GDP is most often used by the government of a single country to measure its economic health. Due to its complex and subjective nature, this measure is often revised before being considered a reliable indicator.
GDP definitions are maintained by a number of national and international economic organizations. The Organisation for Economic Co-operation and Development (OECD) defines GDP as "an aggregate measure of production equal to the sum of the gross values added of all resident and institutional units engaged in production and services (plus any taxes, and minus any subsidies, on products not included in the value of their outputs)". An IMF publication states that, "GDP measures the monetary value of final goods and services—that are bought by the final user—produced in a country in a given period of time (say a quarter or a year)."
The history of the concept of GDP should be distinguished from the history of changes in many ways of estimating it. The value added by firms is relatively easy to calculate from their accounts, but the value added by the public sector, by financial industries, and by intangible asset creation is more complex. These activities are increasingly important in developed economies, and the international conventions governing their estimation and their inclusion or exclusion in GDP regularly change in an attempt to keep up with industrial advances. In the words of one academic economist, "The actual number for GDP is, therefore, the product of a vast patchwork of statistics and a complicated set of processes carried out on the raw data to fit them to the conceptual framework."
China officially adopted GDP in 1993 as its indicator of economic performance. Previously, China had relied on a Marxist-inspired national accounting system.
Determining gross domestic product (GDP)
An infographic explaining how GDP is calculated in the UK
GDP can be determined in three ways, all of which should, theoretically, give the same result. They are the production (or output or value added) approach, the income approach, and the speculated expenditure approach. It is representative of the total output and income within an economy.
The most direct of the three is the production approach, which sums the outputs of every class of enterprise to arrive at the total. The expenditure approach works on the principle that all of the product must be bought by somebody, therefore the value of the total product must be equal to people's total expenditures in buying things. The income approach works on the principle that the incomes of the productive factors ("producers", colloquially) must be equal to the value of their product, and determines GDP by finding the sum of all producers' incomes.
Also known as the Value Added Approach, it calculates how much value is contributed at each stage of production.
This approach mirrors the OECD (Organisation for Economic Co-operation and Development) definition given above.
Estimate the gross value of domestic output out of the many various economic activities;
Determine the intermediate consumption, i.e., the cost of material, supplies and services used to produce final goods or services.
Deduct intermediate consumption from gross value to obtain the gross value added.
Value of output = value of the total sales of goods and services plus value of changes in the inventory.
The sum of the gross value added in the various economic activities is known as "GDP at factor cost".
GDP at factor cost plus indirect taxes less subsidies on products = "GDP at producer price".
For measuring output of domestic product, economic activities (i.e. industries) are classified into various sectors. After classifying economic activities, the output of each sector is calculated by any of the following two methods:
By multiplying the output of each sector by their respective market price and adding them together
By collecting data on gross sales and inventories from the records of companies and adding them together
The value of output of all sectors is then added to get the gross value of output at factor cost. Subtracting each sector's intermediate consumption from gross output value gives the GVA (=GDP) at factor cost. Adding indirect tax minus subsidies to GVA (GDP) at factor cost gives the "GVA (GDP) at producer prices".
The second way of estimating GDP is to use "the sum of primary incomes distributed by resident producer units".
If GDP is calculated this way it is sometimes called gross domestic income (GDI), or GDP (I). GDI should provide the same amount as the expenditure method described later. By definition, GDI is equal to GDP. In practice, however, measurement errors will make the two figures slightly off when reported by national statistical agencies.
This method measures GDP by adding incomes that firms pay households for factors of production they hire - wages for labour, interest for capital, rent for land and profits for entrepreneurship.
The US "National Income and Product Accounts" divide incomes into five categories:
Wages, salaries, and supplementary labor income
Interest and miscellaneous investment income
Income earned by sole proprietors and from the Housing subsector (net of expenses)
Net income from transfer payments from businesses
These five income components sum to net domestic income at factor cost.
Two adjustments must be made to get GDP:
Taxes on production and imports minus subsidies are added to get from factor cost to market prices.
Compensation of employees (COE) measures the total remuneration to employees for work done. It includes wages and salaries, as well as employer contributions to social security and other such programs.
Gross operating surplus (GOS) is the surplus due to owners of incorporated businesses. Often called profits, although only a subset of total costs are subtracted from gross output to calculate GOS.
Gross mixed income (GMI) is the same measure as GOS, but for unincorporated businesses. This often includes most small businesses.
