Gross domestic product


Gross domestic product is a monetary measure of the market value of all the final goods and services produced in a specific time period.
GDP per capita does not, however, reflect differences in the cost of living and the inflation rates of the countries; therefore using a basis of GDP per capita at purchasing power parity is arguably more useful when comparing living standards between nations, while nominal GDP is more useful comparing national economies on the international market.
The OECD defines GDP as "an aggregate measure of production equal to the sum of the gross values added of all resident and institutional units engaged in production and services." An IMF publication states that, "GDP measures the monetary value of final goods and services—that are bought by the final user—produced in a country in a given period of time."
Total GDP can also be broken down into the contribution of each industry or sector of the economy. The ratio of GDP to the total population of the region is the per capita GDP and the same is called Mean Standard of Living. GDP is considered the "world's most powerful statistical indicator of national development and progress".

History

came up with a basic concept of GDP to attack landlords against unfair taxation during warfare between the Dutch and the English between 1654 and 1676. Charles Davenant developed the method further in 1695. The modern concept of GDP was first developed by Simon Kuznets for a US Congress report in 1934. In this report, Kuznets warned against its use as a measure of welfare. After the Bretton Woods conference in 1944, GDP became the main tool for measuring a country's economy. At that time gross national product was the preferred estimate, which differed from GDP in that it measured production by a country's citizens at home and abroad rather than its 'resident institutional units'. The switch from GNP to GDP in the US was in 1991, trailing behind most other nations. The role that measurements of GDP played in World War II was crucial to the subsequent political acceptance of GDP values as indicators of national development and progress. A crucial role was played here by the US Department of Commerce under Milton Gilbert where ideas from Kuznets were embedded into institutions.
The history of the concept of GDP should be distinguished from the history of changes in ways of estimating it. The value added by firms is relatively easy to calculate from their accounts, but the value added by the public sector, by financial industries, and by intangible asset creation is more complex. These activities are increasingly important in developed economies, and the international conventions governing their estimation and their inclusion or exclusion in GDP regularly change in an attempt to keep up with industrial advances. In the words of one academic economist "The actual number for GDP is therefore the product of a vast patchwork of statistics and a complicated set of processes carried out on the raw data to fit them to the conceptual framework."

Determining gross domestic product (GDP)

GDP can be determined in three ways, all of which should, theoretically, give the same result. They are the production approach, the income approach, or the speculated expenditure approach.
The most direct of the three is the production approach, which sums the outputs of every class of enterprise to arrive at the total. The expenditure approach works on the principle that all of the product must be bought by somebody, therefore the value of the total product must be equal to people's total expenditures in buying things. The income approach works on the principle that the incomes of the productive factors must be equal to the value of their product, and determines GDP by finding the sum of all producers' incomes.

Production approach

Also known as Value Added Approach, it calculates how much value is contributed at each stage of production.
This approach mirrors the OECD definition given above.
  1. Estimate the gross value of domestic output out of the many various economic activities;
  2. Determine the intermediate consumption, i.e., the cost of material, supplies and services used to produce final goods or services.
  3. Deduct intermediate consumption from gross value to obtain the gross value added.
Gross value added = gross value of output – value of intermediate consumption.
Value of output = value of the total sales of goods and services plus value of changes in the inventory.
The sum of the gross value added in the various economic activities is known as "GDP at factor cost".
GDP at factor cost plus indirect taxes less subsidies on products = "GDP at producer price".
For measuring output of domestic product, economic activities are classified into various sectors. After classifying economic activities, the output of each sector is calculated by any of the following two methods:
  1. By multiplying the output of each sector by their respective market price and adding them together
  2. By collecting data on gross sales and inventories from the records of companies and adding them together
The value of output of all sectors is then added to get the gross value of output at factor cost. Subtracting each sector's intermediate consumption from gross output value gives the GVA at factor cost. Adding indirect tax minus subsidies to GVA at factor cost gives the "GVA at producer prices".

Income approach

The second way of estimating GDP is to use "the sum of primary incomes distributed by resident producer units".
If GDP is calculated this way it is sometimes called gross domestic income, or GDP. GDI should provide the same amount as the expenditure method described later. By definition, GDI is equal to GDP. In practice, however, measurement errors will make the two figures slightly off when reported by national statistical agencies.
This method measures GDP by adding incomes that firms pay households for factors of production they hire - wages for labour, interest for capital, rent for land and profits for entrepreneurship.
The US "National Income and Expenditure Accounts" divide incomes into five categories:
  1. Wages, salaries, and supplementary labour income
  2. Corporate profits
  3. Interest and miscellaneous investment income
  4. Farmers' incomes
  5. Income from non-farm unincorporated businesses
These five income components sum to net domestic income at factor cost.
Two adjustments must be made to get GDP:
  1. Indirect taxes minus subsidies are added to get from factor cost to market prices.
  2. Depreciation is added to get from net domestic product to gross domestic product.
Total income can be subdivided according to various schemes, leading to various formulae for GDP measured by the income approach. A common one is:
The sum of COE, GOS and GMI is called total factor income; it is the income of all of the factors of production in society. It measures the value of GDP at factor prices. The difference between basic prices and final prices is the total taxes and subsidies that the government has levied or paid on that production. So adding taxes less subsidies on production and imports converts GDP at factor cost to GDP at final prices.
Total factor income is also sometimes expressed as:

Expenditure approach

The third way to estimate GDP is to calculate the sum of the final uses of goods and services measured in purchasers' prices.
Market goods which are produced are purchased by someone. In the case where a good is produced and unsold, the standard accounting convention is that the producer has bought the good from themselves. Therefore, measuring the total expenditure used to buy things is a way of measuring production. This is known as the expenditure method of calculating GDP.

