Gross Domestic Product - GDP

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What is 'Gross Domestic Product - GDP'

Gross domestic product (GDP) is the monetary value of all the finished goods and services produced within a country's borders in a specific time period. Though GDP is usually calculated on an annual basis, it can be calculated on a quarterly basis as well. GDP includes all private and public consumption, government outlays, investments and exports minus imports that occur within a defined territory. Put simply, GDP is a broad measurement of a nation’s overall economic activity.

Gross domestic product can be calculated using the following formula:

GDP = C + G + I + NX

where

C is equal to all private consumption, or consumer spending, in a nation's economy, G is the sum of government spending, I is the sum of all the country's investment, including businesses capital expenditures and NX is the nation's total net exports, calculated as total exports minus total imports (NX = Exports - Imports).

BREAKING DOWN 'Gross Domestic Product - GDP'

GDP is commonly used as an indicator of the economic health of a country, as well as a gauge of a country's standard of living. Since the mode of measuring GDP is uniform from country to country, GDP can be used to compare the productivity of various countries with a high degree of accuracy. Adjusting for inflation from year to year allows for the seamless comparison of current GDP measurements with measurements from previous years or quarters. In this way, a nation’s GDP from any period can be measured as a percentage relative to previous years or quarters. When measured in this way, GDP can be tracked over long spans of time and used in measuring a nation’s economic growth or decline, as well as in determining if an economy is in recession

GDP’s popularity as an economic indicator in part stems from its measuring of value added through economic processes. For example, when a ship is built, GDP does not reflect the total value of the completed ship, but rather the difference in values of the completed ship and of the materials used in its construction. Measuring total value instead of value added would greatly reduce GDP’s functionality as an indicator of progress or decline, specifically within individual industries and sectors. Proponents of the use of GDP as an economic measure tout its ability to be broken down in this way and thereby serve as an indicator of the failure or success of economic policy as well. For example, from 2004 to 2014 France’s GDP increased by 53.1%, while Japan’s increased by 6.9% during the same period.

Criticisms of GDP

There are, of course, drawbacks to using GDP as an indicator. For example, the previous example omits the fact that France’s GDP climbed to an all time high in 2008 and subsequently dropped. Critics of GDP add that the statistic does not take into account the underground or unofficial economy: everything from black market activity to under-the-table employment, as well as other transactions that, for various reasons, are not reported to the government. Others criticize the tendency of GDP to be interpreted as a gauge of material well being, when in reality it serves as a measure of a nation's productivity, which are not necessarily unrelated.

There are three primary methods by which GDP can be determined. All, when correctly calculated, should yield the same figure. These three approaches are often termed the expenditure approach, the output (or production) approach, and the income approach.

The expenditure approach measures the total sum of all products used in developing a finished product for sale. To return to the example of the ship, the finished ship’s contribution to a nation’s GDP would here be measured by the total costs of materials and services that went into the ship’s construction. This approach assumes a relatively fixed value of the completed ship relative to the value of these materials and services in calculating value added.

The production approach is something like the reverse of the expenditure approach. Instead of exclusively measuring input costs that feed economic activity, the production approach estimates the total value of economic output and deducts costs of intermediate goods that are consumed in the process, like those of materials and services. Whereas the expenditure approach projects forward beyond intermediate costs, the production approach looks backward from the vantage of a state of completed economic activity.

The third approach, the income approach, is something of an intermediary between the two aforementioned approaches. It measures GDP by way of totaling domestic incomes earned at all levels and by using gross income both as an indicator of implied productivity and of implied expenditure. GDP calculated in this way is sometimes referred to as gross domestic income (GDI), or as gross national income (GNI) when incorporating income received from overseas.

History

GDP first came into use in 1937 in a report to the US Congress in response to the Great Depression after Russian economist Simon Kuznets conceived the system of measurement. At the time, the preeminent system of measurement was the Gross National Product (GNP). GNP differs from GDP in that GNP measures the productivity of a nation’s citizens regardless of their locales, as opposed to the GDP’s measurement of production by geographic location. After the Bretton Woods conference in 1944, GDP was widely adopted as the standard means for measuring national economies.

Beginning in the 1950s, however, some began to question the faith of economists and policy makers in GDP internationally as a gauge of progress. Some observed, for example, a tendency to accept GDP as an absolute indicator of a nation’s failure or success, despite GDP’s failure to account for health, happiness, and other constituent factors of general welfare. In other words, these critics drew attention to a distinction between economic progress and social progress. Others, like Arthur Okun, an economist for President Kennedy’s Council of Economic Advisers, held firm to the belief that GDP is as an absolute indicator of economic success, claiming that for every increase in GDP there would be a corresponding drop in unemployment.

In recent decades, governments have created various nuanced modifications in attempts to increase GDP accuracy and specificity. Means of calculating GDP have also evolved continually since its conception so as to keep up with evolving measurements of industry activity and the generation and consumption of new, emerging forms of intangible assets.