When discussing about the economy of one country, people often talk about Gross Domestic Product (GDP). However, there are a number of disagreements among economist about the value of GDP. Therefore, this essay will discuss whether or not GDP is an ideal measurement of the development of a nation. It first explores the term GDP and ways to measure it. The essay then compares GDP with Gross National Product (GNP) and Human Development Index (HDI).
According to Mankiw (2011), the value of all final goods and services in the market produced within a country in a given time span is defined as GDP. Through this definition, there is only one measure of all the value of the economic activities for a range of products, and both goods and services are included in GDP at their market value. Nevertheless, comparing the value of one product to the other is not always easy, for example it is difficult to say if an orange is more valuable than an apple as different consumers value a good differently. It is important to have criteria to differentiate the value of different goods and services. Hence, the market price was introduced in order to identify the volume of customers who are able to purchase particular products.
To measure GDP by using the market value helps to include a wide range of commodities in the market. Not only are common items such as food, clothes and other living necessity but also the housing services included in the market value. By measuring GDP this way, many business activities like market rental housing reflect the market value and become indicators of the market. Moreover, volume of owner-occupied housing can be used to measure the market rental value of a country. Nevertheless, according to Abel et al (2008), although this measurement of GDP encompasses a number of goods and services, it still does not cover some products like which are traded in informal markets.
It is ideal that all of the goods and services exiting in the market are reflected through GDP. However, in many cases measuring the value of a number of goods and services in non-market and illegal markets is impossible, this makes measuring GDP more difficult. For instance, although the vegetables consumers buy in supermarkets are included in GDP, the ones that farmers grow in their gardens are not counted in GDP. Moreover, it is obvious that the trade of illegal drugs and other products is not counted in GDP. In addition, manufacturing and trading goods and services often relate to the impact in the environment. However, the benefits of clean air and natural water are not traded in the market; and GDP does not reflect actions to reduce pollution or improve environmental quality.
There are three main methods for measuring GDP, namely product approach, expenditure approach and income approach. According to Tucker (2011) the product approach is based on value- added concept; it measures economic activity by summing the value added by all producers. In this product approach, the market value of the goods and services traded in the market are included in the economic activities. Nevertheless, the value which is produced and used up in the intermediate stage of the manufacture process is excluded.
The second approach is based on expenditure, it consider GDP from a different angle by including expenditure in national income account. GDP is measured as the total spending of final commodities within a nation during a certain period of time. The spending is categories into four kinds, which added to get the GDP (Y), they are consumption (C), investment (I), government purchase of goods and services (G), and net exports of goods and services, indicating the difference between export and import (NX= X-M).
Therefore, GDP by expenditure approach is formulated as follow: Y= C+ I + G+ NX (Brezina, 2012).
The third method measuring GDP is the income approach, which takes in to account the income gained by manufacturers, such as profits and taxes paid. There are eight types of national incomes, which are:
* Compensation of employees consists of workers incomes including salaries, wages, pension plans or other benefits businesses deliver to their employees * Income of Proprietors includes capital income and labor incomes of the non-incorporated self-employed. * Peoples Rental income: people who have lands, structures or properties can rent them out and receive an amount of money; this is called rental income. * Corporate Profits: this is the amount of money earned by corporations through their business activities. Corporate profits are the results of corporate revenue after rents, wages and costs deductions.
* Net income: is the income of individuals earned from their businesses or paid by businesses or other sources after tax deduction or interest paid. * Taxes on production and imports: this encompasses indirect business taxes * Business current transfer payments (net): these are payments which governments or individuals receive from businesses as charitable donations from insurance payments or translation. It should be notice that these payments are not paid for taxes, wages or service charges. * Current surplus of government enterprises: these are businesses profits owned by government including electricity, water, public transportations and so forth.
There are three main concepts of GDP, namely nominal GDP, real GDP and GDP deflator. Tucker (2011) defines The nominal GDP means that the value of all final goods which based on the prices existing during the time period of production. It is known as current dollar or money GDP and it increases in three different ways. Firstly, it increases when output rises while prices remain unchanged. Nominal GDP also grows when prices increase while the output is constant. The final way which is seen in the typical case, is that both of output and price rise.
A major distinction between nominal and real GDP is to measure the gaps between changes in output and the price level which relate to marketing. When the current dollar GDP of a country increases significantly, it is possible that its productions have enlarged markedly. Nevertheless, it is probably that inflation is increasing, so the prices of goods and services grow accordingly. As for the real GDP, the value of all final products production based on the existing prices in a given year. The real GDP which is measured after taking inflation in to account is also known as constant dollar GDP.
A price index used to measure the overall level of prices of goods and services included in GDP is defined as the GDP deflator, which is formulated as: GDP deflator = (Nominal GDP/ Real GDP) x 100. It is a measure of the average level of prices for some specified set of products, proportionate to the prices in a specified based year. Hence, the choice of base year decides the value of real GDP and the GDP deflator. In addition, Brakman et al (2006) suggests the method to calculate the real GDP by the use of the chained volume measure of GDP and to take an average of the variation in price.
Another way to measure the status of a national economy is through Gross National Product (GNP) and many governments use it as a standard to measure their economy. Brakman et al 2006 defines GNP as the market value of the goods and services, which produced by labor and property of residents of a country. GNP and GDP are different in that they treat output generated by capital and labours having job outsides its home country differently (Abel et al 2008). While the former takes into account the market value of final goods newly produced by domestic factors of production during the current period, the latter only includes production produced within a country.
