Gross Domestic Product (GDP) – Not Fit for Purpose

The Gross Domestic Product (GDP) is the value of all goods and services produced within a country as estimated, for example, for a year or a quarter adjusted for inflation or deflation, or calculated by using current market prices. The first calculation of estimates of the total output of a country dates back to the 1930s.

EU member states follow the rules and procedures laid out in ESA 2010 (European System of Accounts) for estimating GDP. ESA 2010 is broadly consistent with the System of National Accounts of the United Nations (SNA 2008). Within each country GDP is usually measured by a national government statistical agency.

Image of chart showing Malta Government revenues, expenditure, debt and GDP for the years 2011 to 2015 Chart showing Malta Government revenues, expenditure, debt and GDP for the years 2011 to 2015

 

The data used to estimate the components of Gross Domestic Product is largely gathered from surveys sent to businesses around the country and from Government accounting sources. Not all data comes in punctually and for this reason Gross Domestic Product numbers are subject to regular and sometimes material revisions, with preliminary estimates being released and subsequently revised as more information is obtained. The GDP number for the same period does therefore change over time.

It is important to understand that GDP is in fact not measured but, by far and large, estimated. Change the assumptions or recalibrate the model used and everything changes. Albeit used by Governments to justify their actions in relation to the economy, we must appreciate that it is just an estimate and only as good as the formulas and models that are used.

The success of Governments is measured by the success of the economy, and the economy is considered successful if the GDP is growing. You may see how Governments are therefore highly motivated to produce, by any means, GDP numbers that are larger than the previous quarter or the previous year. This belief in a forever growing Gross Domestic Product is untenable as nothing grows forever.

Thousands of economists use Gross Domestic Product in their research. Governments use ‘Debt to GDP’ ratios in order to measure and justify Government debt; ‘GDP % growth or % recession’ to compare economic performance in relation to the past or to other countries; ‘GDP per Capita’ adjusted for Purchasing Power Parity to assess relative wealth; ‘Tax to Gross Domestic Product’ ratio to shape policy or determine how much public spending is affordable. Its use is indeed widespread and its effects far reaching.

I would argue that GDP estimates are not only widely used but also widely abused.

How is it possible for Government Debt to grow year on year beyond levels that can ever be repaid and that this is considered acceptable? The fact is that we are deceived by percentages. Percentages are a relative measure. If Government Debt is measured as a percentage of a GDP, that is itself growing at the same or a higher rate than the Debt, then the ‘Debt to Gross Domestic Product ratio will remain constant or even go down giving us the illusion of a Government debt that is not really growing or that is even getting smaller. Contrary to such a popular perception the Maltese Government Debt is in fact growing bigger with every year that passes. In view of the country’s high debt levels a sudden and substantial drop in GDP would be disastrous for our economy.

Governments are also in the habit of guaranteeing 3rd party debt with our future tax monies. At the end of 2015 the total value of 3rd party debt guaranteed by the Maltese Government amounted to Eur1.4bn or 16% of GDP. Do the maths. Add that guaranteed debt to the Government Debt and see what it does to the Debt to GDP ratio of our country.

The EU rules in ESA 2010 stated that by September 2014 every EU member state had to include undeclared or illegal prostitution and illegal drugs in their national accounts and in their GDP estimates. By definition these activities are not declared and so Governments need to annually come up with more, truly nonsensical, estimates. I do not think that this point requires further comment.

Countries may also find themselves to be unduly punished by GDP estimates (that may later change). A fall in GDP numbers over two quarters is considered a recession. If a country is publicly considered to be in recession, this affects the country’s credit ratings and can have serious economic and political repercussions.

Economic (GDP) growth is considered to be synonymous with progress. Progress as estimated by Gross Domestic Product does not tell the whole story. It does not take into account quality of life; it dismisses outright environmental degradation and loss of species and habitats; it ignores human values; it sacrifices stability and sustainability and gambles on the future; it promotes the delusion of the benefits of globalisation and conveniently forgets that the only jobs that matter are local.

Gross Domestic Product estimates have some value as one element in an array of economic indicators. In my opinion, however, GDP does not deserve the status of statistical royalty. I suspect that its revered status has more to do with the flexibility it affords to produce desired results. We should be on our guard and we should be critical of any Government argument that uses GDP, or one of its many derivatives, to justify actions that would otherwise not make sense.

I believe that the GDP estimates we hold so dear are not fit for purpose. Our goal should not be economic growth by any means. The economy may grow or otherwise but that is not the point. Rather than pursuing the unattainable goal of a forever increasing output, we would be well advised to differentiate our country by having a sustainable economy that upholds human values within the context of accountability towards future generations and a respect for the environment. Rather than allowing Government to control over-sized budgets that are open to abuse and go beyond all rational justification, what we do need is to lower taxes thereby providing Government with smaller budgets. Such an economy would have deep roots and would be able to weather the economic storms and the winds of change that surround us.

This approach would go a long way towards improving the reputation of our country internationally. It would also attract towards our shores the right type of international business and foreign direct investment.

Article published in the Sunday Times of Malta, 29th January 2017

Sources: The Economist; Eurostat; NSO; OECD; World Bank; IMF