Components of GDP by expenditure

GDP is the sum of consumption , investment , government spending and net exports .
Here is a description of each GDP component:
Note that C, G, and I are expenditures on final goods and services; expenditures on intermediate goods and services do not count.
According to the U.S. Bureau of Economic Analysis, which is responsible for calculating the national accounts in the United States, "In general, the source data for the expenditures components are considered more reliable than those for the income components ."

GDP and GNI

GDP can be contrasted with gross national product or, as it is now known, gross national income. The difference is that GDP defines its scope according to location, while GNI defines its scope according to ownership. In a global context, world GDP and world GNI are, therefore, equivalent terms.
GDP is product produced within a country's borders; GNI is product produced by enterprises owned by a country's citizens. The two would be the same if all of the productive enterprises in a country were owned by its own citizens, and those citizens did not own productive enterprises in any other countries. In practice, however, foreign ownership makes GDP and GNI non-identical. Production within a country's borders, but by an enterprise owned by somebody outside the country, counts as part of its GDP but not its GNI; on the other hand, production by an enterprise located outside the country, but owned by one of its citizens, counts as part of its GNI but not its GDP.
For example, the GNI of the USA is the value of output produced by American-owned firms, regardless of where the firms are located. Similarly, if a country becomes increasingly in debt, and spends large amounts of income servicing this debt this will be reflected in a decreased GNI but not a decreased GDP. Similarly, if a country sells off its resources to entities outside their country this will also be reflected over time in decreased GNI, but not decreased GDP. This would make the use of GDP more attractive for politicians in countries with increasing national debt and decreasing assets.
Gross national income equals GDP plus income receipts from the rest of the world minus income payments to the rest of the world.
In 1991, the United States switched from using GNP to using GDP as its primary measure of production.
The relationship between United States GDP and GNP is shown in table 1.7.5 of the National Income and Product Accounts.

International standards

The international standard for measuring GDP is contained in the book System of National Accounts, which was prepared by representatives of the International Monetary Fund, European Union, Organisation for Economic Co-operation and Development, United Nations and World Bank. The publication is normally referred to as SNA93 to distinguish it from the previous edition published in 1968
SNA93 provides a set of rules and procedures for the measurement of national accounts. The standards are designed to be flexible, to allow for differences in local statistical needs and conditions.

National measurement

Within each country GDP is normally measured by a national government statistical agency, as private sector organizations normally do not have access to the information required.

Nominal GDP and adjustments to GDP

The raw GDP figure as given by the equations above is called the nominal, historical, or current, GDP. When one compares GDP figures from one year to another, it is desirable to compensate for changes in the value of money – for the effects of inflation or deflation. To make it more meaningful for year-to-year comparisons, it may be multiplied by the ratio between the value of money in the year the GDP was measured and the value of money in a base year.
For example, suppose a country's GDP in 1990 was $100 million and its GDP in 2000 was $300 million. Suppose also that inflation had halved the value of its currency over that period. To meaningfully compare its GDP in 2000 to its GDP in 1990, we could multiply the GDP in 2000 by one-half, to make it relative to 1990 as a base year. The result would be that the GDP in 2000 equals $300 million × one-half = $150 million, in 1990 monetary terms. We would see that the country's GDP had realistically increased 50 percent over that period, not 200 percent, as it might appear from the raw GDP data. The GDP adjusted for changes in money value in this way is called the real, or constant, GDP.
The factor used to convert GDP from current to constant values in this way is called the GDP deflator. Unlike consumer price index, which measures inflation or deflation in the price of household consumer goods, the GDP deflator measures changes in the prices of all domestically produced goods and services in an economy including investment goods and government services, as well as household consumption goods.
Constant-GDP figures allow us to calculate a GDP growth rate, which indicates how much a country's production has increased compared to the previous year.
Another thing that it may be desirable to account for is population growth. If a country's GDP doubled over a certain period, but its population tripled, the increase in GDP may not mean that the standard of living increased for the country's residents; the average person in the country is producing less than they were before. Per-capita GDP is a measure to account for population growth.

Cross-border comparison and purchasing power parity

The level of GDP in countries may be compared by converting their value in national currency according to either the current currency exchange rate, or the purchasing power parity exchange rate.
The ranking of countries may differ significantly based on which method is used.
There is a clear pattern of the purchasing power parity method decreasing the disparity in GDP between high and low income countries, as compared to the current exchange rate method. This finding is called the Penn effect.
For more information, see Measures of national income and output.