To illustrate, a Chinese worker working in the US, on one hand his services are part of American GDP, on the other hand they contribute to China GNP. In addition, besides labor services, the difference between GNP and GDP also hold for many factors of production like capital. The differentiation between them is calculated as in the formula: GDP= GNP- NFP. Abel et al referred NFP as net factor payments from abroad, which to be income paid to domestic factors of production by the rest of the world minus income paid to foreign factors of production by domestic economy. However, in reality the value of GDP is similar to that of GNP. For example, British GDP was only 0.2% lower than its GNP, $ 1415 billion compared with $ 1417 billion. That is a reason why only two countries out of thirty six having an income level of over $ 100 billion differentiate GDP and GNP.
Though the argument whether GNP or GDP is an ideal measurement of national development is debatable, both of the measures still cannot cover many other aspects of the national economy. There are a number of drawbacks pointed out. For instance, it is difficult to set up the best criteria to measure standard of living, quality of goods and services provided the economy activities in shadow economy, welfare issues, income inequality and the negative externality issue (Brezina, 2012). As a result, it is possible that in a country with high GDP not every people live in high standard or benefit form that high GDP.
Regarding to the case of China, the China GDP demonstrates approximately equal market value to that in the United Kingdom. Nevertheless, China GDP per capita according to current prices is 19 times lower than that of the UK, indicating a relatively huge gap in GDP per capita between the two nations. Likewise, Australia and India have the same situation as that between China and the UK. Both of these countries have nearly the same level of GDP; on the other hand, GDP per capital of Australia is 46 times greater than that of India.
In terms of PPP, the number of goods and services purchased with a unit of each countrys currency is measured by this indicator. PPP takes into consideration the differences in price levels of different goods and different demand patterns in different countries. In PPP calculation approach, the amount of disposal income per capita in the UK is just seven times higher than that in China. Similarly, the amount of disposal income per capital in Australia is just 17 times larger than that in India. By PPP indicator, income gaps between countries are much narrower than those calculated by GDP per capital indicator.
It should be noticed that the increase in GDP trend when it is measured by the government is not always a positive sign. GDP increases could be resulted from either economic development or inflation. Therefore, in the case that GDP increase because of inflation then the increase in GDP does not lead to the increase in living standard; alternatively, it would remain the same. Furthermore, According to Abel et al., (2008), there are a number of trades are excluded from GDP such as illegal transactions with drugs, smuggling or other business activities which are not declared formally on documents.
Therefore, the total amount of GDP is somewhat flawed when it only could measure formal and legal economic activities which are demonstrated under formal documents. In a number of countries including Nigeria, Bolivia and Switzerland, informal business activities under shadow economy account for a considerable amount of percentage of total GDP. Nigeria, Bolivia and Switzerland had 77%, 67% and 9% of GDP of those activities in the shadow respectively.
The definitions of GDP are flawed; thus, there has not any comprehensive definition for GDP. Therefore, According to Robert Kennedy
The GDP measures neither our wit nor our courage, neither our wisdom nor our learning, neither our compassion nor our devotion to the country. It measures everything, in short, except that which makes life worth living (Robert Kennedy)
Although GDP indicates average income level in a country functioning as navigation for living standard, it does not what it is spent on. Generally, HDI (Human Development Index) has a huge gap with GDP. HDI is regarded as a valid measure of a nations progress; it is the result of the average value of the three indices called educational attainment, longevity and income (Karalay, 2005, p.214). Furthermore, there has been a major concern about inequality in income, which facing the position of GDP. China can be used as a typical example since the richest 10% income is 18.4 times than the 10% poorest. Ultimately, measuring GDP failed in addressing the cost of negative externality and the value of leisure; actually, these factors are ignored in GDP.
Thus, the calculation of GDP is based on the assumption that most of population just does business activities. Moreover, it is hard to quantify the cost of environment. Although the increase in GDP indicates the development of an economy, factors such as air pollution, water pollution, noise pollution and annoy are not taken into account in calculating GDP. Environment has been come a major issue for the new generation, who have been attempting to protect the environment, which are under a great deal of damage. Therefore, the concept of Green GDP has been introduced. Leisure life, a crucial indicator of social and economic welfare was not counted in GDP. In order to increase GDP, people, workers and employees often have to increase their working hours, thus, reduce their leisure time. The value of leisure is hard to be measured but it is also regarded as services and goods expected by the people in a country. GDP often excludes leisure activities.
For example, in Taiwan, government imposes the policy which allows workers to have two days off at weekend. Although this policy would increase cost of employers, it would increase social welfare in general. Because of incomprehensiveness, GDP is unable to provide people a thorough picture of a national economy such as living standard, social welfare and so on. GDP is actually just a number given by government in order to demonstrate its people that government is working hard for the prosperity of a nation. GDP measures have been facing a large number of limitations. According to the economist Joseph Stiglitz, there should be another measurement.
Hence, he introduced the concept Gross Deceptive Product in the Commission on the Measurement of Economic Performance and Social Progress report in 2009. In this report, limitations in measuring GDP is emphasized; then additional information needed for the introduction of more comprehensive indications is presented. The report also evaluates the feasibility of alternative measurement tools of GDP. In addition, the report introduced twelve improvements in the ways to measure economic development. For example, income and consumption should be assessed rather than production; household perspective, income and consumption should be emphasized together with wealth broaden income measure to non-market activities and so forth.
Despite a great deal of flaw, GDP has contributed greatly in measuring the development of a country as well as providing important information for foreign investment and immigration. Nevertheless, GDP is not a perfect statistic since it is unable to demonstrate living standard and social welfare. GDP is just can general information of national wealth and income.
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