In defence of GDP, the much-maligned measure of growth

GDP sign and upwards arrow on top of US dollars — (Image credit: Wong Yu Liang via Getty Images)

Figures for the level and rate of growth of gross domestic product (GDP) are quoted ubiquitously, including in this magazine.

They are widely agreed to tell us something of importance. But there is a growing counter-consensus among critics that GDP is not in fact a measure of anything we should be overly concerned with. That criticism cuts across the political divide.

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Critics on the left say that doesn’t account for the contribution of unpaid work in the home, for example, for the costs of environmental destruction (which, indeed, may well end up on the positive side of the ledger), or for the distribution of wealth.

Critics on the right mock governments that seek to make the “line go up”, regardless of whether what is done to that end makes any sense from the point of view of promoting general human flourishing, or of the proper tasks of government.

Smashing every window in the realm would make the GDP line go up – people would go out to buy more raw materials and hire workers to repair the damage, and this would boost GDP – but the result would be nothing worth having, and certainly not an increase in real wealth – actually the opposite.

Centrist and technocratic critics are fine with the basic concept, but argue that GDP does not capture everything we should care about, and hence should be replaced with some other measure, or a number of measures, that keep track of how happy people are, for example, or that measure the technological progress that makes our lives easier, but might involve no monetary transaction and hence are not captured by GDP.

Radical “degrowthers”, for their part, argue that it would be better all round if “line go down”.

All these critics might agree that a higher material standard of living, even if measured accurately, does not necessarily make for happier or more fulfilled citizens, at least above a certain level.

The consensus, in short, is that GDP is just not up to the job it is being asked to do.

GDP is the foundation of happiness

The critics are in good company. Simon Kuznets, the economist who first developed a comprehensive set of measures of national income in the US, warned in a report to Congress in 1937 that his innovation was strictly a measure of economic output, and should not be taken to be a measure of welfare or progress per se.

The government at the time wanted to know, in a time of war, whether the economy was recovering from the onset of the Great Depression and, if so, how fast and by how much, as Brian Albrecht explains on Vox.

GDP’s origins tell us a lot about its fundamental nature and purpose. That it does not take account of how happy we all are is not some kind of hidden or controversial failing. It was simply not designed to measure such things, and no metric can be all-encompassing.

Yet as Nicholas Oulton argued in a piece for the CEPR think tank in 2012, although GDP is not a measure of welfare, it is a component of it.

“The volume of goods and services available to the average person clearly contributes to welfare in the wider sense, though of course it is far from being the only component,” he wrote.

It’s plausible, then, that GDP could in fact serve as an indicator of welfare, even if it doesn’t capture all the things that we might care about.

Indeed, “in cross-country data, GDP per capita is highly correlated with other factors that are important for welfare”.

GDP is, for example, positively correlated with life expectancy and negatively correlated with infant mortality and inequality.

Economist Justin Wolfers calculated in a piece for Freakonomics in 2010 that the correlation between the objective measure of GDP and the subjectively expressed experiences of people’s lives was greater than 0.8 (where 0 represents no correlation and one indicates lockstep).

That’s “astonishingly high”.

There’s a robust correlation with a range of other measures too, and with the UN’s Human Development index, which combines data on life expectancy, adult literacy, educational enrolment and GDP per capita.

So GDP carries weight as a metric for good reason, says Albrecht: “despite its narrowness, it relates closely with nearly every outcome people care about”.

GDP correlates with higher educational attainment, reduced extreme poverty and higher levels of self-reported happiness. This last point is somewhat ironic and “deserves emphasis”: life satisfaction, the primary measure used in the World Happiness Report and similar wellbeing indices that are often promoted as alternatives or supplements to GDP, themselves highly correlate with GDP.

The “closest thing to an exception” is environmental quality, but even here the story doesn’t reflect badly on GDP. Pollution tends to rise in the early stages of economic growth before declining as countries grow wealthy enough to be able to afford clean technology and environmental protection.

This shouldn’t really be surprising.

“Economic production is the foundation of tons of other things we care about. You can’t have broad or universal healthcare without the economic capacity to pay for it.

You can’t fund education, build infrastructure, or protect the environment without resources. And GDP tells you how much resource-generating capacity you have by looking at how much you are doing right now.”

An illustration of what is at stake is provided by Bhutan. In 1972, the King of Bhutan announced that henceforth “gross national happiness” would take the place of concerns about gross domestic product.

It was, as Albrecht says, a “charming soundbite” that captured imaginations worldwide. But today, more than 50 years later, Bhutan still ranks near the bottom of countries globally in GDP per capita and is no happier – internationally comparable surveys show a fall in self-reported happiness in the country.

South Korea, by contrast, took the opposite approach. In 1961, general Park Chung-hee seized power with the stated aim of modernisation and economic growth. GDP since has exploded – as have all measures of general welfare, from life expectancy to child mortality, and surveys of self-reported happiness show that South Korea is consistently ahead of Bhutan.

