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Wednesday, September 22, 2021

ExplainSpeaking: In defence of GDP as a measure of economic growth

GDP has often been criticised for failing to capture some aspects of the economy. Instead of pulling it down, using a broader set of variables can provide a more nuanced understanding of people's wellbeing.

Written by Udit Misra , Edited by Explained Desk | New Delhi |
Updated: June 21, 2021 11:58:58 am
Labourers working in a factory in New Delhi. (Express Photo/Praveen Khanna)

Dear Readers,

Ever since India revised the way it calculates its Gross Domestic Product in 2015, there’s been a debate raging not just about how India calculates its GDP but also about GDP as a measure itself.

Before tackling either of these questions, it would help to recollect how GDP is defined.

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The International Monetary Fund states “GDP measures the monetary value of final goods and services—that is, those that are bought by the final user—produced in a country in a given period of time (say a quarter or a year)”.

It is important to note that GDP maps the “final” goods and services, not the intermediate ones. As such, if a tree is cut to make three cricket bats then the final market value of those three bats is the number that gets added to the GDP, not the market value of the wood as it passes through different stages of processing (supply chain) to become a cricket bat.

Back to the controversies.

In 2019, when Arvind Subramanian, the former Chief Economic Advisor to the government, questioned the validity of the new GDP data series that was unveiled in 2015, we explained the issue in detail and you can read about the arguments and counter-arguments here.

But what about the larger question about the appropriateness of GDP as a measure of economic growth?

For a while now, GDP’s dominance has been questioned.

Most notably, in 2008, Nicholas Sarkozy, then the President of France, commissioned a report from Joseph Stiglitz (President of the Commission), Amartya Sen (Advisor) and Jean Paul Fitoussi (Coordinator) “to identify the limits of GDP as an indicator of economic performance and social progress, including the problems with its measurement; to consider what additional information might be required for the production of more relevant indicators of social progress; to assess the feasibility of alternative measurement tools, and to discuss how to present the statistical information in an appropriate way”.

The 2018 book, “Beyond GDP: Measuring what counts for economic and social performance” by Stiglitz, Fitoussi and Durand built on the Stiglitz-Sen-Fitoussi report to find alternatives to GDP.

Similarly, in “The Growth Delusion” (2018), David Pilling, a senior journalist with the Financial Times, raised what sounds like a commonsensical question: “Our policies are geared relentlessly towards increasing our standard measure of growth, Gross Domestic Product. By this yardstick, we have never been wealthier or happier. So why doesn’t it feel that way? Why are we living in such fractured times, with global populism on the rise and wealth inequality as stark as ever?”.

This is an argument put forward by several other critics as well who resent GDP becoming the all-important variable to track.

In a nutshell, they argue that GDP is the wrong way to measure the wellbeing of a society, and that pursuing policies that solely focus on raising GDP often ends up hurting the welfare of the people. Mischievously enough, sometimes government representatives or ruling party members have tried to hide behind this broader disenchantment with GDP to avoid answering questions on India’s faltering GDP growth rate.

How far are these allegations against GDP valid?

Several people have worded their reservations differently and no single answer can comprehensively counter all allegations.

For instance, is GDP a faulty measure?

It all depends on what you use it for. GDP measures the total market value of goods and services in an economy in a year. Does it claim to measure welfare or wellbeing? No. Does it claim to measure happiness? No. Does it claim to measure inequality? No. Is it a measure of corruption or the lack of it? No. Does it measure the robustness of a democracy? No. Does it measure pollution or climate change? No. Such questions can go on with the same reply.

So, for argument’s sake, you could have an economy that has rising levels of inequality, falling levels of democratic norms, falling levels of civil liberties, increasing air and water pollution, worsening gender equality etc. and still have rising levels of GDP.

The question is: Does the existence of any (or all) of these ills imply that GDP is a faulty measure of “the total market value of all final goods and services”?

The answer is: No.

The GDP is a simple measure, and berating it by judging it based on social or moral norms would be completely missing the point of using GDP.

