Gross Domestic Product Explained Clearly
|April 27, 2005||Posted by Staff under Progress Report, The Progress Report|
An Explanation of GDP, GNP, GPI, and All That
We often hear of Gross Domestic Product, or GDP. Is that a statistic too complex for us to understand? Or is it a fake statistic manipulated by corrupt bureaucrats? Let’s get the straight truth.
The Progress Report is pleased to present a guest article by Edward J. Dodson, head of the School of Cooperative Individualism. We invite the reactions, replies and responses of all our readers.
Should We Pay Attention to Statistics on “Gross Domestic Product?
by Edward J. Dodson
For most of us who get our news regarding the economy from the daily newspaper, radio or television news programs, we are likely to read or hear that the economy is doing well or poorly as measured by changes in something called Gross Domestic Product, or GDP. So, exactly what is GDP and is it something that tells much of anything important?
GDP is generally defined as the measure of the USA’s output of goods and services. The U.S. Department of Commerce gathers data from various sources on personal consumption, government expenditures, private investment, inventory growth and the nation’s trade balance to come up with a GDP figure.
Additionally, the component elements in the GDP calculation are given various weights based on the relative prices of goods and services and their importance in the economy. This figure is then further adjusted to take into account the effects of inflation, yielding what economists refer to as the inflation-corrected GDP.
Just looking at what is included in the calculation of GDP suggests just how inappropriate (i.e., unscientific) this measurement is of anything related to the well-being of the people in a society. All spending — whether on the construction of prisons, the development of military weaponry, the dumping of untreated and toxic chemicals into the ground, waterways or air — all add to GDP. An alternative approach has been developed by environmental economists working with the Greens, referred to as the Genuine Progress Indicator, or GPI.
GPI takes into consideration whether the output of goods and services of a society is positively impacting the well-being of the population. The expenditures on criminal justice and pollution clean-up, for example, are deducted from total increases in spending to assess whether there is a net improvement or net decline in social welfare. Other components look at the extent to which production occurs utilizing sustainable processes that are not harmful to the environment. Here’s a graphic image of just how far off GPI suggests we are from what the GDP measures.
Critics point out that the GDP measure was created during the Second World War in an effort to keep track of wartime production gains. The purpose was never to use this as a measure of our wellbeing and social progress. A report issued in 1995 by the San Francisco-based organization Redefining Progress offers a detailed analysis of GDP’s inconsistencies:
- GDP TREATS CRIME, DIVORCE AND NATURAL DISASTERS AS ECONOMIC GAIN. Since the GDP records every monetary transaction as positive, the costs of social decay and natural disasters are tallied as economic advance. Crime adds billions of dollars to the GDP due to the need for locks and other security measures, increased police protection, property damage, and medical costs. Divorce adds billions of dollars more through lawyer’s fees, the need to establish second households and so forth. Hurricane Andrew was a disaster for Southern Florida. But the GDP recorded it as a boon to the economy of well over $15 billion.
- GDP IGNORES THE NON-MARKET ECONOMY OF HOUSEHOLD AND COMMUNITY. The crucial functions of childcare, elder care, other home-based tasks, and volunteer work in the community go completely unreckoned in the GDP because no money changes hands. As the non-market economy declines, and its functions shift to the monetized service sector, the GDP portrays this process as economic advance. The GDP also adds the cost of prisons, social work, drug abuse and psychological counseling that arise from the neglect of the non-market realm.
- GDP TREATS THE DEPLETION OF NATURAL CAPITAL AS INCOME. The GDP violates basic accounting principles and common sense by treating the depletion of natural capital as income, rather than as the depreciation of an asset. The Bush Administration made this point in the 1992 report of the Council on Environmental Quality. “Accounting systems used to estimate GDP” the report said, “do not reflect depletion or degradation of the natural resources used to produce goods and services.” As a result, the more the nation depletes its natural resources, the more the GDP goes up.
- GDP INCREASES WITH POLLUTING ACTIVITIES AND THEN AGAIN WITH CLEAN-UPS
- GDP TAKES NO ACCOUNT OF INCOME DISTRIBUTION. By ignoring the distribution of income, the GDP hides the fact that a rising tide does not lift all boats. From 1973 to 1993, while GDP rose by over 50 percent, wages suffered a decline of almost 14 percent. Meanwhile, during the 1980s alone, the top 5 percent of households increased their real income by almost 20 percent. Yet the GDP presents this enormous gain at the top as a bounty to all.
- GDP IGNORES THE DRAWBACKS OF LIVING ON FOREIGN ASSETS. In recent years, consumers and government alike have increased their spending by borrowing from abroad. This raises the GDP temporarily, but the need to repay this debt becomes a growing burden on our national economy. To the extent that Americans borrow for consumption rather than for capital investment, they are living beyond their means and incurring a debt that eventually must be repaid. This downside of borrowing from abroad is completely ignored in the GDP.
. Superfund clean-up of toxic sites is slated to cost hundreds of billions of dollars over the next thirty years, which gets added to the GDP. Since the GDP first added the economic activity that generated that waste, it creates the illusion that pollution is a double benefit for the economy. This is how the Exxon Valdez oil spill led to an increase in the GDP.
Our nightly news programs are apt to dedicate a few minutes at most to the state of the economy. It is very tempting to use a simplistic indicator, such as GDP, to provide viewers and listeners with a sense that things are going well or are turning downward. Are people fooled? Well, as the old saying goes: When our neighbor is unemployed, we conclude we are in a recession. When we are unemployed, we conclude we are in a depression. The GPI represents a major improvement in the way statistical information is interpreted to describe trends and the state of reality.
Ed Dodson runs the School of Cooperative Individualism.
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