Why GDP is not the best measure of economic growth

GDP

Measuring the GDP is difficult; is it even worth coming up with the number? Image: Flickr / michaelreuter / CC-BY

The Gross Domestic Product forecast in the United States has recently been downgraded. In many news reports, the GDP is seen as the biggest indicator for how well the economy is doing. However, the GDP is an outdated and inaccurate way of measuring economic growth.

The basics of GDP

The Gross Domestic Product is a single number that encompasses the entire value of goods and services produced in one country. GDP began as a measurement of the standard of living in various countries, but it is used in several other ways. Gross Domestic Product is usually figured by adding up private consumption, gross investment, government spending and exports (minus the gross amount imported). GDP was first calculated in 1934 for a report given to Congress by economist Simon Kuznets. The Federal Reserve bases many of its monetary decisions, at least partially, on the GDP figure.

Inflation, consumer price and the GDP measure

Since it was first created, the measure of Gross Domestic Product has had limitations. The Bureau of Economic Analysis releases a number referred to as “real” GDP that adjusts the number for inflation. Without that adjustment, the GDP would always appear to be growing with the rate of inflation. The Consumer Price Index, which is a measure of the inflation or deflation of the cost of most household goods, also has no effect on the GDP. So if the cost of household goods goes up by 400 percent, it is seen as a growth of the GDP, despite the fact that the average American has less disposable income.

Why the GDP is like a credit card

The biggest limitation of the GDP measure is that it does not take into account any negative numbers. To translate the GDP in terms of a household budget, it would be as if you measured the health of your household finances based on how much money you spent — both in cash and on your credit cards. The repayment on those cards that would eventually come due, the damage to your budget and the possibility you wouldn’t make your mortgage payment are all left on the cutting room floor. Measuring the economic growth of the United States — or any country — based solely on GDP is too simplistic to be accurate.

Sources

The Money Alert
Blogging Stocks
Investopedia

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