Gross Domestic Product measures the total value of final goods produces in an economy in any given year. This is derived by summing the total of consumer expenditures (C), with business investment spending (I), total government spending (G) plus net exports (Exports – Imports). The GDP is used as the primary indicator for the health of any economy. However, the economy is not as clear cut as C+I+G but in reality far more nuanced and complicated than a simple equation.
Firstly, and perhaps the greatest deceptive element of the GDP, is that many people today assume the GDP to represent the entire economy. In reality, GPD is the calculation for all final goods produced in an economy. It erroneously omits all the other stages of production that bring those final goods to the market place for personal consumption. If we just think about the production of any consumer good, such as a car, there are many other products, mainly manufacturing products, that have to be yielded in order to bring a car to the marketplace. GDP leaves all those intermediary production stages out. In effect neglecting all the economic activities they generate.
Another issue is GDP’s treatment of government spending. If we are using GDP as a calculation for the net addition to human welfare, then the problem stems from the fact that we do not know if the spending is an actual positive to our welfare or not. The reason being we did not consent to the spending. When government taxes its citizens and spends their money, those spending decision are not made through the voluntary exchanges of everyday people. Hence, there is not valuation mechanism that determines what those goods are worth to society. When individuals spend their own money, they’re willing to trade only if they value that item more than cash they are being asked to give up. When we spend someone else’s money, we are far less cautious and potentially willing to spend more than we would if the money was your own. This prevents the existence of any real price system which in effect distorts the true value of goods or services to society. In other words, GDP fails to separate monetary transactions that contribute to a healthier standard of living from those that are destructive and wasteful.
Overall, GDP is not completely useless. To the extent that we want to measure the total value of final consumer goods produced, it is an important figure. However, where this indicator becomes dangerous is when we start to expand its application to policy making decision based on the assumption that it is an accurate gauge for the health of an economy. Since the GDP today has become the foremost indicator of progress in our economy, politicians impulsively place too much emphasis on GDP growth. Thanks to Keynesian economics since World War II, GDP has given government’s free range to focus purely on spending as the heart of any economy. With the notion that all spending is good spending, the idea that government expenditures can substitute consumer spending when needed, has created significant economic hardships over the decades.