Economists traditionally use gross domestic product (GDP) to measure economic progress. If GDP is rising, the economy is in solid shape, and the nation is moving forward. On the other hand, if gross domestic product is falling, the economy might be in trouble, and the nation is losing ground. Two consecutive quarters of negative GDP typically defines an economic recession.
What Is GDP?
Gross domestic product is equal to the total monetary value of all final goods and services that have been exchanged within a specific country (economy) over a set period of time. For the United States, GDP usually means the annual dollar-amount value of all purchased goods and services, including purchases from private for-profit, non-profit, and government sectors. If you buy a roast chicken for $10, for example, GDP increases by $10.
- Gross Domestic Product is the dollar value of all goods and services that have changed hands throughout an economy.
- Increasing GDP is a sign of economic strength, and negative GDP indicates economic weakness.
- GDP can offer false information when it results from economic destruction—such as a car accident or natural disaster—rather than truly productive activity.
- Genuine Progress Indicator is designed to improve on GDP by including more variables in the calculation.
There is a direct and logical sense in which wealth can measure well-being. All economic value is subjective—free-market prices are determined by how much better off individuals believe a good or service can make them. Greater access to wealth literally means greater access to things that can improve everyday life. On the other hand, those who produce wealth in an honest way have literally created the most value for others, at least in an economic sense.
So, in some sense, higher GDP should equate to greater human progress, because it means more valuable goods and services have been created. Scratch a little deeper, however, and GDP does not even capture this traditional economic value very well.
What’s the Difference Between GDP and GPI?
How GDP Misses the Mark
GDP can increase after a car accident or a major flood. GDP can grow rapidly during a war or after a terrorist attack. If all of Chicago caught fire once again and burnt to the ground, the rebuilding effort just might boost GDP. This is because GDP is very susceptible to the broken window fallacy—false signals of rising prosperity when obvious destruction has taken place.
However, from the perspective of a citizen living with the day-to-day realities of life, GDP can be rather misleading, which is why the genuine progress indicator (GPI) was created in 1995 by a socially responsible think tank called Redefining Progress. The indicator was developed as an alternative to the traditional GDP measure of a nation's economic and social health.
Although GPI and GDP calculations are based on the same personal consumption data, GPI provides adjustment factors—variables designed to apply monetary values to non-monetary aspects of the economy. The variables fall into the following general categories:
- Personal consumption - This number is the same data used to calculate GDP.
- Income distribution - GPI is adjusted upward when a greater percentage of the nation's income goes to the poor because an income increase provides a tangible benefit to the poor. GPI is adjusted downward when the majority of a nation's increased income goes to the rich. GDP is only concerned with the sum of all exchanged goods and services, not the distribution of their proceeds. If five individuals each earn $200,000, GDP treats that the same as one individual earning $800,000 and four individuals earning $50,000 each.
- Housework, volunteering, and higher education - GPI factors in the value of the labor that goes into housework and volunteering. It also factors in the benefit of an increasingly educated populace.
- Service of consumer durables and infrastructure - Money spent on durable goods is treated as a cost, while the value the purchases provide is treated as a benefit. Long-lasting goods that provide benefits without having to be frequently repurchased are viewed positively. Goods that wear out quickly and drain consumers' wallets when they must be replaced are viewed negatively. GDP, on the other hand, views all expenditures as good news. Infrastructure spending by the government is treated similarly: If spending provides a long-lasting benefit, GPI views it as a positive; if spending drains the government's coffers, GPI views it as a negative. Again, GDP views all spending as positive. If the U.S. government spends $2 billion developing a new jet warplane that never lifts off the ground, GDP treats that the same as a hospital delivering $2 billion of cheap medicine or a tech entrepreneur selling $2 billion worth of new software.
- Crime - Rising crime costs money in legal fees, medical bills, replacement costs, and other outlays. GDP views this spending as a positive development. GPI views it as a negative.
- Resource depletion - When wetlands or forests are destroyed by economic activity, GDP views the events as good news for the economy; GPI views these events as bad news for future generations.
- Pollution - Pollution is good news for GDP. Industry gets paid once for the economic activity that creates pollution and again when money is spent to mitigate the pollution. GPI views pollution as a negative.
- Long-term environmental damage - Global warming, nuclear waste storage, and other long-term consequences of economic activity are factored into GPI as negatives.
- Changes in leisure time - Prosperity should lead to an increase in leisure time. Most modern workers would disagree with this theory. GPI views an increase in leisure as a positive and a decrease in leisure as a negative.
- Defensive expenditures - Defensive expenditures refer to medical insurance, auto insurance, health care bills, and other expenses that are required to maintain quality of life. GPI views these as a negative. GDP views them positively.
- Dependence on foreign assets - When a nation is forced to borrow from other nations to finance consumption, GPI factors in the result as a negative. If the borrowed money is used for investments and benefits the country, it is viewed as a positive.
Genuine progress indicator calculations use economic statistics and mathematical formulas to place value on the social, economic, and environmental variables. The final result is then added to or deleted from the GDP figure. For example, the cost of consumer durables is subtracted from GDP.
The number of economic, social, and environmental variables included in the genuine progress indicator calculation.
The amount of money that foreigners invest in the United States is subtracted from the amount Americans invest overseas. A five-year rolling average is used to determine whether the U.S. is becoming a lender or a borrower. If the economy is healthy enough that we are a net lender, the resulting number is added to GDP. If we are borrowing to sustain our economy, the resulting number is subtracted.
While GPI factors in many of the variables that have a direct impact on peoples' quality of life, capitalist economies tend to focus strictly on making money. Because of this, GPI has not yet been widely adopted in such economies, although its proponents note it has been reviewed by the scientific community and recognized for its validity. GPI-type measures are in use in Canada and in some of Europe's small and more progressive nations. Over time, other nations might slowly adopt the concept as environmental concerns move into the public's consciousness.
The Bottom Line
GDP has its strengths and weaknesses. While the number is closely watched by economists and widely followed by the financial media, the calculation is sometimes flawed because GDP can add some items that are actually destructive, rather than productive, to an economy. GPI, on the other hand, includes a host of economic, social, and economic variables that are then subtracted or added to gross domestic product, resulting in robust indicator of economic strength or weakness.