Why ‘NOT’ To Trust GDP

Let’s start by understanding what GDP really is; Gross Domestic Product (or GDP) is the value of all final goods and services produced in a country, in a particular year. So, the money we spent on all the things in a year, adds to the GDP of that year. The most basic way to calculate it is what economists call the expenditure method. Its formula is:

GDP = C + G + I + (X – M)

Here, C stands for consumption, G for government spending, I for investment, and X – M is net exports or exports minus imports. But, over the years GDP, as a measure, has become increasingly flawed. Some flaws are rooted right in its origin, and some have developed over the years. To start, let us look at some of them in the above formula.

Import – The Evil (or is it?)

Imagine a country whose imports are equal to its exports. How much will that add to their GDP? ZERO. After all the manufacturing that happens in the country, after all the efforts each labour put while doing the same tedious work every day, the output comes out to be zero. Yes, that’s because imports are taken as negative in the GDP (look at net exports in the formula). But, are imports really bad for an economy? Tim Harford, in his article, A trade deficit with a babysitter gives an example of the babysitter “Sally” his wife has employed for Ms. Harford. He gives her salary every month, but gets no money in return. If “pub pundits” were to judge this trade, then they would definitely advise to stop it immediately, considering the huge trade deficit. Certainly, this is all wrong. Sally gets to earn, Mrs. Harford gets the freedom and liberty to devote more time in her interests, and little Harford seems to enjoy as well. Hence, it is a fair trade. Amit Varma, a writer and podcaster, calls this zero – sum fallacy. Every trade, be it import or export, “leaves both sides better off”. This is why it is made in the first place. When consumers benefit from cheap imports, they spend more, thus adding to the economy.

The Controversy over Government Spending

Government spending has been a matter of debate right from the starting. Simon Kuznets, who is considered as the father of GDP, was reluctant to add it in calculating GDP, but economists like John Maynard Keynes were against this. It was ultimately included. Yet, now a government just has to give a boost to its expenditure, even if unproductively, in order to meet its targeted GDP growth rate. This is precisely what has happened in India in the recent times.

Source- https://www.theglobaleconomy.com/

The graph clearly shows how the government boosted its expenditure when Demonetisation and GST shook India’s economy.

The Revised Method

In 2015, Central Statistical Office announced a revised method of calculating the GDP. It has been a controversy among the intellectuals ever since. Without getting into the complexity of the details, Vivek Kaul, author and an economic commentator, did an easy test. According to the new method, the average GDP growth rate between 2004-05 and 2011-12, and growth rate between 2011-12 and 2017-18 were almost similar (6.89% and 6.87% respectively). So, kaul decides to compare some “real economic indicators” between the same periods. What he found was something like this:

Source – https://www.firstpost.com/business/gdp-back-series-data-new-numbers-do-not-pass-the-basic-smell-test-mess-of-the-past-has-just-got-worsened-5640271.html

And the new method could not pass the test. Data manipulation is not a new thing in India. As Ruchir Sharma wrote in his book The Ten Rules of Successful Nations, “…former central bank governor Y. V. Reddy once cracked to me that while the future is always uncertain, in India even the past is uncertain.”

A Common Measure for All

It is a small but a very important point. Every country is different. Their geography, politics, population are all different. Hence, a single measure cannot compare every nation. This is why something like a Human Development Index, which has a mix of goals, is used. Also, there are a lot of things that the GDP can’t measure, such as happiness, political freedom, liberty, dignity of citizens or sustainable development.

The Obsession

The last and most important point; GDP has become an obsession. People have a very short memory. Certain “groups” on social media will always point out the first ever Indian economic contraction in over four decades, while other “groups” will point out how India became the fifth largest economy of the world by overtaking Britain in 2019. Both of them are wrong. The contraction was because of a stringent lockdown (although we were already in a severe slowdown). Whereas, Britain is only around 5% of India’s population, so there are only 5 people in Britain as compared to 100 in India which make their economy equal to India’s.

As Tim Harford wrote in his book How to Make the World Add Up, “When a measure becomes a target, it ceases to be a good measure.” Same has happened with the concept of GDP. We look at it to fulfill our biases.

To conclude, GDP is a concept which was much needed at the time of its creation. Absence of something like this led to Germans facing hyperinflation; taking cartons of money to buy a loaf of bread. But, it’s time to look at something like HDI or “real economic indicators” in today’s time. It’s time to move on.

The key question is ‘When does the Good become Evil?

Amish Tripathi, The Oath of the Vayuputras

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