For instance, GDP can go up with both prostitution as well as coal mining. That it does so is not its fault. The question of whether an economy should allow either prostitution or mining or both or neither is completely separate from what happens to GDP when either of these activities is undertaken openly.

Even if it is not faulty per se, is it adequate?

This brings us back to how we calculate GDP and the controversy surrounding the revisions in 2015. On paper, the 2015 revisions brought India’s GDP calculation in line with the global norms. But many have pointed to discrepancies.

Beyond the methodology, in an economy such as India, there are several limitations with regard to data availability. For instance, the mere fact that a large part of India’s economy functions in the informal sector suggests that “formal” estimates of GDP would be missing out on accurately capturing the GDP.

What about the criticism that GDP often fails to account for all the things that bring down our welfare and diminish our wellbeing? For instance, the damage done by the use of fossil fuels.

This is true; yes, GDP fails to capture the welfare loss. But then the reverse is also true. GDP often doesn’t adequately account for all the welfare gains as well. For instance, as we have seen during the Covid pandemic, a bar of soap or a simple mask, both of which can be obtained for less than Rs 10, provide welfare far in excess of Rs 10 (their final market value) by saving lives!

Delhi: Work off to a slow start despite unlock Construction workers rejoin work in New Delhi after Covid-19 restrictions were eased. (Photo: PTI)

As far as the broader question of people’s wellbeing is concerned, of course, GDP is inadequate but again, that is by design. In other words, if one wants to know about the state of air pollution or the cost (or ease) of getting a hospital bed or the unequal distribution of wealth, or even happiness, then one would need to map other measures.

What are the alternatives?

In his book, Pilling devotes several chapters discussing the alternatives. They are GDP per capita, median income, inequality (Gini coefficient), net domestic product (NDP, calculated after subtracting depreciation of capital goods from GDP), well-being (using Maryland’s Genuine Progress Indicator) and, lastly, carbon dioxide emissions.

But pick any measure and you can find faults with it — especially if you want to treat it as the single go-to metric for making policies.

For instance, we often use GDP per capita as a measure to provide a more accurate picture of the wellbeing of an average Indian. Why? If one looks at the overall GDP, India is one of the world’s largest economies — standing next to the likes of the United States, China, Japan etc. To an alien, who knows nothing else, overall GDP data puts India among the best-placed countries in the world. But if one looks at GDP per capita, the picture changes completely as even Bangladesh is now better off than us.

But even this measure doesn’t do justice. For one, much like GDP, it too suffers from the inability to map variables such as rising pollution etc. Moreover, per capita GDP can easily fail to even spot rising inequalities. Imagine, the top 100 Indians doubling their income in a year while the rest of India remains at the same level. In such a scenario, per capita GDP will rise and give an impression — albeit a faulty one — that the average Indian is better off.

Not surprisingly, “Beyond GDP” authors summarised: “There is no simple way of representing every aspect of well-being in a single number in the way GDP describes market economic output. This has led to GDP being used as a proxy for both economic welfare (i.e. people’s command over commodities), and general welfare (which also depends on people’s attributes and non-market activities). GDP was not designed for this task.”

That is why they argue to move ‘Beyond GDP’ when assessing a country’s health, and “complement GDP with a broader dashboard of indicators that would reflect the distribution of well-being in society and its sustainability across its social, economic and environmental dimensions.”

“The challenge,” they say, “is to make the dashboard small enough to be easily comprehensible, but large enough to summarise what we care about the most.”

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The upshot: It is true that solely focussing on GDP can lead to policies that are blind to people’s broader wellbeing. For instance, completely private provisioning of basic amenities such as health and education may result in GDP going up but may result in bringing down people’s welfare as the poor and marginalised find it hard to access these services. Similarly, policies that raise industrial output may or may not raise industrial employment adequately enough.

But it is also true that it’s easier to berate GDP than to find a worthy replacement. Instead of pulling down GDP, it is better to look at a broader set of variables to get a more nuanced understanding of people’s wellbeing.

Share your views and queries with me at Udit.Misra@expressindia.com

Mask up and stay safe,

Udit

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