Former Microsoft Corporation (NASDAQ: MSFT) chief architect Edward Jung once called gross domestic product (GDP) the standard measurement of economic health and well-being, a misleading indicator that sabotaged development and innovation. He's not alone in his disapproval of simple aggregates. A growing chorus of researchers, economists, industry leaders and policy makers have made it clear that they think GDP is a poorly devised relic.

What GDP Actually Measures

GDP is equal to the total monetary value of all final goods and services that have been exchanged within a specific border over a set period of time. For the United States, GDP usually means the dollar-amount value of all purchased goods and services over the course of one year. This includes purchases from private for-profit, non-profit and government sectors. If you buy a roast chicken for $10, GDP increases by $10.

There are two widely accepted and more realistic modifications of GDP. The first is real GDP, or GDP after an adjustment for increases in the cost of living. The second is GDP per capita, which divided total output by the number of people in a geographic area. GDP per capita is used to give a more accurate idea of how well off the median individual in any given economy is.

Can GDP Measure Progress?

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 that a good or service can make them. Greater access to wealth literally means greater access to things that can improve your 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, a 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.

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 taking place.

Is GDP a Measure of Social Welfare?

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.

It is possible for GDP to increase while the many individuals in a society actually experience a declining standard of living. And even though government statisticians attempt to control the quality of goods and services produced, it is even possible for real GDP to increase while the condition of economic products declines.

Is GDP a Measure of Environmental Welfare?

The environment is one area where traditional GDP metrics are almost blind. A short-term increase in total output may correspond with long-term damage to the environment. The only way environmental changes might be reflected in GDP is in the relative scarcity of resources, which makes prices go up, or changes the value of environmental goods, such as land.

Not All Domestic Product Is Equal

As an aggregate, GDP is unconcerned with the shape, coordination or location of product. 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.

One problem is that GDP imagines that government spending is as valuable as private sector spending, even if no consumers want or value the government spending. The original author of national income statistics, Simon Kuznets, initially treated government spending as a cost to the private sector. He was overruled by John Maynard Keynes, who insisted on including the capacity of a government to make guns, tanks and other wartime products.

Want to learn how to invest?

Get a free 10 week email series that will teach you how to start investing.

Delivered twice a week, straight to your inbox.