Economics for Non Economists – Explaining GDP and Economic Growth

By Girish Menon

You may have recently come across articles like:      

At 13%, Economist Intelligence Unit Pegs India’s Growth In 2021 Higher Than IMF     

Western economies recovering faster than expected from Covid, says IMF     

UK GDP rose 0.4% in February   

China’s economy grows 18.3% in post-Covid comeback

What does this mean?

Just like the Forbes magazine compiles an annual list of the richest individuals on the planet, most countries participate in an annual “show of wealth”. The most commonly used measure in this competition is called GDP or Gross Domestic Product. At the end of 2019, the top six countries according to this measure were:

Source: Worldometers

What do these terms mean?

Simply defined, GDP is the money value of all goods and services (goods) produced within an economy in a period of time. In the above table, the GDP is estimated over the year of 2019.

Economic growth is a measure of the additional goods produced by an economy over the last period of time  (say a year or a quarter). Per Capita GDP means the value of goods each resident would get if all goods produced in an economy is shared equally. This is calculated by dividing the GDP with the residents of the country.

Share of World GDP means the share of global goods produced by an economy. This is calculated by dividing each country’s GDP with the whole world’s total GDP.

Why is GDP and the rate of economic growth so important?

Materialism is the underlying principle of using GDP and economic growth as the most important indicator of economic performance. Materialism, according to the Cambridge English Dictionary, is the belief that having money and possessions is the most important thing in life. It follows that as one’s material goods increases one’s standard of living (happiness) tends to increase.

GDP is a tool that measures the volume of material goods produced by an economy. A high rate of economic growth demonstrates the rate at which the material goods in an economy is increasing and theoretically, the happiness of the residents as well. So, when the rate of economic growth becomes negative, as in the data mentioned in the introduction, it supposedly follows that your happiness will decrease.

Are GDP and GNP the same?

They are similar but not the same. GDP measures the volume of goods produced by people living within the boundaries of an economy. If you take UK’s GDP for example, the output of Nissan’s Sunderland plant will be included in the measure. In other words, the output of Britons and foreign nationals living in the UK will be added to calculate UK’s GDP.
GNP stands for Gross National Product. It is a measure of the volume of goods produced by British nationals living in the UK AND outside. It will exclude the output of foreign nationals (say Nissan Sunderland) operating within the British economy.

Is GDP an accurate measure of the volume of goods produced within an economy?

The answer is No. The calculation is arduous and with questionable assumptions which I will not go into here. I will however mention some weaknesses here:

1. Even though there are some standardised procedures for its computation, governments are known to deliberately intervene in its methodology and calculation.

2.   Not all goods are included. For example, if you clean your own house and look after your family – these services are not included. However, if you employ a cleaner, a cook, a nanny and a driver then their services are included.

3.   In some countries where there is a large informal economy, the goods produced by such activities are not included in GDP computations.

Does an increase in GDP necessarily improve residents’ happiness?

In economics, happiness is better known as welfare. If there is an earthquake in your country and many roads, buildings, bridges and stadia are destroyed, then rebuilding them will increase the national GDP but does that mean it improved the citizens’ welfare?

As a resultant of economic growth the quality of air you breathe has gone down and the water supply is polluted. Has this improved your standard of living?

Due to increased standard of living, everybody has a car and you are now required to spend one hour extra in commuting time. Has this resulted in improved happiness?

What is the prognosis for GDP and economic growth?

Due to Covid-19, the GDP of most nations became lower in 2020 from 2019. These economies faced negative economic growth which means that in 2020 they produced fewer goods than in 2019.

When the GDP falls, the terms most used are recession and depression. The difference between the two according to Harry Truman is – “It’s a recession when your neighbour loses his job; it’s a depression when you lose yours”.

As you have witnessed for over a year, firms are busy firing staff which means there has been increased unemployment. When more people are unemployed, there is no money to buy goods and thus there will be even less demand for goods in the future. Those who had jobs yesterday do not have them today; and those who have jobs today may lose them next year in a downward spiral of negative economic growth begetting even more negative growth.

Will there be lower emphasis on GDP and economic growth in the future? For such a change to happen there needs a material change in organising the world economy.

About the author

Girish Menon is a teacher of economics at Stephen Perse Foundation, Cambridge, UK, having graduated from the Bombay University and the London School of Economics.
He prescribes a heterodox approach to economics.

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