Albert Einstein once said, “Not everything that can be counted counts, and not everything that counts can be counted.” Einstein’s wisdom resonates even in the realm of economics, aligning with the modern world and highlighting that GDP as a metric for economic growth often overlooks important aspects. This can lead to negative consequences for the economy in the long run.
In the pursuit of understanding economic growth, we often turn to the gross domestic product (GDP). Its numerical precision seems reassuring, but beneath those figures lies a more nuanced reality.
“While GDP is widely used and recognised, it is not always a good, comprehensive measure of economic growth.”
Gross domestic product (GDP) is a figure representing the total value of all goods and services produced over a specific time period within a country. While GDP is widely used and recognised, it is not always a good, comprehensive measure of economic growth.
This article explores why GDP falls short of capturing the full picture of a nation’s economic health, supported by relevant data and case studies.
GDP and Income Inequality
Economists argue that one of the main criticisms of GDP is its inability to reflect income inequality within a country. GDP measures the total economic output but does not indicate how wealth is distributed among the population.
According to the New York Times, income inequality has serious consequences for societies. When the gap between rich and poor widens, wealthy individuals can wield too much power, creating a society where money equals control, sidelining the government’s role.
This inequality also leads to political instability, making it harder for societies to stay united and function smoothly.
A country can have a high GDP while simultaneously experiencing significant income inequality, where the benefits of economic growth are not shared equally. 24/7 Wall Street analysed data involving 42 countries from the OECD to identify those with the widest gaps between the rich and the poor.
Unfortunately, nations on all six populated continents have massive wealth gaps between their richest and poorest residents. Many of the most economically productive countries in the world have not been able to devise a way to stop, or even slow, the growing inequality.
Income inequality across a population is quantified using the Gini coefficient measure. On the Gini scale, inequality is measured from 0 to 1, where 0 represents a perfectly equal society and 1 represents extreme inequality, where a single individual controls all the wealth.
The top 15 countries include Latvia, New Zealand, the United Kingdom, South Korea, Russia, Lithuania, the United States, Turkey, Chile, Mexico, Brazil, Costa Rica, India, China, and South Africa.
Despite most of these countries having a growing GDP and GDP per capita above the global average as of 2022, the GDP per capita for OECD member countries stands at $43,476, marking a 1.74 percent increase from the previous year.
In comparison, the global average GDP per capita is approximately $12,688. However, the widening gap between the rich and poor remains a sobering reality.
More so, For instance, Nigeria’s GDP of $253 billion, according to the International Monetary Fund (IMF), is almost four times bigger than Ghana’s over $70 billion. But the West African nation boasts $2,203 as per capita income, more than Nigeria’s $2,162.
Ranked as the as the fourth-largest economy in Africa by the IMF, 87 million Nigerians live below the poverty threshold, the largest poor population after India. This disparity illustrates that GDP growth does not necessarily translate to economic well-being for all citizens.
Environmental impact and sustainability
An environmentalist once pointed out that GDP fails to account for environmental degradation and sustainability, reflecting the Environmental Kuznets Curve (EKC). Thus, economic activities that boost GDP may harm the environment, leading to long-term negative consequences not captured by GDP figures.
For example, activities like deforestation, pollution, and carbon emissions can contribute to GDP growth but have adverse effects on the environment and public health. Climate change is a stark illustration of this, disrupting the global economy. According to ScienceDaily.com, climate change has led to a 21 percent decline in global farming productivity compared to its potential without these environmental shifts, equivalent to forfeiting seven years of productivity gains since the 1960s.
Specific effects include reduced crop yields due to rising temperatures and CO2 changes, heat stress in dairy cows impacting milk production, soil erosion worsened by heavy rainfall, and prolonged droughts in regions like the U.S. Southwest.
These events severely limit water resources and crop growth, as reported by the Environmental Protection Agency (EPA).
The China case further highlights this issue. China’s rapid economic growth over the past few decades has significantly increased its GDP. However, this growth has come at a high environmental cost.
The country has experienced severe air pollution, water contamination, and deforestation, leading to health problems and a decreased quality of life for its citizens.
The World Health Organisation reported that air pollution in China is linked to over a million premature deaths each year. Despite impressive GDP figures, the environmental damage and health costs highlight the shortcomings of GDP as a comprehensive measure of economic progress.
Quality of life and well-being
In furtherance, GDP does not measure the overall well-being or quality of life of a population. Factors like health, education, work-life balance, and personal safety are crucial for assessing a society’s true progress but are not included in GDP calculations.
One notable alternative to GDP is Bhutan’s Gross National Happiness (GNH). In 1972, Bhutan’s Fourth King, Jigme Singye Wangchuck, introduced GNH as the guiding philosophy for the country’s development. GNH prioritises economic, social, and environmental well-being, emphasising sustainable development and the happiness of citizens.
Bhutan’s focus on GNH has led to policies that promote education, healthcare, and environmental conservation, resulting in a high quality of life.
Although Bhutan’s GDP is relatively low, its citizens report high levels of happiness and well-being, showing that GDP alone does not capture the full spectrum of economic growth.
Non-market activities
Another limitation of GDP is that it excludes non-market activities such as household labour, volunteer work, and informal economy transactions. These activities significantly contribute to well-being and economic stability but are not reflected in GDP figures.
In many developing countries, a substantial portion of economic activity occurs in the informal sector. For example, in India, the informal sector accounts for about 85 percent of total employment and over 80 percent in Nigeria, according to the International Labour Organisation and World Bank.
This includes small-scale farming, street vending, and household services, which are essential for the livelihoods of millions of people. The exclusion of these activities from GDP calculations means that the economic contributions of a large segment of the population are overlooked, leading to an incomplete picture of economic growth.
Underground economy
The underground economy, which includes unreported or illegal economic activities, is another aspect not captured by GDP. This can lead to an underestimation of the actual economic activity within a country. The size of the underground economy varies widely across countries, with some estimates suggesting it accounts for as much as 20 percent of global GDP.
According to a report by Stavros Katsios from Ionian University, published in the South-Eastern Europe Journal of Economics, in Greece, the underground economy is estimated to be around 20–25 percent of the official GDP. This includes activities such as tax evasion, unregistered businesses, and informal employment.
The presence of a significant underground economy means that official GDP figures do not fully reflect the true economic activity and health of the country.
Beyond GDP: Alternative Measures
While GDP has long been the go-to metric for measuring economic growth, it is far from a comprehensive indicator. It fails to capture income inequality, environmental degradation, quality of life, non-market activities, and the underground economy.
These limitations highlight the need for alternative metrics that can provide a more holistic view of a nation’s progress and well-being.
As illustrated by Bhutan’s emphasis on Gross National Happiness and the detrimental environmental impact of GDP-focused growth in China, it is clear that relying solely on GDP can lead to policies that overlook crucial aspects of societal welfare.
By incorporating measures like the Human Development Index (HDI) and the Genuine Progress Indicator (GPI), policymakers can gain a more nuanced understanding of economic health and craft policies that promote sustainable and inclusive growth.
Ultimately, moving beyond GDP to embrace a broader set of indicators will better reflect the complexities of modern economies and the true progress of societies. This shift is essential for addressing the challenges of the 21st century and ensuring a more equitable and sustainable future for all.