“For most countries, for more policy decisions, what we need is to build productive capacity, and raising GDP captures whether they’re succeeding. All the outcomes move together.”

How do you measure a story?

Some critics might say that this is all very well as far as it goes, but why not improve upon the flawed adequacy of GDP? It’s hard to object on principled grounds, but practically it’s hard to believe it would be worth the bother.

Any conceivable alternative will have flaws too, for all measures will ultimately be wrong, even if some are useful.

GDP’s flaws are well known already and it has been refined and improved upon over the years. It is tried-and-tested and produced globally in a timely manner. It provides a reliable, accurate, cross-cultural and cross-historical measure for economists and policymakers, and more importantly gives crucial information to states concerned with raising taxes, borrowing on the markets and managing debt sustainability.

A new-fangled measure that seeks to measure how people are feeling at the time they fill in a survey might tell us something useful, but it’s hard to see that it will be of much use to credit-ratings agencies, or to governments considering whether to cut taxes, or central bankers deciding whether to raise interest rates.

If we’re looking for an alternative to GDP, we want one that is plausibly much better, well understood and has been tested through many economic cycles and in different contexts. We just do not have anything like that to hand.

Economist Diane Coyle has written two significant books on GDP, its history and flaws, and her proposed alternatives. But as a sympathetic reviewer, David Goodhart, had to conclude, “there is currently no consensus on what the alternative would look like and I confess I did not fully understand Coyle’s own proposal”.

Goodhart’s inability to grasp just what the alternative is suggests that it is the sort of thing that would appeal to a handful of technocrats, whose main achievement in recent years has been not to impress with their brilliance, but to feed “general anxiety about the reliability of our economic statistics”. Complicating things hardly seems likely to improve them.

The case for sticking with GDP can be made through a thought experiment, as economist Saad Siddiqui told MoneyWeek.

Imagine that we live in a pre-Kuznets world and someone told you they intended to calculate the value of the economy by adding up all the income individuals and companies are making.

Might you not think that that is a reasonable starting point? You might quibble about issues of measurement and the practicalities of actually doing it, but conceptually you might see that this is “probably the most intuitive way to think about the economy, even if we agree that there’s more to life than incomes”.

And this is what GDP is. (The reality is a bit more complicated than this short sketch might imply, but it captures the gist for the sake of this argument.)

Coyle is right that it is getting ever more difficult to measure what we produce since a lot of it is in services.

“How to measure the output of a management consultant or a Wall Street analyst telling you stories about the market? We can’t really say very easily. However, we can still measure incomes and the price of a basket of goods and services (CPI) that that basket could buy and still arrive at a measure of the economy that is broadly sensible,” says Siddiqui.

The health of nations

There is a more radical path that is at least worth knowing about. Instead of worrying about all this, we could simply follow China’s example and stop publishing economic statistics for public consumption. Shortly after Xi Jinping became leader, the country’s National Bureau of Statistics stopped updating thousands of data series, reports the Financial Times. By 2016, more than half of all indicators published by official agencies had been discontinued. Since then, more and more have been quietly dropped.

Xi may be more motivated by the desire to hide bad performance than by more noble motives, but his may nevertheless be a move in the right direction. When asked how developing economies should seek to improve, John Cowperthwaite, a former financial secretary of Hong Kong, who introduced most of the city’s free-market reforms in the 1960s, replied: “They should abolish the office of national statistics”.

The trouble with economic data, he thought, was that “someone might try to do something with it”, as David Hutt of The Diplomat points out. Any meaningless fluctuation would encourage bureaucrats to meddle needlessly. Any period of apparent growth might convince businesses they no longer needed to innovate.

If that seems too radical, we could at least adopt a more minimal approach. Governments should focus on those things that only the state can do and should do.

To the extent that that involves economic management, do those things most likely to boost GDP – or perhaps more importantly, don’t do those things likely to retard it.

Goodhart’s Law is an important caveat – a measure that is used as a goal ceases to be a good measure. But awareness of this law and an appreciation of the brilliance of GDP as a measure might be the best that we can hope for and the best way to hold governments to account.

The “funny thing about GDP”, as Wolfers says, is that, despite all its shortcomings, it “still turns out to be a surprisingly useful indicator of the health of nations”. “Line goes up” remains, in other words, something very much to be desired.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

Stuart graduated from the University of Leeds with an honours degree in biochemistry and molecular biology, and from Bath Spa University College with a postgraduate diploma in creative writing.

He started his career in journalism working on newspapers and magazines for the medical profession before joining MoneyWeek shortly after its first issue appeared in November 2000. He has worked for the magazine ever since, and is now the comment editor.

He has long had an interest in political economy and philosophy and writes occasional think pieces on this theme for the magazine, as well as a weekly round up of the best blogs in finance.

His work has appeared in The Lancet and The Idler and in numerous other small-press and online publications.