GDP and its alternatives

Robert Sweeney04/04/2018

Perhaps no other single number or indicator receives as much attention as the total output of an economy. The standard measure for this is gross domestic product, or GDP. GDP, however, is unfit for purpose in Ireland, and increasingly elsewhere. Here we will discuss some of the issues surrounding GDP, and proposals to move beyond it.


There are three ways to measure and conceive of GDP. First, GDP is the market value of final output of goods and services produced within a geographic border (typically a state) and within a certain time frame (typically a year). Second, GDP is the sum of income of all the economic actors within an economy (profits + wages + interest income etc.). Third, GDP is the sum of expenditure on final goods and services (consumption + investment + government spending + net exports). GDP is constructed in such a way that these approaches are equivalent. For instance, what is produced will eventually be bought so that spending and production match (if consumers delay purchases, accumulation of inventories is treated as investment, so that spending and output continue to match).


There are several problems with GDP as a measure of national prosperity, aside from the fact that accumulation of goods and services does not equate to wellbeing. One is that many of things that society produces reflect social ills, not progress. Market prices do not as a rule factor in social costs, but instead reflect the agreed upon price bargained between the buyer and seller. Thus greater military spending may require further domestic security spending as the effects of foreign wars come home to roost. Spending on dirty fossil fuels requires later spending to clean it up. Inefficient allocation begets further allocation, and both contribute to increasing GDP.


Moreover, what is considered productive has significant political and distributional consequences in that it affects the level of GDP and its attribution to various sectors. Much of what is produced does not take place within the market and so is excluded. Domestic household labour, mostly undertaken by women, is a case in point. Its inclusion may add 25 percent or more to GDP. Decomposing the contributions of different sectors to national output is similarly fraught. The financial sector, for instance, was long thought of as non-productive in which transfers of money between parties (with interest charges) were viewed similarly as informal transfers between groups of people. A change to accounting practices in 1993 and also 2008 ‘made finance productive’ so that its contribution to national output increased, and other sectors fell.


In Ireland, GDP is even more problematic given that the presence of foreign multinationals inflates the amount of income/profits produced here, but that does not ultimately accrue to Irish people. This problem has been particularly acute since 2015 as foreign companies relocate their intellectual property (IP) to Ireland, so that sales based on that IP boost the income/profits of multinationals, and hence GDP. The next best measure is typically gross national income, GNI (GNI is equivalent to GNP, though measured differently). GNI measures income accruing to Irish nationals wherever located, as opposed to income accruing to those located within the geographic borders of Ireland. GNI, however, is similarly contaminated as companies have redomicled here for tax purposes, effectively becoming Irish companies, though without the benefits to the local economy.  


The upshot is that this along with other distortions render traditional measures of economic activity increasingly detached from the real economy. Since 2017, the CSO has been publishing a modified measure of GNI, GNI*, which attempts to remove such distortions. While this is a big improvement, it retains the weaknesses inherent in conventional measures of national income. It is also questionable to what extent multinational distortions have been fully purged from the data, as the most recent ESRI quarterly discusses.


An alternative to GDP is the so-called genuine progress indicator (GPI), which is to be produced by the CSO going forward. GPI takes personal consumption weighted by income distribution as a starting point. It adds the purchase of durable goods, investment, but also the value of housework, voluntary work, and other ‘goods’. Unlike conventional measures, environmental clean-up, natural resource depletion, the cost of crime, and other ‘bads’ are subtracted. In so doing, it purports to create a more realistic measure of economic well-being. By including desirables and removing undesirables, I think it achieves that.


GPI is not without its detractors. Countries that do measure it do not do so in a standardised way. Thus, the precise form GPI takes varies from country to country. This introduces an element of subjectivity as to what constitutes welfare and precludes meaningful comparisons across countries. Subjective valuations of wellbeing are, however, also embedded in GDP and GNI (and cross-country comparisons are, as noted, becoming increasingly difficult). But an increase in GPI is almost certainly more likely to result in greater wellbeing than a commensurate increase in GDP or GNI.


Conventional measures are not going anywhere, not least because statistical offices are required to measure them. Many other measures are derived from them (e.g. public debt to GDP), which then form the basis to evaluate economic health or assess whether a country is fulfilling its international obligations. As a measure of national wellbeing, though, they have always been and are increasingly flawed. And it’s time to move beyond them.



Posted in: EnvironmentWelfare

Tagged with: growthinequalitysustainability

Robert Sweeney     @sweeneyr82

Sweeney, Robert

Robert Sweeney is a policy analyst at TASC and focuses on issues surrounding Irish political economy and distribution. He has a PhD in economics from University of Leeds, which concentrated on financial markets and investors, banking, international macroeconomics, and housing. He is also interested in debates on alternative schools and methodology in economics, and ownership.



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