Explained: What is GDP and why does it matter?

Dubey said “GDP came into this world in 1934. Before that, there was no GDP anywhere in the world”. As such it should not be treated as a gospel “like Bible or Ramayana”. Further, he quoted, albeit inaccurately, Nobel winning economist Simon Kuznets, who is also credited with being the person who first came up with GDP as it is being used in the current form (see attached picture).

(Credit: Routledge Handbook of Sustainability Indicators; Google Books).

What is GDP?

GDP measures the monetary value of all goods and services produced within the domestic boundaries of a country within a timeframe (generally, a year). It is slightly different from the other commonly used statistic for national income — the GNP.

The Gross National Product (GNP) measures the monetary value of all goods and services by the people and companies of a country regardless of where this value was created.

For example, if Apple manufactures its mobile phone worth $1 million within India, then this $1 million will be counted in India’s GDP and US’ GNP. On the other hand, if the US office of Infosys created software worth $1 million, then it will be counted in US’ GDP and India’s GNP. It is the domestic boundary that distinguishes the GDP.

When were these notions of GDP and GNP created?

The modern-day definitions of GDP and GNP can indeed be traced back to Simon Kuznets, who was entrusted with the task of creating National Accounts in 1933 by then US President Franklin D Roosevelt. According to Financial Times journalist David Pilling (The Growth Delusion, Bloomsbury), “Kuznets’ team travelled the length and breadth of the USA asking farmers and factory managers what and how much they had produced and what they had purchased in order to make their final product”. The final report, National Income, 1929-32, was presented to the US Congress in January 1934.

However, the origins of GDP as a concept date far back. Indeed, the man credited with inventing the concept is William Petty (1623-1687), an Englishman who was a professor of anatomy at Brasenose College. Petty’s quest started when he received an estate in Ireland. To figure out how much did it value, Petty attempted to account for the benefits from the estate and find an appropriate “present value” of the estate. Later on, he applied his approach to the whole of England and Wales to provide the first set of national accounts for the two countries. The idea here was to figure out a reasonable level of taxation on the landowners.

To be sure, since GDP forms the basis of all tax inquires, it would incorrect to assume that past kingdoms — even those dating back millenniums — did not track the performance of the broader economy. Kautilya Arthshastra speaks in detail about the principles governing the taxation of different sorts and all of these first require some sort of assessment of the level and type of produce.

Was Kuznets completely satisfied with GDP as a measure?

Dubey is correct in pointing out that Kuznets was not entirely happy with the final product. Pilling writes that “Kuznets was striving for a measure that would reflect welfare rather than what he considered a crude summation of all activities”.

But, again, one has to understand that no measure can accurately summarise the welfare or wellbeing of an entire population. All measures suffer from some weaknesses. For instance, annual GDP of India is $2.8 trillion but that does not mean that an average Indian is better off than say the average New Zealander. That’s because even though NZ’s total annual GDP is just $0.18 trillion — that is, India produces more goods and services (in value terms) in a month than NZ produces in a year — its GDP per capita is $38,000 while India’s is just over $2,000. In other words, an average Kiwi is 19-times richer than an average Indian even though India’s annual GDP is 15-times than of NZ’s.

For a complete picture of any society or economy, one has to look at a variety of variables.

So, what is the point of GDP?

Yet, GDP is a variable of great merit. That’s because as a measure, it most sums up more information about an economy than any other variable. For instance, countries with higher GDPs have citizens with higher incomes and better standards of living. Of course, one can point out variations and suggest that a country ranked 1 in GDP is ranked 9 in GDP per capita but these divergences would be relatively small when data is seen at a global level.

Similarly, countries with higher GDP can be expected to have much better health and education metrics. The so-called richer countries would have better institutions devoted to higher education, research and development etc primarily because they have the money to spare.

As such, while it helps not to depend overly on just the GDP of a country to make up one’s mind, it is also not a good idea to disregard it as a measure.

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