The gross domestic product or GDP of a particular country represents the total monetary value of all final goods and services produced within its borders during a specific period. It is used to measure economic size, determine the direction of economic growth, and compare economic performance against other countries. However, despite the advantage of GDP as a widely used macroeconomic indicator, it does not take into account the other facets of economic health and does not provide insights as regards the quality of life of a population.
Advantages of GDP: Benefits of Using Gross Domestic Product as an Indicator of Economic Success
English economist and philosopher William Petty developed a concept similar to the gross domestic product to criticize and attack landlords against unfair taxation during the Anglo-Dutch Wars that spanned from 1654 to 1676. Another English economist and politician Charles Davenant developed the concept further in 1695.
It was Belarusian-American economist Simon Kuznets who introduced the modern concept of GDP in 1934 for a United States Congress Report. The U.S. government commissioned him to develop a suitable measure for determining the economic output of the U.S. economy during the Great Depression that occurred between 1929 and 1939.
The work of Kuznets was further developed and expanded by other economists and statisticians. Nonetheless, during the Bretton Woods Conference that was held from July 1 to July 22 in 1944 and participated by 730 delegates from 44 allied nations, the GDP became one of the main tools for measuring the economy of a particular country.
Measurements of GDP during World War II were crucial in the subsequent widespread political acceptance of the gross domestic product as a tool for determining economic progress and national development. The U.S. officially switched from using the gross national product to GDP in 1991. China officially adopted the same concept in 1993.
The main advantage of GDP as a macroeconomic indicator is that it assigns a monetary value to the economic activity of a particular country based on the sales of final goods and services produced within its borders. This makes economic activity an aggregate of all value-producing and income-generating activities of a country.
Furthermore, based on the monetary value, the growth of an economy can be compared across different periods just by looking at how much the value has increased or decreased compared to the previous period. This is important for determining if the economy is in an expansionary or contraction phase or anticipating a possible recession.
Another interesting use of GDP is in decision-making. It has been used by governments to guide policies or courses of action pertaining to the management of the economy. In addition, because it tells the size of a particular economy and trends in economic growth, it can supplement market research pursuits of investors and businesses.
Below are the specific advantages of gross domestic product as a macroeconomic indicator:
• Measures Economic Activity and the Size of the Economy: Remember that it represents the monetary value of all final goods and services produced within the borders of a particular country during a specific period. This tells how much the results of economic activity are worth during a specific time and also quantifies the size of the economy based on the worth of its final goods and services.
• Offers Insights for Macro and Micro Decision-Making: Another advantage of GDP is that it can help the government or its policymakers and economic managers formulate and evaluate economic policies. It can provide insights that can guide individuals or organizations in making sound business or investment decisions. GDP also serves as a fundamental input for economic forecasting models.
• Provides Data For Local and International Comparisons: It can tell how an economy performed compared to previous periods. This is essential for a country to determine whether its economy is growing or shrinking. Furthermore, because it is a popular macroeconomic tool, it has become a standard metric to evaluate and compare the relative economic performance of different countries.
Disadvantages of GDP: Limitations of Using Gross Domestic Product as an Indicator of Economic Success
It is interesting to note that even Kuznets warned against the use of gross domestic product and other national income measurements in the follow-up report he submitted to the U.S. Congress in 1937. He specifically warned against its use as a measure of economic welfare. He argued further that quantitative measurements tend to simplify complex situations.
American politician and former U.S. Attorney General Robert F. Kennedy captured the problems of using GDP as a sole macroeconomic indicator in his speech “The New Frontier of Social Welfare” he gave at the University of Kansas on 18 March 1968. He said that it is a measure of everything except that which makes life worthwhile.
The criticisms of gross domestic product all boil down to its limitations in providing a proper context of economic growth and its constraining definition of economic development. It is also important to underscore the fact that there have been several examples in which a high or increasing level of GDP did not equate to a high standard of living.
Venezuela had a GDP of more than USD 300 billion from 2010 to 2015. This was close to the GDP of Singapore and Thailand. However, beyond the number, the country has been suffering from hyperinflation and mass emigration due to the absence of opportunities. Over 90 percent of the population has even fallen below the poverty line.
Another example is Russia. It has the highest gross domestic product in the world at USD 1.77 trillion in 2022 but has a standard of living that is arguably lower than Western countries Income inequality is pervasive because Russian oligarchs control more than 70 percent of the wealth in the country and average adjusted disposable income is substandard.
The approaches in calculating GDP also do not include activities under the so-called informal economy sector or gig economy and underground markets. The value of these activities can be significant considering the impact of globalization, outsourcing of smaller tasks and projects, and widespread work-from-home or remote work arrangements.
In addition, as regards the different approaches to calculating, another disadvantage of GDP is that its open to manipulation. The 2022 study by economics and political science professor Luis R. Martinez found signs of manipulation of economic growth statistics in countries with authoritarian or semi-authoritarian governments.
Below are the specific disadvantages of gross domestic product as a macroeconomic indicator:
• Simplifies the Facets and Essence of Economic Development: Using the gross domestic product as the main macroeconomic indicator is limiting. It does not capture all economic activities within a country, disregards income distribution and purchasing power, and neglects non-economic factors like education, healthcare, sustainability, quality of life or living standards, and government services or programs.
• Opens to the Possibilities of Misinterpretation and Manipulation: A growth in value for a particular period might be misinterpreted as a sign of real economic growth if it is compared to data obtained from periods characterized by the occurrence of unusual albeit temporary situations like natural disasters or a global economic downturn. The data can also be manipulated by corrupt government authorities.
• Availability of Other Concepts, Measures, Tools, and Indicators: There are alternatives to GDP. These include the Human Development Index and the Better Life Index. Some also use contextualize GDP value with other indicators like purchasing power parity, employment rate or unemployment rate, poverty incidence and poverty prevalence, inflation rate, and government revenues, among others.
FURTHER READINGS AND REFERENCES
- Callen, T. 2016. “Gross Domestic Product: An Economy’s All.” Finance & Development. International Monetary Fund. Available online
- Kuznets, S. 1934. “National Income, 1929–1932.” 73rd U.S. Congress, 2nd Session. Senate Document No. 124, Page 5-7
- Martínez, L. R. 2022. “How Much Should We Trust the Dictator’s GDP Growth Estimates?” Journal of Political Economy. 130(1): 273102769. DOI: 1086/720458