Three Reasons to Scrap GDP

Make sure the fortune that you seek
Is the fortune that you need.

- Ben Harper, “Diamonds on the Inside”

Typically, the biggest impact GDP has on the life of an options trader is the response of the markets to each new release of quarterly GDP estimates. But the whipsawing knee-jerk reactions of the markets to economic datapoints are immature and shallow, at best; traders who care only about the symbolic and immediately tradable impact of economic data are equally short-sighted. So forgive us this relative digression, but even we can recognize that there’s a whole lot more to life than trading.

Commentators in the financial media routinely trot out positive GDP numbers as proof that economic growth – and by implication, our standard of living – is improving. But while GDP measurements are helpful for understanding changes in the variables analyzed, critics of GDP have long charged that this one method of analyzing an economy is inadequate and inappropriate when we want to make the shift from raw economic data to the reality of the lived experiences of economic participants.

Some quick review: GDP, or Gross Domestic Product, is defined as the total market value of all final goods and services produced within a given country in a given period of time. It is commonly calculated as:

GDP = consumption + gross investment + government spending + (exports ? imports), or,
GDP = C + I + G + (X-M) [Wikipedia]

This formula is useful if you want to track the overall economic productivity of a country, or compare the economic growth of two or more countries (assuming certain adjustments). But the problem critics have with it is that GDP is almost never recognized as the wonkish, highly selective formula that it really is. Rather, it has become common practice to use GDP figures as a general proxy for quality of life, standards of living, and well-being in general.

Three Reasons to Scrap GDP

Here are three reasons why we should scrap Gross Domestic Product as the key headline metric for analyzing the health of an economy:

  1. Life is more than what happens at the office. Myopically focusing on GDP headline numbers skews our sense of what it means to have a healthy economy, and when we use GDP figures to assess the quality of life and strength of our society, we are minimizing or ignoring other extremely important variables. Domestic labor, volunteer work, and other forms of unpaid labor are not tracked by GDP, yet they are extremely important aspects of any economy. And the well-being of a country cannot be inferred solely from the measurements of its consumption and production: life expectancy, infant and maternal mortality, education, literacy, and public health are just some of the crucial variables that are ignored by the GDP formula.
  2. A strong economy is a sustainable one. A high GDP does not necessarily indicate a sound economy, since GDP does not measure the long-term sustainability of visible growth. A country may be in the midst of an asset bubble (think housing, tech stocks), may be over-exploiting its natural resources (oil, mining, logging…), or may have a very low savings rate and/or misdirected investments; and thus will show an artificially high GDP number. What’s the point of measuring growth if we can’t tell whether that growth is sustainable over the long or even medium term?
  3. Oil spills, prison cells, and dead smokers are not positives for our economy. But then why are those things counted as positive contributors to growth? Robert F. Kennedy said it better than we ever could: “The gross national product includes air pollution and advertising for cigarettes and ambulances to clear our highways of carnage. It counts special locks for our doors and jails for the people who break them. GNP (a slightly different but related measure) includes the destruction of the redwoods and the death of Lake Superior. It grows with the production of napalm, and missiles and nuclear warheads… it does not allow for the health of our families, the quality of their education, or the joy of their play. It is indifferent to the decency of our factories and the safety of our streets alike. It does not include the beauty of our poetry or the strength of our marriages, or the intelligence of our public debate or the integrity of our public officials. It measures everything, in short, except that which makes life worthwhile.”

The most immediate response to these criticisms is that GDP was never intended to be a catch-all measurement for quality of life or the overall success of a country. But that’s precisely what it has become. While we have little to say about the formulas academic economists choose to use in their research, as citizens and individuals we each have every right to insist on accurate and responsible analysis of how our economy and our society are functioning.

It’s not as if there aren’t reasonable alternatives to GDP:

  • the Genuine Progress Indicator is similar, but it also factors in the externalities that GDP ignores, and can thus make a claim to greater accuracy; while
  • the Human Development Index factors in GDP along with life expectancy, literacy, and education.

In addition to the scientific and the moral reasons for proposing alternative models to GDP, we wonder whether there may be a small practical benefit as well to using a broader set of variables: namely, that including variables with some predictive power (like education, income distribution, and maternal mortality), we may be able to develop economic indicators which aren’t simply lagging tabulations of what was consumed and produced last year, but are instead comprehensive and leading indicators of where our societies are going.

On the cusp of what may be a very painful recession, it may seem a bit absurd to be asking for a change this abstract and progressive and esoteric. But perhaps it is precisely the lack of long-term, mature, and egalitarian thinking on the part of our government that allowed our economic health to deteriorate in the first place.

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  1. Pollyanna Creep | ø§§» INVEST News, Tips, & Analysis ø§§» Says:

    [...] Creep April 16th, 2008 | Category: Stock Market Analysis Our April 6 post entitled “Three Reasons to Scrap GDP” considered what’s wrong with drawing too many conclusions about the health of the [...]

  2. Week 6: “Buen vivir” – Good living Says:

    [...] The author of this article argues that GDP was never intended to be a catch-all measurement for quality of life or the overall success of a country but is nevertheless widely used that way. [] [...]

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Jared Woodard specializes in trading volatility as an asset class. With over a decade of experience trading options and other volatility products ... Read More


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