What is GDP?

Years ago, when I was still in university, I took 3 economics classes: microeconomics, macroeconomics, and political economy.

At one point in my studies, I learned about gross domestic product.

Popularly known as GDP, gross domestic product measures the total market value of all the final goods and services that are produced and rendered during a specific period.

This metric is often used by economists and politicians to demonstrate the change in economic activity in a region, such as a country, or to compare economic activity between regions.

Those who calculate GDP do so by adding up consumption, government spending, net exports, and investment.

While it is a common way to gauge economic activity, I argue that it is an efficiency metric for doing so.

Keep in mind that when GDP considers consumption, government spending, net exports, and investment, it does so by only factoring the dollar value of those 4 values.

For example, let’s say one year, consumption of tires in an economy was $500 million. Then, the following year, tire consumption was at $650 million. On the surface, that looks like increased economic activity.

However, this does not indicate that the number of tires purchased increased, only that the total value of tires purchased did.

If the price of the tires increased by 30%, the total value of tire purchases could have risen while the actual number of tires could have stayed the same.

Not only does GDP not account for volume, but it also does not account for the causes of increases in total value. Using my same example, if would not specify that the increased value of tire consumption was partially driven by, say, a 15% increase in profit by the tire manufacturers and tire retailers.

Another thing that GDP does not measure is income distribution.

If 75% of the consumption in an economy is carried out by 2% of the population because the other 98% live below the poverty line, that would not be reflected in the GDP value.

Likewise, if consumers use credit cards to buy groceries because they do not make enough to live, it still shows up as consumption.

GDP also does not consider unpaid domestic labour, even though such labour is foundational to the economy.

Plus, it leaves out externalities, such as environmental impact.

And these weaknesses are magnified when GDP is broken down to GDP per capita. It is meaningless to take an inaccurate measurement of economic activity and divide it by the population.

Keep this all in mind the next time you hear a politician using GDP to demonstrate how great (or how poorly) a government is doing in governing.