The sum of COE, GOS and GMI is called total factor income; it is the income of all of the factors of production in society. It measures the value of GDP at factor (basic) prices. The difference between basic prices and final prices (those used in the expenditure calculation) is the total taxes and subsidies that the government has levied or paid on that production. So adding taxes less subsidies on production and imports converts GDP(I) at factor cost to GDP(I) at final prices.
Total factor income is also sometimes expressed as:
Total factor income = employee compensation + corporate profits + proprietor's income + rental income + net interest
The third way to estimate GDP is to calculate the sum of the final uses of goods and services (all uses except intermediate consumption) measured in purchasers' prices.
Market goods that are produced are purchased by someone. In the case where a good is produced and unsold, the standard accounting convention is that the producer has bought the good from themselves. Therefore, measuring the total expenditure used to buy things is a way of measuring production. This is known as the expenditure method of calculating GDP.
Components of GDP by expenditure
U.S. GDP computed on the expenditure basis.
GDP (Y) is the sum of consumption (C), investment (I), government Expenditures (G) and net exports (X – M).
Y = C + I + G + (X − M)
Here is a description of each GDP component:
C (consumption) is normally the largest GDP component in the economy, consisting of private expenditures in the economy (household final consumption expenditure). These personal expenditures fall under one of the following categories: durable goods, nondurable goods, and services. Examples include food, rent, jewelry, gasoline, and medical expenses, but not the purchase of new housing.
I (investment) includes, for instance, business investment in equipment, but does not include exchanges of existing assets. Examples include construction of a new mine, purchase of software, or purchase of machinery and equipment for a factory. Spending by households (not government) on new houses is also included in investment. In contrast to its colloquial meaning, "investment" in GDP does not mean purchases of financial products. Buying financial products is classed as 'saving', as opposed to investment. This avoids double-counting: if one buys shares in a company, and the company uses the money received to buy plant, equipment, etc., the amount will be counted toward GDP when the company spends the money on those things; to also count it when one gives it to the company would be to count two times an amount that only corresponds to one group of products. Buying bonds or companies' equity shares is a swapping of deeds, a transfer of claims on future production, not directly an expenditure on products; buying an existing building will involve a positive investment by the buyer and a negative investment by the seller, netting to zero overall investment.
X (exports) represents gross exports. GDP captures the amount a country produces, including goods and services produced for other nations' consumption, therefore exports are added.
M (imports) represents gross imports. Imports are subtracted since imported goods will be included in the terms G, I, or C, and must be deducted to avoid counting foreign supply as domestic.
Note that C, I, and G are expenditures on final goods and services; expenditures on intermediate goods and services do not count. (Intermediate goods and services are those used by businesses to produce other goods and services within the accounting year.) So for example if a car manufacturer buys auto parts, assembles the car and sells it, only the final car sold is counted towards the GDP. Meanwhile, if a person buys replacement auto parts to install them on their car, those are counted towards the GDP.
According to the U.S. Bureau of Economic Analysis, which is responsible for calculating the national accounts in the United States, "In general, the source data for the expenditures components are considered more reliable than those for the income components [see income method, above]."
Encyclopedia Britannica records an alternate way of measuring exports minus imports: notating it as the single variable NX.
GDP is product produced within a country's borders; GNI is product produced by enterprises owned by a country's citizens. The two would be the same if all of the productive enterprises in a country were owned by its own citizens and those citizens did not own productive enterprises in any other countries. In practice, however, foreign ownership makes GDP and GNI non-identical. Production within a country's borders, but by an enterprise owned by somebody outside the country, counts as part of its GDP but not its GNI; on the other hand, production by an enterprise located outside the country, but owned by one of its citizens, counts as part of its GNI but not its GDP.
For example, the GNI of the USA is the value of output produced by American-owned firms, regardless of where the firms are located. Similarly, if a country becomes increasingly in debt, and spends large amounts of income servicing this debt this will be reflected in a decreased GNI but not a decreased GDP. Similarly, if a country sells off its resources to entities outside their country this will also be reflected over time in decreased GNI, but not decreased GDP. This would make the use of GDP more attractive for politicians in countries with increasing national debt and decreasing assets.
Gross national income (GNI) equals GDP plus income receipts from the rest of the world minus income payments to the rest of the world.
Another example that amplifies the difference among GDP and GNI are the comparison of developed and developing country indicators. The GDP of Japan for 2020 is 5,040,107.75 USD (in a million). Predictably, as a developed country, Japan has a higher GNI of 182,779.46 USD (in million), which is indicative that the production level in the country is higher than that of national production. On the other hand, the case with Armenia is the opposite, with GDP being lower than GNI by 196.12 USD (in million). This demonstrates that countries receive investments and foreign aid from abroad.
