Gross Domestic Product (GDP) needs to be either re-thought, or scrapped as a measure of economy. Why? For several reasons, including:
- It measures output, not economy, and with grave unintended consequences
- It measures output domestically, and this is no longer a useful measure
GDP Measures Output, Not Economy
The whole point of both Gross National Product (GNP) and its ultimate successor, Gross Domestic Product (GDP) was to measure economic output at the scale of a nation. For not very interesting reasons, GDP triumphed over GNP as an economic measure and is the focus of this piece (bye, GNP). Both measures were created by economists to help nations understand the economic activity taking place within their borders and to help governments steer economic policy. But GDP was never intended as a measure of economic growth. But we show an increase in economic output as an increase in economic growth – for example, GDP globally in 2017 grew 3.535% – but this logs the growth in output, not the growth in economy.
What is Actual Economic Growth?
The notion that GDP is not economic growth may seem strange, and it may even seem nuanced, but it isn’t; instead it is a critical distinction. First, and simply:
Economic Growth = Getting more output from the same amount of inputs, or the same output from a smaller set of inputs.
In other words, you finding a quicker way to get home on your commute is economic growth because the same problem solved but done in less time = economic growth. Figuring out a new way of constructing a silicon chip to do as many calculations, but with either less energy or less space = economic growth. Virtually any idea that results in conservation of, or better utilization of resources results in economic growth. This is a very different measure than output.
What is Output?
At the national economic level, GDP can be thought of as having three major components: inflation; more mouths to feed; and actual economic growth as we described above. We adjust GDP and other measures of economic growth for inflation because we recognize that it is simply a measurement distortion caused by a change in prices. But what about the “more mouths to feed” bit? When a baby is born, parents need to provide necessities for their kids. In turn, this results in additional shelter (crib, room, carriage, etc.), additional food, additional clothing, additional healthcare, additional education, additional energy, and so on. However, this is not economic growth as described above. Instead, it is additional output and consumption.
Similarly, your purchase of another pair of shoes is not economic growth unless none of your other pairs of shoes provides protection for your feet. After all, you can only wear one pair of shoes at a time. Now, additional shoes may provide you with additional satisfaction, but that is not economic. So, what is it? It is additional revenues for the company that sold you the shoes, and it is additional GDP, and it is additional output, but it is not additional economic growth.
Here’s another example. Think of your use of a car. We can measure higher economic output from the car over the short-term by delaying or avoiding basic maintenance on the car. How? Temporarily the output looks the same because you still get from point A to point B, yet this result has fewer costs associated with it, so it is registered as net ‘profit’ or ‘output’ growth. Yet, as we know, in the long-run this is disastrous when inevitably maintenance must be done.
Are you following us? Consumption is not growth, nor growth in productivity, it is just consumption of, in the case of GDP, physical goods and services. Consumer consumption represents approximately 70% of current U.S. GDP. Is consumption actual economic growth, or just consumption? In the Age of Climate Change, living on a planet with finite resources, any consumption of new goods has a negative cost, yet non-accounted for by GDP. Humanity currently consumes 1.7 earths per year. That means that we are consuming 70% more than Earth can replenish in a year. Consuming 70% more than what the planet has as renewable resources will have long term costs that currently do not make it into the cost accounting of growth. A present false measurement of the cost both of growth and output.
In 2013, Global GDP was $75 trillion. In the same year the value of the ecosystem services supplied by Earth was $125 trillion. So, the ecosystem was both larger and non-accounted for than the global economy. For example, a T-shirt may be produced by labor and sold for $15. Nowhere in the cost of that t-shirt are the 400 gallons of water used to make it. Given a finite amount of planetary fresh water, this obviously has off-setting costs in the present and especially in our future.
Anybody who believes that exponential growth can go on forever in a finite world is either a madman, or an economist”
-Kenneth Boulding (an economist)
So, by maximizing at the business-level revenue growth, and at the national policy level, GDP growth, we are actually engaged in the wrong activity relative to a planet with fixed resources. At the environmental level, if we focus on output, not economy, any ‘growth’ is actually only temporary, as we are, in the long-run, committing the same sin of running the global car without performing maintenance.
One last example that takes our example of the environment down to the level of a likely future business scenario. To the engineering firm that can build gigantic walls (in this case not a North American border wall), a rise in global sea levels that necessitates a huge build out of sea walls looks like a gigantic economic boom. But when measured at the level of the economy it is a disaster. Why? Because it is a huge and unproductive investment in assets. All of the billions in currency used to build up sea walls could instead have been invested in developing new, more efficient energy sources, more education, better urban design, better healthcare, and so on. GDP, nonetheless measures as output the sea wall manufacturer’s gain, as well as the additional insurance premiums collected by insurance companies insuring beach front and flood-zone properties
Likewise, in the case of the production and consumption of fossil fuels which cause air pollution, there is no production offsetting cost of the reality that someone dies every 6 seconds in the world due to a lung disorder caused by such pollution. It measures as “good” (because it results in GDP growth) an increase in cigarette smoking, medical treatment, and burial costs, and so on.
To summarize, GPD measures output, not economic growth. And this is a disaster for our future because it leads to misguided and poor choices.
GDP is Measured Nationally, not Globally
Another, smaller problem with measuring GDP is that overwhelmingly as a policy tool it is measured at the national, not global level. To us, this is too 20th century in its thinking. From a governmental policy perspective, it certainly makes sense to consider GDP nationally. But with businesses operating transnationally and multi-nationally, many of them operating in every country in the world, how do you measure ‘national income’ or ‘national wealth?’
One example that may make this clear, the most dominant companies of the 21st century so far are all from the United States: Facebook, Amazon, Apple, Netflix, Google, the so-called FAANG companies. But their income is earned globally, and usually not repatriated to the United States. So, does that make them US companies, global companies, or what? If they are not US companies, then what can be said of their income, or of their wealth? Asked another way, if Facebook collects ad revenues from a Ukraine-based real estate company advertising on its site, what claim can the US make on that income?
Famously several years ago, Cupertino, the home of Apple, had some of the worst streets in the United States. Most were lying in disrepair despite the fact that the world’s most valuable business was ‘domiciled’ there. Another example is that the current executive branch of the United States pulled out of the Paris Accords, yet most US companies, because they operate globally, have not withdrawn their support of the environmental policy. These examples, and many others, highlight the absurdity of GDP being used by governments to set economic policy. Think nationally, act globally is not something most governments can do, but businesses can.
To The Sarasota Institute the notion that we are still living in a nation-state world is outdated. We think that in the decades ahead, the age of nation states will give way to a more global form of governance. The first driver of this is financial; we already live in a global economy. The second driver are the global problems of today, such as climate change or wealth inequality, which can no longer be solved by any nation state. To us, if we had to guess, in about the mid to late-1990s the balance of power shifted from governments being the most dominant of the active institutions on the planet to businesses, who were the first and still only globally oriented entities. But to us, GDP is also outdated and needs to be re-thought. This topic is the basis for several upcoming articles as we consider what should replace GDP as a measure of actual economic growth and how we are actually moving away from pure output economies and forms of consumption.