public policy and culture and philosophy in our society which focuses on growth of GDP as an economic goal.

The beauty is that if we let go of this (inane) goal, we are freed.  All these problems disappear.  They won’t vanish overnight, but if we can agree to abandon the idea of growth of GDP as a goal and set as a goal the prosperity of all people, they will disappear without us having to struggle so hard, because we will have removed the main incentive holding them in place.

What can you do?

• Make a commitment right now to working to create wealth and build prosperity for all people, and recognize that growth of GDP is often at odds with this goal.  Make life decisions accordingly.
• Buy only what you need, and be price-conscious when you shop.
• Buy high-quality goods and take care of the things that you buy so that they last longer.
• Donate or give away things rather than throwing them out, assuming they are still in good condition.
• Reduce your expenditures and your need for money so that you can work less in the money economy during your life, spending more time doing productive things not included in GDP like spending time with friends and family, volunteering, gardening, cooking, working on your home, sewing, and being involved in your local community.
• Pick role models and ideals by focusing on intelligent use of resources and a long-term outlook, rather than conspicuous consumption and and a high-income, high-spending lifestyle.
• Support businesses and individuals committed to quality and wise use of resources.
• Support local businesses and buy locally-produced goods, especially food, to whatever degree possible.
• For those who engage in political or economic discourse, whenever anyone talking about GDP or growth (usually meaning growth of GDP) implicitly or explicitly states that increasing GDP or growth is a good thing, call them out on the fallacy of their viewpoint.  Suggest that they focus directly on quality of life issues rather than numerical economic measures.  If a dollar value measurement is to be used, insist that a measure be used that includes the value of production not included in GDP, and subtracts the value of goods destroyed–and thus focuses on measuring wealth rather than a particularly narrow view of production in the money economy.
• If you are an economist, work to develop better indicators that address the points here, and conduct and publish work critical of GDP.  Focus your criticism on economists who remain wedded to the outdated notion of GDP, and show your support for economists working towards better measures of wealth and prosperity.
• If you work in government, media, or influence policy in any way, make sure to act based on promoting actual prosperity, not growth of GDP.  Ask yourself the question about every policy–how does this affect the actual wealth in society–and act accordingly.