Countries or territories by GDP (PPP) per capita in 2022.
$50,000 – $60,000
$40,000 – $50,000
$30,000 – $40,000
$20,000 – $30,000
$10,000 – $20,000
$5,000 – $10,000
$2,500 – $5,000
$1,500 – $2,500
Countries or territories by GDP (nominal) per capita in 2022.
$50,000 - $60,000
$40,000 - $50,000
$30,000 - $40,000
$20,000 - $30,000
$10,000 - $20,000
$5,000 - $10,000
$2,500 - $5,000
$1,000 - $2,500
$500 - $1,000
U.S 2015 GDP computed on the income basis
Within each country GDP is normally measured by a national government statistical agency, as private sector organizations normally do not have access to the information required (especially information on expenditure and production by governments).
Nominal GDP and adjustments to GDP
The raw GDP figure as given by the equations above is called the nominal, historical, or current, GDP. When one compares GDP figures from one year to another, it is desirable to compensate for changes in the value of money – for the effects of inflation or deflation. To make it more meaningful for year-to-year comparisons, it may be multiplied by the ratio between the value of money in the year the GDP was measured and the value of money in a base year.
For example, suppose a country's GDP in 1990 was $100 million and its GDP in 2000 was $300 million. Suppose also that inflation had halved the value of its currency over that period. To meaningfully compare its GDP in 2000 to its GDP in 1990, we could multiply the GDP in 2000 by one-half, to make it relative to 1990 as a base year. The result would be that the GDP in 2000 equals $300 million × 1⁄2 = $150 million, in 1990 monetary terms. We would see that the country's GDP had realistically increased 50 percent over that period, not 200 percent, as it might appear from the raw GDP data. The GDP adjusted for changes in money value in this way is called the real, or constant, GDP.
The factor used to convert GDP from current to constant values in this way is called the GDP deflator. Unlike consumer price index, which measures inflation or deflation in the price of household consumer goods, the GDP deflator measures changes in the prices of all domestically produced goods and services in an economy including investment goods and government services, as well as household consumption goods.
Constant-GDP figures allow us to calculate a GDP growth rate, which indicates how much a country's production has increased (or decreased, if the growth rate is negative) compared to the previous year.
Real GDP growth rate for year n = (Real GDP in year n) − (Real GDP in year n − 1)/ (Real GDP in year n − 1)
Another thing that it may be desirable to account for is population growth. If a country's GDP doubled over a certain period, but its population tripled, the increase in GDP may not mean that the standard of living increased for the country's residents; the average person in the country is producing less than they were before. Per-capita GDP is a measure to account for population growth.
Standard of living and GDP: wealth distribution and externalities
GDP per capita is often used as an indicator of living standards.
The major advantage of GDP per capita as an indicator of standard of living is that it is measured frequently, widely, and consistently. It is measured frequently in that most countries provide information on GDP on a quarterly basis, allowing trends to be seen quickly. It is measured widely in that some measure of GDP is available for almost every country in the world, allowing inter-country comparisons. It is measured consistently in that the technical definition of GDP is relatively consistent among countries.
GDP does not include several factors that influence the standard of living. In particular, it fails to account for:
Externalities – Economic growth may entail an increase in negative externalities that are not directly measured in GDP. Increased industrial output might grow GDP, but any pollution is not counted.
Non-market transactions – GDP excludes activities that are not provided through the market, such as household production, bartering of goods and services, and volunteer or unpaid services.
Non-monetary economy – GDP omits economies where no money comes into play at all, resulting in inaccurate or abnormally low GDP figures. For example, in countries with major business transactions occurring informally, portions of local economy are not easily registered. Bartering may be more prominent than the use of money, even extending to services.
Quality improvements and inclusion of new products – by not fully adjusting for quality improvements and new products, GDP understates true economic growth. For instance, although computers today are less expensive and more powerful than computers from the past, GDP treats them as the same products by only accounting for the monetary value. The introduction of new products is also difficult to measure accurately and is not reflected in GDP despite the fact that it may increase the standard of living. For example, even the richest person in 1900 could not purchase standard products, such as antibiotics and cell phones, that an average consumer can buy today, since such modern conveniences did not exist then.
Sustainability of growth – GDP is a measurement of economic historic activity and is not necessarily a projection.
It can be argued that GDP per capita as an indicator standard of living is correlated with these factors, capturing them indirectly. As a result, GDP per capita as a standard of living is a continued usage because most people have a fairly accurate idea of what it is and know it is tough to come up with quantitative measures for such constructs as happiness, quality of life, and well-being.