Standard of living and GDP: wealth distribution and externalities

GDP per capita is often used as an indicator of living standards.
The major advantage of GDP per capita as an indicator of standard of living is that it is measured frequently, widely, and consistently. It is measured frequently in that most countries provide information on GDP on a quarterly basis, allowing trends to be seen quickly. It is measured widely in that some measure of GDP is available for almost every country in the world, allowing inter-country comparisons. It is measured consistently in that the technical definition of GDP is relatively consistent among countries.
GDP does not include several factors that influence the standard of living. In particular, it fails to account for:
It can be argued that GDP per capita as an indicator standard of living is correlated with these factors, capturing them indirectly. As a result, GDP per capita as a standard of living is a continued usage because most people have a fairly accurate idea of what it is and know it is tough to come up with quantitative measures for such constructs as happiness, quality of life, and well-being.

Limitations and criticisms

Limitations at introduction

, the economist who developed the first comprehensive set of measures of national income, stated in his first report to the US Congress in 1934, in a section titled "Uses and Abuses of National Income Measurements":
The valuable capacity of the human mind to simplify a complex situation in a compact characterization becomes dangerous when not controlled in terms of definitely stated criteria. With quantitative measurements especially, the definiteness of the result suggests, often misleadingly, a precision and simplicity in the outlines of the object measured. Measurements of national income are subject to this type of illusion and resulting abuse, especially since they deal with matters that are the center of conflict of opposing social groups where the effectiveness of an argument is often contingent upon oversimplification.

All these qualifications upon estimates of national income as an index of productivity are just as important when income measurements are interpreted from the point of view of economic welfare. But in the latter case additional difficulties will be suggested to anyone who wants to penetrate below the surface of total figures and market values. Economic welfare cannot be adequately measured unless the personal distribution of income is known. And no income measurement undertakes to estimate the reverse side of income, that is, the intensity and unpleasantness of effort going into the earning of income. The welfare of a nation can, therefore, scarcely be inferred from a measurement of national income as defined above.
In 1962, Kuznets stated:
Distinctions must be kept in mind between quantity and quality of growth, between costs and returns, and between the short and long run. Goals for more growth should specify more growth of what and for what.

Further criticisms

Ever since the development of GDP, multiple observers have pointed out limitations of using GDP as the overarching measure of economic and social progress. For example, many environmentalists argue that GDP is a poor measure of social progress because it does not take into account harm to the environment.
Although a high or rising level of GDP is often associated with increased economic and social progress within a country, a number of scholars have pointed out that this does not necessarily play out in many instances. For example, Jean Drèze and Amartya Sen have pointed out that an increase in GDP or in GDP growth does not necessarily lead to a higher standard of living, particularly in areas such as healthcare and education. Another important area that does not necessarily improve along with GDP is political liberty, which is most notable in China, where GDP growth is strong yet political liberties are heavily restricted.
GDP does not account for the distribution of income among the residents of a country, because GDP is merely an aggregate measure. An economy may be highly developed or growing rapidly, but also contain a wide gap between the rich and the poor in a society. These inequalities often occur on the lines of race, ethnicity, gender, religion, or other minority status within countries. This can lead to misleading characterizations of economic well-being if the income distribution is heavily skewed toward the high end, as the poorer residents will not directly benefit from the overall level of wealth and income generated in their country. Even GDP per capita measures may have the same downside if inequality is high. For example, South Africa during apartheid ranked high in terms of GDP per capita, but the benefits of this immense wealth and income were not shared equally among the country.
GDP does not take into account the value of household and other unpaid work. Some, including Martha Nussbaum, argue that this value should be included in measuring GDP, as household labor is largely a substitute for goods and services that would otherwise be purchased for value. Even under conservative estimates, the value of unpaid labor in Australia has been calculated to be over 50% of the country's GDP. A later study analyzed this value in other countries, with results ranging from a low of about 15% in Canada to high of nearly 70% in the United Kingdom. For the United States, the value was estimated to be between about 20% on the low end to nearly 50% on the high end, depending on the methodology being used. Because many public policies are shaped by GDP calculations and by the related field of national accounts, the non-inclusion of unpaid work in calculating GDP can create distortions in public policy, and some economists have advocated for changes in the way public policies are formed and implemented.
The UK's Natural Capital Committee highlighted the shortcomings of GDP in its advice to the UK Government in 2013, pointing out that GDP "focuses on flows, not stocks. As a result, an economy can run down its assets yet, at the same time, record high levels of GDP growth, until a point is reached where the depleted assets act as a check on future growth". They then went on to say that "it is apparent that the recorded GDP growth rate overstates the sustainable growth rate. Broader measures of wellbeing and wealth are needed for this and there is a danger that short-term decisions based solely on what is currently measured by national accounts may prove to be costly in the long-term".
It has been suggested that countries that have authoritarian governments, such as the People's Republic of China, and Russia, inflate their GDP figures.

Proposals to overcome GDP limitations

In response to these and other limitations of using GDP, alternative approaches have emerged.
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