Is GDP still a good measure of economies

28 Oct 2019

By Andrew Dittberner, Chief Investment Officer at Old Mutual Wealth, Private Client Securities

Gross Domestic Product (GDP) is the standard proxy to measure a country's economic progress, with a high GDP growth rate commonly equated with economic success. However, treating GDP as the gold standard for economic success or failure can lead to paradoxical outcomes. Given that society today places value on many aspects of life other than pure transactional value, perhaps it is time to find more holistic measures that align with how economies have evolved over the years.

GDP measures the value of all goods and services that are produced in an economy for both local and international consumption. The methodology was developed in the 1930s by economist Simon Kuznets at a time when mass production was taking off. Today, questions are rising as to whether it remains a suitable proxy for success as it does not capture many aspects of our lives today that we may consider beneficial to our wellbeing, or to society as a whole. These include environmental quality, levels of health and education, levels of inequality, the amount of time spent at leisure, increases in technology, and the list goes on.

Advances in technology provide an interesting case study in this regard. In the 1980s, the perceived failure of massive investment in information technology to boost productivity growth became known as the productivity paradox. In 1987, economist Robert Solow famously quipped that computers are everywhere "but in the economic statistics". This statement could be viewed in a number of ways. Perhaps the technology is not as good as we believe it to be, hence the productivity improvement is not seen in the GDP number. Alternatively, it could be due to the fact that new technology takes some time to make a significant impact on productivity which ultimately flows through to the GDP number. Lastly, perhaps the GDP methodology is outdated and is not capturing the improvement in productivity due to new technologies. In the case of Robert Solow's theory, it was due to the lag effect of the PC and the ‘negative' impact it had on productivity.

Compared to the three large motor manufacturing companies (GM, Ford and Chrysler) of the 1990s, today Alphabet, Facebook and Apple produce the same amount of revenue in real terms as those companies did in 1990, however, the three tech companies today employ one fifth the number of employees. This would suggest that productivity has increased significantly over the past two decades. The problem though is that large businesses today are in the business of making money by employing fewer and fewer people. It is for this reason that the labour share of GDP has fallen over the past two decades, and the gap between the rich and poor continues to grow wider. This is why small and medium enterprises (SMEs) are so critical to any economy, as it is these businesses that are in the business of creating jobs.

In a country like South Africa, the informal sector is practically invisible to GDP, but in reality, the informal economy counts for a great deal of economic growth. GDP does not capture informal trade that takes place, but at the same time, it does not capture that the poor are growing poorer and the rich are growing richer. Instead, given that the rich outweigh the poor in terms of transactional value, on average the economy as a whole appears to be growing wealthier. The phrase "on average" is the key, as averages hide the truth, and GDP numbers are based on averages.

Reliance on averages can lead to paradoxical outcomes. For most people, quality trumps quantity. It is therefore, better to have one good experience than many ‘average' experiences. However, GDP prefers quantity to quality. Whether it be a better experience in a restaurant, or booking your flight online and checking in online, GDP does not capture these. In fact, GDP evaluates booking a flight online and checking in online as a negative as it negates a travel agent's job as well as the jobs of the individuals working at the check-in desks at the airport.

The same paradox plays out at a country level. According to a report released in August by World Population Review, Africa's richest countries in terms of nominal GDP per capita (total value of goods and services produced divided by population) are Seychelles, with a nominal GDP per capita of over USD15 000, and the small oil-rich nation of Equatorial Guinea. In the latter, however, life expectancy and infant mortality are below the sub-Saharan African average, while roughly half the population lacks access to potable water.

Against this background, one needs to bear in mind that GDP is a measure of income, not wealth. Thus, while one's income may be high, it does not automatically translate into wealth as that money could be squandered or spread very thinly. One's income should be invested appropriately in order to grow wealth, and the same principle applies to an economy. A country's fiscal position will give you a much better indication of the country's financial position. We need to be innovative in thinking about other measures of wellbeing that could complement our existing measures of the progression of economies.

Nevertheless, at this stage GDP remains the most important measurement of an economy's progress. However, it is becoming increasingly necessary to consider other measures that complement GDP and give us a more complete view of the progress of society.

Content by:

OM Wealth