Limitations and criticisms
Limitations at introduction
Simon Kuznets, the economist who developed the first comprehensive set of measures of national income, stated in his second report to the U.S. Congress in 1937, in a section titled "Uses and Abuses of National Income Measurements":
The valuable capacity of the human mind to simplify a complex situation in a compact characterization becomes dangerous when not controlled in terms of definitely stated criteria. With quantitative measurements especially, the definiteness of the result suggests, often misleadingly, a precision and simplicity in the outlines of the object measured. Measurements of national income are subject to this type of illusion and resulting abuse, especially since they deal with matters that are the center of conflict of opposing social groups where the effectiveness of an argument is often contingent upon oversimplification. [...]
All these qualifications upon estimates of national income as an index of productivity are just as important when income measurements are interpreted from the point of view of economic welfare. But in the latter case additional difficulties will be suggested to anyone who wants to penetrate below the surface of total figures and market values. Economic welfare cannot be adequately measured unless the personal distribution of income is known. And no income measurement undertakes to estimate the reverse side of income, that is, the intensity and unpleasantness of effort going into the earning of income. The welfare of a nation can, therefore, scarcely be inferred from a measurement of national income as defined above.
Distinctions must be kept in mind between quantity and quality of growth, between costs and returns, and between the short and long run. Goals for more growth should specify more growth of what and for what.
Ever since the development of GDP, multiple observers have pointed out limitations of using GDP as the overarching measure of economic and social progress. For example, many environmentalists argue that GDP is a poor measure of social progress because it does not take into account harm to the environment. Furthermore, the GDP does not consider human health nor the educational aspect of a population. American politician Robert F. Kennedy criticized the GDP as a measure of “everything except that which makes life worthwhile”. He said that it "does not allow for the health of our children, the quality of their education or the joy of their play.”
Although a high or rising level of GDP is often associated with increased economic and social progress, the opposite sometimes occurs. For example, Jean Drèze and Amartya Sen have pointed out that an increase in GDP or in GDP growth does not necessarily lead to a higher standard of living, particularly in areas such as healthcare and education. Another important area that does not necessarily improve along with GDP is political liberty, which is most notable in China, where GDP growth is strong yet political liberties are heavily restricted. GDP does not account for the distribution of income among the residents of a country, because GDP is merely an aggregate measure. An economy may be highly developed or growing rapidly, but also contain a wide gap between the rich and the poor in a society. These inequalities often occur on the lines of race, ethnicity, gender, religion, or other minority status within countries. This can lead to misleading characterizations of economic well-being if the income distribution is heavily skewed toward the high end, as the poorer residents will not directly benefit from the overall level of wealth and income generated in their country (their purchasing power can decline, even as the mean GDP per capita rises). GDP per capita measures (like aggregate GDP measures) do not account for income distribution (and tend to overstate the average income per capita). For example, South Africa during apartheid ranked high in terms of GDP per capita, but the benefits of this immense wealth and income were not shared equally among its citizens. An inequality which the United Nations Sustainable Development Goal 10 amongst other global initiatives aims to address.
GDP excludes the value of household and other unpaid work. Some, including Martha Nussbaum, argue that this value should be included in measuring GDP, as household labor is largely a substitute for goods and services that would otherwise be purchased with money. Even under conservative estimates, the value of unpaid labor in Australia has been calculated to be over 50% of the country's GDP. A later study analyzed this value in other countries, with results ranging from a low of about 15% in Canada (using conservative estimates) to high of nearly 70% in the United Kingdom (using more liberal estimates). For the United States, the value was estimated to be between about 20% on the low end to nearly 50% on the high end, depending on the methodology being used. Because many public policies are shaped by GDP calculations and by the related field of national accounts, public policy might differ if unpaid work were included in total GDP. Some economists have advocated for changes in the way public policies are formed and implemented.
The UK's Natural Capital Committee highlighted the shortcomings of GDP in its advice to the UK Government in 2013, pointing out that GDP "focuses on flows, not stocks. As a result, an economy can run down its assets yet, at the same time, record high levels of GDP growth, until a point is reached where the depleted assets act as a check on future growth". They then went on to say that "it is apparent that the recorded GDP growth rate overstates the sustainable growth rate. Broader measures of wellbeing and wealth are needed for this and there is a danger that short-term decisions based solely on what is currently measured by national accounts may prove to be costly in the long-term".
It has been suggested that countries that have authoritarian governments, such as the People's Republic of China, and Russia, inflate their GDP figures.
