What Are the Different Problems with GDP?
Gross Domestic Product (GDP) is the most commonly used indicator of a country's economic growth, but there are a number of problems involved with the way GDP is calculated that must be kept in mind. One of the primary problems with GDP is that it measures goods and services sold through markets but does not take into account anything that is produced but not sold. Also, this value does not factor in a country's underground economy of tax evaders and criminal enterprises. Most importantly, GDP purports to determine a country's growth and standard of living, but it only does this from a material perspective and does not factor in actual social welfare.
A country is concerned with its rate of economic growth because it predicts the ability its people to produce and consume goods and services in the future. Consumption, or the demand for goods and services, in turn drives job creation, which in turn drives the country's standard of living. The rate of economic growth is measured by tracking GDP, or the total value of the goods and services produced. This number is calculated by the government based on the sale of goods and services in the marketplace, which can be determined by looking at government transactions such as sales and income taxes.
One of the problems with GDP is that it only takes into account the goods and services an economy produces and sells in a legitimate marketplace. This is only a portion of the total economic activity that takes place in a country. In areas where bartering is still in use, GDP is particularly unsuitable as an economic indicator. The value of economic production that is not exchanged in a traditional sense also goes uncounted, such as the work done by a stay-at-home mom.
Problems with GDP also arise when you consider that there is a portion of a country's economy that does not flow through legitimate government channels. This “underground” economy can be significant. If this was a true unbiased indicator, all production would be valued, regardless of the legality of the transaction. GDP ignores the person who works off the books, the illegal immigrants who work without paying taxes, the corporate tax scofflaws and the criminal masterminds equally.
Perhaps, one of the most significant problems with GDP is its framing paradigm. This value is used to indicate a country's standard of living, or how well off its citizens are compared to other citizens in other countries. The indicator uses market sales exclusively to reach its conclusion, however, which are mostly driven by a profit motive. As an indicator, GDP only really measures how well off a country is materialistically and how capable the populace is of making purchases. It does not truly measure the increase in social welfare, which is a multifaceted approach to an analysis of the standard of living.
Take a country that is completely devastated by an earthquake. All buildings have to be re-built. Economic growth from rebuilding is reflected in an increased GDP! Has the GDP really been increased?
Another example: Let's all become lawyers and sue each other. Yup, the GDP per capita will rise. Also take an economy with surplus capital that does not spend all its income. Savings? What happens to this factor? Nothing unless it is spent internally.
A high GDP sometimes translates into social welfare and sometimes it doesn't. I think we can say that most developed countries such as Germany, US and Japan have high social welfare and they also have high GDP rates. But there are newly growing economies in the world, where GDP rates are impressive, but social welfare is not.
We can't simply look at GDP and say that the citizens of that country have high standards of living or that they have opportunities and freedom. Capital does not equal to social development and using GDP as an indicator is problematic for this reason.
@Melonlity-- That's a good point but I don't think anyone is trying to replace GDP as an economic indicator. Perhaps more metrics can be developed so that the measurement of GDP is more realistic.
There are undoubtedly problems with measuring GDP. It's not always a realistic measurement and depends on various factors as the article said. But I still think that the advantages of this indicator are greater than the disadvantages. Although the measurement may not be 100% accurate, it still gives an overall idea about how the economy is doing.
This is one of the measurements that economists rely on to decide on economic policies. Without this measurement, it would be very difficult to make predictions about the future of the economy and it would not be possible to take precautions.
For example, right now, if economists see that GDP is being negatively affected by inflation, then they will suggest actions to reduce inflation so that the GDP can keep growing without negative side effects.
Using gross domestic product (GDP) to measure a nation's economic growth may be problematic, but what alternatives to it exist. And, here's a problem -- let's say a new metric is developed. Is there enough data appropriate to that measurement to track economic growth over a long period of time? Such comparisons are necessary to determine if an economy is, in the long run, expanding or contracting.
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