GDP - Gross Domestic Product - Essay Example

Full topic and Section # of What is GDP? Does GDP correctly describe your personal economic well being? Does it adequately explain the overall economic well being of your country? GDP or Gross Domestic Product gives the net value of the all the all the goods and services that are made by a region or a country in a certain year of twelve months. The methods of calculating GDP differ from country to country but the general formula is as follows: GDP = C + I + G + E – IM GDP provides is the addition of expenditure, invested money, government expenditure and the net exports of a country in a given year as shown above. It must be noted that GDP does not stand for the goods and services produced by the home country in foreign countries but only those produced domestically within the home countries own geographic boundaries. Nominal GDP is the GDP according to current year prices while real GDP accounts for the effect of inflation on prices and is therefore also known as inflation adjusted GDP. By the use of a base year and elimination of effects due to price changes, real GDP allows useful comparisons to be made regarding the production of goods and services in an economy. For instance if the economy were growing at the rate of 4% per year while the rate of inflation was 1% then only 3% of the growth would be due to an increase in the economic output while 1% would be only due to price changes. GDP per capita describes the average number of goods and services consumed per person in a country. The significance of GDP as an instrument for channeling of aid and investments into countries is highlighted by Canoy and Lerais in the research titled ‘Beyond GDP’ that was composed for the European Commission in which they say: ‘GDP is the best-recognized measure of economic performance in the world, often used as a generic indicator of well-being. GDP is used in a large variety of political and financial arenas. It serves as a criterion to decide who has access to funds at international organizations such as the EU, UN, IMF and World Bank, GDP plays an important part in the Stability and Growth Pact, and it is a lead indicator for forecasts of financial markets and banks, to mention just a few examples. It is also used for international comparison and rankings and plays a crucial role in political debates.’ (Canoy and Lerais, 2007) The GDP of any given country fails to adequately explain its overall economic well being since its calculation either excludes or overstates a number of crucial aspects that describe the standard of living of a population. Usage of GDP for measuring the individual economic wealth: The notion of ‘well being’ has been described as a multidimensional concept ‘with both an individual interpretation in the Aristotelian spirit and a collective one to capture the progress of a nation’ (Canoy and Lerais, 2007). Although GDP per capita i.e. goods and services consumed by the average person measures the spending by an individual yet it does not accurately depict an individuals’ well being. Materialistic expenditure is not all that characterizes individual well being. Rather it is a much more comprehensive idea including psychological well being as well as happiness derived from non material sources. An individual’s health, diet, achievements, mobility and participation in society are all essential sources of contentment that are not included in calculation of GDP. Also, in the tradeoff between time spent with family or at work, the former would figure as income lost and therefore would mean a lower GDP per capita even though the satisfaction derived from it for an individual may be greater than that from extra work. GDP also excludes the differences between individuals that make the notion of any single definition of well being impossible. Furthermore Sens’ Capabilities approach that asks us to differentiate between individuals according to their freedoms and real opportunities introduces further complexity in the calculation of well being as it asks us to for instance make a distinction between the well being of an individual who is starving and another who fasts by choice (Canoy and Lerais, 2007). How GDP is understated? GDP also doesn’t include the goods and services produced outside of the official formal sector of the economy. This informal sector constitutes a significant portion of total goods and services consumed by an individual. It includes domestic work which cannot be measured since there is no price attached to it. Voluntary work can also not be assigned a figure and societies in which volunteering is a widespread practice, there would be a significant rise in GDP if the same work was to be done by the formal sector. Self employed individuals tend to avoid income regulation authorities in order to evade taxes and therefore their incomes also go unrecorded. Services provided by the public sector such as administration, free roads and parks also do not appear in the GDP and therefore understate it. GDP fails to take into account underground economies which include profits made from smuggling illegal commodities which are expected to be an especially large percentage of the GDPs of both developing and developed economies. The American hidden economy for instance is estimated to be around 9% of its real economy, while that of Greece and Italy is 29% and 27% respectively (Jim McTague, 2005). How GDP is overstated? Reconstruction that takes place after production and destruction has already taken place tends to overstate GDP without increasing the standard of living in a place. An example would be the reorganization of residential space taking place in many of the urban centers around the world after the destruction of already established well functioning buildings. Excessive exploitation of human and natural resources would mean that there are significant negative effects on the standard of living and a lot of environmental degradation that is not being accounted for. South Korea and Taiwan are two of the East Asian economies that went through more than a decade of constant growth in GDP. But its limited influence on raising the well being of the people is now being proven by the massive labor unrests taking place in South Korea for a more equitable redistribution of incomes and in Taiwan for an end to exploitation of the country’s natural resources. The sudden diversion of large amounts of capital into these East Asian economies in the 80’s and the 90’s has led to destabilizing influences on their societies and their environments that have negatively impacted their standards of living. Another factor that is not accounted for by the GDP is the influence of consumption on the collective health of the nation over a period of time. Obesity has been on the rise in the developed countries. Health problems that result from excessive consumption of junk foods such as diabetes and heart attacks have been on the rise particularly in USA. This collective decline in the welfare of societies although with severe repercussions for growing societies is not being included in the calculation of GDPs. In addition the nature of the spending is also not taken into account. A country may be spending a significant amount on the upkeep and maintenance of its defense sector and military budget. But this would not translate into an increase in the standards of living of the Pakistani population. The usefulness of GDP is a measure of comparison of well being of countries is also limited by the fact that the products being consumed and their relative importance would not be same across countries. Even if the same basket of goods was to be used in the comparison of standards of living between countries it would still not be a fair method since the structure of spending of the economies would differ. Factors such as lower crime rates, lower divorce rates, a more educated population and a cleaner and more eco-friendly environment that add to the standard of living in a country would not be included in its comparison with another country that lacks these characteristics but has a with GDP. Therefore countries carrying out more sustainable development would figure as having a lower standard of living if GDP is to be used as a measure of well being when actually the opposite would true. Its effectiveness as a measure of drawing qualitative comparisons between well being of countries has been much disputed. It can therefore be safely concluded that the widespread use of GDP across nations and international institutes derives less from its use as a measure of well being than due to a lack of alternatives that do so. In fact over the last decade a variety of other measures for the measurement of ‘well being’ have been created to counter the shortcomings of GDP such as (Human Development Index (HDI) which incorporate factors such as health and access to knowledge in their calculation. Countries such as USA that have traditionally topped GDP rankings ranked quite low in the recent HDI rankings conducted by UNDP (David Jolly, 2009) References: Beyond GDP, Overview paper for the Beyond GDP conference, Bureau of European Policy Advisers (BEPA), European Commission by Marcel Canoy and Frederic Lerais, 06/11/2007 [Accessed 19 April 2010] Going Underground: Americas Shadow Economy, Jim Mctague, Barons, Thursday, January 06, 2005 [Accessed 19 April 2010] G.D.P. Seen as Inadequate Measure of Economic Health, David Jolly, September 14, 2009 [Accessed 19 April 2010] Read More