Research and development about the relation between GDP and use of GDP and reality
In response to these and other limitations of using GDP, alternative approaches have emerged.
In the 1980s, Amartya Sen and Martha Nussbaum developed the capability approach, which focuses on the functional capabilities enjoyed by people within a country, rather than the aggregate wealth held within a country. These capabilities consist of the functions that a person is able to achieve.
In 1990, Mahbub ul Haq, a Pakistani economist at the United Nations, introduced the Human Development Index (HDI). The HDI is a composite index of life expectancy at birth, adult literacy rate and standard of living measured as a logarithmic function of GDP, adjusted to purchasing power parity.
In 2005, Med Jones, an American Economist, at the International Institute of Management, introduced the first secular Gross National Happiness Index a.k.a. Gross National Well-being framework and Index to complement GDP economics with additional seven dimensions, including environment, education, and government, work, social and health (mental and physical) indicators. The proposal was inspired by the King of Bhutan's GNH philosophy.
In 2009 the European Union released a communication titled GDP and beyond: Measuring progress in a changing world that identified five actions to improve indicators of progress in ways that make them more responsive to the concerns of its citizens.
Since 2012, John Helliwell, Richard Layard and Jeffrey Sachs have edited an annual World Happiness Report which reports a national measure of subjective well-being, derived from a single survey question on satisfaction with life. GDP explains some of the cross-national variation in life satisfaction, but more of it is explained by other, social variables (See 2013 World Happiness Report).
In 2019, Serge Pierre Besanger published a "GDP 3.0" proposal which combines an expanded GNI formula which he calls GNIX, with a Palma ratio and a set of environmental metrics based on the Daly Rule.
In the beginning of the 21st century the World Economic Forum published a series of analyses and propositions to create economic measurement tools more effective than GDP.
Problems with GDP data
Manipulation of data
A peer-reviewed study published in the Journal of Political Economy in October 2022 found signs of manipulation of economic growth statistics in the majority of countries. According to the study, this mainly applied to countries that were governed semi-authoritarian/authoritarian or did not have a functioning separation of powers. The study took the annual growth in brightness of lights at night, as measured by satellites, and compared it to officially reported economic growth. Authoritarian states had consistently higher reported growth in GDP than their growth in night lights would suggest. An effect that also cannot be explained by different economic structures, sector composition or other factors. Incorrect growth statistics can also falsify indicators such as GDP or GDP per capita.
^ abCongress commissioned Kuznets to create a system that would measure the nation's productivity in order to better understand how to tackle the Great Depression.Simon Kuznets, 1934. "National Income, 1929–1932". 73rd U.S. Congress, 2d session, Senate document no. 124, page 5-7 Simon Kuznets, 1934. "National Income, 1929–1932". 73rd U.S. Congress, 2d session, Senate document no. 124, page 5-7
Simon Kuznets, 1934. "National Income, 1929–1932". 73rd U.S. Congress, 2d session, Senate document no. 124, page 5-7. https://fraser.stlouisfed.org/title/971Archived 2018-09-14 at the Wayback Machine
^United States Bureau of Economic Analysis, "A guide to the National Income and Product Accounts of the United States"(PDF). Archived(PDF) from the original on 2007-06-04., page 5; retrieved November 2009. Another term, "business current transfer payments", may be added. Also, the document indicates that the capital consumption adjustment (CCAdj) and the inventory valuation adjustment (IVA) are applied to the proprietor's income and corporate profits terms; and CCAdj is applied to rental income.
^Lequiller, François; Derek Blades (2006). Understanding National Accounts. OECD. p. 18. ISBN978-92-64-02566-0. Archived from the original on 2023-03-12. Retrieved 2021-02-15. To convert GDP into GNI, it is necessary to add the income received by resident units from abroad and deduct the income created by production in the country but transferred to units residing abroad.
^HM Treasury, Background information on GDP and GDP deflator
Some of the complications involved in comparing national accounts from different years are explained in this World Bank documentArchived 16 June 2010 at the Wayback Machine.
Joseph E. Stiglitz, "Measuring What Matters: Obsession with one financial figure, GDP, has worsened people's health, happiness and the environment, and economists want to replace it", Scientific American, vol. 323, no. 2 (August 2020), pp. 24–31.
The Maddison Project of the Groningen Growth and Development Centre at the University of Groningen, the Netherlands. This project continues and extends the work of Angus Maddison in collating all the available, credible data estimating GDP for countries around the world. This includes data for some countries for over 2,000 years back to 1 CE and for essentially all countries since 1950.