A:

Economists and statisticians use several different methods to track economic growth. The most well-known and frequently tracked metric is gross domestic product (GDP). Over time, however, some economists have highlighted limitations and biases in GDP calculation. Organizations such as the Bureau of Labor Statistics (BLS) and the Organization for Economic Co-operation and Development (OECD) also keep relative productivity metrics to gauge economic potential. Some suggest measuring economic growth through increases in the standard of living, although this can be tricky to quantify.

Gross Domestic Product

Gross domestic product is the logical extension of measuring economic growth in terms of monetary expenditures. If a statistician wants to understand the productive output of the steel industry, for example, he needs only to track the dollar value of all of the steel that entered the market during a specific period.

Combine the outputs of all industries, measured in terms of dollars spent or invested, and you get total production. At least that was the theory. Unfortunately, the tautology that expenditures equal sold-production does not actually measure relative productivity. The productive capacity of an economy does not grow because more dollars move around, an economy becomes more productive because resources are used more efficiently. In other words, economic growth needs to somehow measure the relationship between total resource inputs and total economic outputs.

The OECD itself described GDP as suffering from a number of statistical problems. Its solution was to use GDP to measure aggregate expenditures, which theoretically approximates the contributions of labor and output, and to use multi-factor productivity (MFP) to show the contribution of technical and organizational innovation.

Gross National Product

Those of a certain age may remember learning about gross national product (GNP) as an economic indicator. Economists use GNP mainly to learn about the total income of a country's residents within a given period and how the residents use their income. GNP measures the total income accruing to the population over a specified amount of time. Unlike gross domestic product, it does not take into account income accruing to non-residents within that country’s territory; like GDP, it is only a measure of productivity, and it is not intended to be used as a measure of the welfare or happiness of a country.

The Bureau of Economic Analysis (BEA) used GNP as the primary indicator of U.S. economic health until 1991. In 1991, the BEA began using GDP, which was already being used by the majority of other countries; the BEA cited easier comparison of the United States with other economies as a primary reason for the change. Although the BEA no longer relies on GNP to monitor the performance of the U.S. economy, it still provides GNP figures, which it finds useful for analyzing the income of U.S. residents.

There is little difference between GDP and GNP for the U.S., but the two measures can differ significantly for some economies. For example, an economy that contained a high proportion of foreign-owned factories would have a higher GDP than GNP. The income of the factories would be included in GDP, as it is produced within domestic borders, but not in GNP, since it accrues to non-residents. Comparing GDP and GNP is a useful way of comparing income produced in the country and income flowing to its residents.

Productivity vs. Spending

The relationship between production and spending is a quintessential chicken-and-egg debate in economics. Most economists agree that total spending, adjusted for inflation, is a byproduct of productive output. They disagree, however, if increased spending is in itself an indication of growth.

Consider the following scenario: In 2017, the average American works 44 hours a week being productive. Suppose there is no change in the number of workers or average productivity for 2018. However, Congress passes a law requiring all workers to work for 50 hours a week instead that year. The GDP in 2018 will almost certainly be larger than the GDP in 2017. Does this constitute real economic growth?

Some would certainly say yes. After all, total output is what matters to those who focus on expenditures. For those who care about productive efficiency and the standard of living, this question does not have a clear answer. To bring it back to the OECD model, GDP would be higher, but MFP would be unchanged.

Reduced Unemployment Does Not Always Equal Positive Economic Growth

Suppose instead the world becomes mired in a third world war in 2018. Most of the nation's resources are dedicated toward the war effort, such as producing tanks, ships, ammunition and transportation, and all of the unemployed are drafted into war service. With an unlimited demand for war supplies and government financing, the standard metrics of economic health would show progress. GDP would soar, and unemployment would plummet.

But would anyone be better off? All of the produced goods would be destroyed soon after, and high unemployment is not worse than high mortality rates. There would be no lasting gains from that sort of economic growth.

(For related reading, see: Is Infinite Economic Growth on a Finite Planet Possible?)

RELATED FAQS
  1. Is real GDP a better index of economic performance than GDP?

    Learn why real GDP is a better index for expressing the output of an economy, as it takes into account the factors that distort ... Read Answer >>
  2. What is the difference between asset-price inflation and economic growth?

    Read about the difference between asset-price inflation and real economic growth, and why a rising stock market or housing ... Read Answer >>
  3. How do you calculate GDP with the Income Approach?

    There are generally two ways to calculate GDP: the expenditures approach and the income approach. Find out the factors that ... Read Answer >>
  4. How did World War II impact European GDP?

    Understand the effect of World War II on the European gross domestic product and what foreign and domestic factors influenced ... Read Answer >>
  5. Why does inflation increase with GDP growth?

    Examine the relationship between inflation and GDP, learn why GDP growth leads to higher prices and understand the effects ... Read Answer >>
Related Articles
  1. Insights

    The GDP and its Importance

    GDP is an accurate indication of an economy's size. Few data points can match the GDP and its growth rate's conciseness.
  2. Insights

    Deadly Flaws in Major Market Indicators

    These indicators give investors and experts some data to work with, but they're far from perfect.
  3. Insights

    Economic Indicators That Affect The U.S. Stock Market

    Macroeconomic factors like GDP, Inflation, and Retail Sales affect the value of your portfolio. Understanding these economic indicators is vital for every investor in the marketplace.
  4. Insights

    Nominal vs. Real GDP

    GDP stands for gross domestic product and is the measure of the total economic output of the goods and services of a country.
  5. Trading

    Trading GDP Like A Currency Trader

    Investors that understand and utilize the U.S. GDP report have a significant advantage over those that don't.
  6. Investing

    Why GDP Can Grow at 3%: The Skeptics Are Wrong

    Hard data including booming earnings show the economy will pick up steam
  7. Insights

    Healthiest And Safest European Economies

    Economic indicators are to economists what symptoms are to doctors: signs of the relative well-being of the patient.
  8. Insights

    5 Government Statistics You Can't Trust

    Government economic statistics carry a lot of weight, but there are some significant gaps in the methodology.
  9. Trading

    Trading Around Key Options Indicators

    Learn the key economic indicators to help predict market movement.
RELATED TERMS
  1. Gross Domestic Product - GDP

    GDP is the monetary value of all the finished goods and services ...
  2. Real Economic Growth Rate

    The real economic growth rate is measure of economic growth expressed ...
  3. Real Gross Domestic Product (GDP)

    Real gross domestic product is an inflation-adjusted measure ...
  4. Expenditure Method

    The expenditure method is a method for calculating GDP that totals ...
  5. Economics

    Economics is a branch of social science focused on the production, ...
  6. Productivity And Costs

    Productivity and costs refers to an economic data set that measures ...
Hot Definitions
  1. Discount Rate

    Discount rate is the interest rate charged to commercial banks and other depository institutions for loans received from ...
  2. Economies of Scale

    Economies of scale refer to reduced costs per unit that arise from increased total output of a product. For example, a larger ...
  3. Quick Ratio

    The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
  4. Leverage

    Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
  5. Financial Risk

    Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
  6. Enterprise Value (EV)

    Enterprise Value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market ...
Trading Center