All Financial Wisdom

How Should GDP Be Measured in the New Economy?

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Today, our economic leaders focus most of their efforts on enhancing GDP growth. This is a globally accepted measure to evaluate the progress and performance of a country, and therefore constitutes the yardstick by which the economic policy of each government will be judged. The problem is that the policy of using GDP growth as the main economic indicator is becoming increasingly imperfect, and thus it inevitably leads it to be increasingly distant from what it aims to measure.

In today’s article, we will analyze why GDP can often be the wrong leading indicator. And we will also analyze what other alternatives exist.

A shared concern

The Economist published an interesting article that lead me to think about this topic for a several days.

The world is changing at an increasingly rapid pace, and in every socioeconomic system, we must bear in mind that the survival of the system depends mainly on its ability to adapt. However it is very human to want to relay on policies and measures that worked in the past. The problem is that does not mean any guarantee that they will continue to work in the future. Different situations obviously require different measures and policies.

The success of some policies in the past does not ensure the success of those same policies in the future

“Past returns are not indicative of future performance.” We could apply this common maxim in finance to the economy in general. Politicians and economists who opt for outdated recipes in order to curry favor with voters  are part of a system that is simply leading us to a dead end.

Let’s start with some context. GDP was a better indicator decades ago, when many economies had an agricultural or industrial character, in which the price was more or less a reliable synonym of higher quality. Thus, an increase in GDP implied an increase in the quality of products produced and purchased by citizens, at a time when the improvement of the quality of life of households also involved the purchase of a washing machine, a television or a car. At the time, all this involved economic and social progress that was accompanied by GDP growth.

But the progressive technification of products and the mechanization of the field has cheapened costs, causing the prices of many products to trickle downward…ahem…Amazon. In parallel, over the years, the most developed economies have been turning towards a tertiary sector or services in which quality or improvement of living conditions no longer has much to do with higher prices and higher GDP, since consumers prioritize the experience of the purchase over the quantity of products purchased.

Technology and the Internet are big GDP deflators

Technology and the Internet are the most powerful deflation tools ever invented by humanity. I do not need to cite the innumerable services that have left the physical world and have moved to a virtual world, making them instantly accessible and free to many. Whole sectors that formerly contributed to GDP no longer do.

For example, we can talk about the collaborative economy, free software or free applications for smartphones. All of them provide services that are often essential, but that do not contribute to GDP; Moreover, the issue is that they even take out of the GDP activities that did contribute to their growth until now. However, all these technifications of our day to day have significantly improved our quality of life in recent years.

Again, in the post WW II world, GDP was a more or less reliable indicator of improvement of quality of life from a purely materialistic point of view, with all that that entails. Nowadays, we can no longer say that. But let’s move on to consider what GDP really is. Are we talking about driving all the efforts of our socioeconomy to achieve uninterrupted growth? Simply producing more should be the endgame, right? Is that what we aspire to achieve as a society? And now the key question: Is that going to provide us with greater well-being and make us happier?

It may be that at this point you agree with me that it is not about having more, but about having better, and especially about having happiness. We can say that happiness is the eternal search that each person does throughout his life. We all want to be happy. Some seek happiness in acquiring material things, others in traveling, some in their social and family relationships. The question is no longer about wrong and right. It may be that everyone is right – each in his/her own way. The issue that should concern us in our socioeconomic analysis is that happiness and well-being suppose a tremendously heterogeneous and hardly measurable concept.

But this heterogeneity is not limited to personal differences. The great problem of measuring socioeconomic progress is that, as with GDP, a comparison with the environment and with other countries is often required. Therefore, the issue of how to measure well-being and happiness has an international dimension. With this new wrinkle, things get complicated, since now we also need the international consensus of each country on how to measure the happiness of its citizens, something much more subjective and that lends itself to disagreement more than a simple measurement of GDP.

Will all countries be able to agree on how to measure this new and subjective variable? As if this were not enough, cultural differences also come into play here: Is a German happy for the same reasons as an American or a New Zealander? Would not the answer change even for yourself if you were asked the same question on a Monday at eight in the morning vs a Friday at six in the evening?

Stay tuned for part 2 tomorrow where we’ll further delve into the new definition of GDP…

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