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GDP: Grossly Deficient Paradigm?

Presidio Economics | Thursday October 13th, 2011 | 2 Comments


3p is proud to partner with the Presidio Graduate School’s Macroeconomics course on a blogging series about “the economics of sustainability.” This post is part of that series. To follow along, please click here.

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By: Wanda Lowrey
Gross Domestic Product (GDP) is a national accounting measure based on the market value of all final goods and services produced within a geographical entity within a given time period. It is often expressed as a comparison to the previous quarter or year. Significant changes in GDP sometimes have important effects on the stock market. Policy makers often use it as the gauge of our economic health and as an indicator of our national economic wellbeing.

But is this the case? According to a recent release from the U.S. Department of Commerce’s Bureau of Economic Analysis, real GDP increased at an annual rate of 1.3% in the second quarter of 2011. Does this mean that our overall economic health and our national economic wellbeing increased by 1.3% during the same time period?

Consider the limitations of the GDP measurement:

  • Non-market transactions are not counted. GDP doesn’t account for nature’s goods and services, or for transactions in informal and underground economies. The estimated value of ecosystem services—such as water and air purification, crop pollination, and nutrient dispersal and cycling—range from about 100% to 300% of GDP. These services are not included in the GDP calculation. Meanwhile, in our households, families, and communities, GDP fails to measure the contribution of transactions such as housework, child and elder care, and other forms of volunteer labor that improve our social welfare.
  • Benefits (revenue) and costs (expenses) are not separated. GDP measures the market value of goods and services, regardless of the effect of those goods and services on our communities’ environmental and social health. Consequently, costs that reflect a decrease in the overall standard of living—such as the costs to clean up an oil spill or a meltdown at a nuclear plant—increase GDP and are perceived as benefits.
  • Environmental and social losses are not counted. GDP is “gross” because the depreciation of environmental and social capital used to produce goods and services is not deducted from the total value of GDP. Ecosystem services—such as storm and flood protection—lost to development and other human activities are not counted. Neither is the deterioration in human health due to runoff from industrial farms.
  • Environmental and social investments are poorly counted. GDP fails to measure the investment value of resource maintenance activities such as environmental restoration, education, and health care, and because GDP measures only input prices, it also fails to measure the impact of government and non-profit services. Regular car maintenance has far more value than the cost of regular servicing; for many, it provides the mobility necessary to be competitive in the labor market. Similarly, the value of investing in the well-being of our ecosystems and in the physical and mental health of our citizens helps to keep our country competitive and to avoid problems such as brain drain.

Columbia University professor and Nobel Prize winner Joseph Stiglitz warns,

“GDP statistics [can] be very misleading. They do not really measure how well the country is doing or how much better off its citizens are becoming. No one would look at just a firm’s revenues to assess how well it was doing. Far more relevant is the balance sheet, which shows assets and liabilities. That is also true for a country.”

What’s the takeaway? Consume economic news intelligently. As an investor, be aware that movements in GDP can impact stock prices. As a business person, be aware of the risks associated with unreported losses in natural capital and ecosystem services and with decreases in overall economic wellbeing that are disguised as gains in GDP.

Measuring economic activity is difficult, and what GDP measures is important, but it is unwise to measure our economic competitiveness only by the value of transactions in the formal market, while ignoring underlying issues that have the potential to undermine our economy. If our goal is to make decisions that result in sustainable, increased human wellbeing, then we need to be aware of the limitations of our tools.

Wanda Lowrey is an MBA candidate at Presidio Graduate School. Her professional interests include sustainability reporting, energy efficiency, and green building. She can be reached at wanda.lowrey@presidiomba.org.

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  • http://www.greeneconomycoalition.org/ Green Economy Coalition

    Interesting piece. The member organisations from the Green Economy Coalition believe the way we measure economic growth clearly mirrors the deficiencies in the economic paradigm itself. One of the priorities for change that we forsee is closely related to measurement and accountability systems. We are open for contributions on our policy document for Rio+20. http://www.greeneconomycoalition.org/document/green-economy-coalition-and-road-rio-2012

  • Jonathan Mariano

    I suggest that we do away and abolish GDP. Wanda pointed out many of it’s flaws. It surprising we still use such a measurement to gauge economic viability.