GDP Explained

There is always some amount of apartheid when it comes to countries, followed at the global level.

I’m talking about a country’s quantum of development. So you have aphorisms like “Developed country” and “Developing Country”, “Third World Nations” and “Backward Economies” being used causally.

What defines these clichés? Success? How do you measure that? If it was a few decades ago, it would have been the expansionist criteria that would have determined whether a country is successful or not based on how many other countries around it and all over the world it has conquered, won, annexed and in general, rules over. So you had the British and the Spanish, the French and the Portuguese being considered rulers of the world owing to the colonies that they held. I don’t want to go deeper to an era when we had kings and emperors who used all sorts of means to wage wars against other kingdoms and expanded their kingdoms. From Greece to Egypt to Indian kingdoms of yore and the Chinese warlords, history is replete with examples of regimes that counted success based on the size of the kingdom, the size of the armed forces including the animals and the fleets at sea, and the wealth possessed by the kings. A country was considered rich and prosperous when its subjects lived a lavish life as did the king in his stately palaces, adorned with jewels and the best the world at that time would offer as luxury. Or, from the world of fiction, the Iron Fleet from Game of Thrones.

Things are a tad different today. Wars have begun to be looked down upon and expansionist agendas are frowned upon by sophisticated countries. For the past century or so, the world has definitely seen major wars, including the world wars, why many nations are still at war with each other- either overtly or covertly, but the focus now has been on economic development. And ever since a country’s wealth began to be measured through its Gross Domestic Product (GDP), we have seen a huge change in perception.

What is GDP?

It is the measure of the total monetary value of the country’s finished goods and services (mostly for sale in the market) in a specified time and is considered as a comprehensive scorecard of a nation’s economic wellbeing and health. It is calculated by using the formula

GDP = Consumption + Investment + Government Spending + Net Exports

Or

GDP = C + I + G + NX

where

  • consumption (C) represents private-consumption expenditures by households and non-profit organizations,
  • investment (I) refers to business expenditures by businesses and home purchases by households,
  • government spending (G) denotes expenditures on goods and services by the government, and
  • net exports (NX) represents a nation’s exports minus its imports.
    (source: britannica.com)

GDP of a country is routinely debated in the media, because it shows the state of the nation’s economy. Single digit or double digit is oftentimes the point of contention, meaning that a GDP forecast of anywhere above the forecasted % is considered healthy. Many countries outperform such forecasts while still many underperform on these standards. A lot of the health of the economy of a country depends on the policies implemented by the country’s ruling party’s ideology, expertise and the people’s mandate. Note, a country’s GDP is also calculated and published by international bodies like the World Bank, the International Monetary Fund (IMF) or the country’s Central Banks and Economic Forums.

Such announcements, wherein the GDP is a determinant for the country’s performance, impacts the overall business scenario of the country. It also has a direct bearing on the country’s rating by agencies like Moody’s and Standard and Poors Index which are followed by lending agencies including banks and financial institutions that lend money to the govt or the country’s large businesses. When GDP is on an uphill for two or more consecutive quarters, the economy is considered flourishing whereas when the opposite happens, it is considered floundering. GDP is also used to calculate the country’s per capita GDP which gives you the country’s wealth per person, which in turn shows the standard of living of its people.

GDP is determined using three different approaches-


  1. Production
  2. Income
  3. Speculated expenditure

Toppers in World GDP

The IMF releases a list of the GDP of all its associate nations every year. Collectively, the world’s GDP for 2021 stands at $ 91.98 Trillion and America tops the chart yet again.
The highest ranking countries in the world in nominal GDP:

  1. United States (GDP: 20.49 trillion)
  2. China (GDP: 13.4 trillion)
  3. Japan: (GDP: 4.97 trillion)
  4. Germany: (GDP: 4.00 trillion)
  5. United Kingdom: (GDP: 2.83 trillion)
  6. France: (GDP: 2.78 trillion)
  7. India: (GDP: 2.72 trillion)
  8. Italy: (GDP: 2.07 trillion)
  9. Brazil: (GDP: 1.87 trillion)
  10. Canada: (GDP: 1.71 trillion)

Why does the US have the world’s highest GDP?

Not just today, but it has been enjoying this distinction ever since 1871. Why does the US top this list year after year? Is it because it enjoys the world’s highest and most valuable natural resources? ( the estimated value of the natural resources of the US are slated at $ 43 Trillion).

The reason is that the US values entrepreneurship and encourages anyone with innovative ideas. It’s ecosystem is conducive to any idea that can make a difference and is not laughed down upon saying it’s trivial. That is how you have got the world’s Microsoft and Apple and Tesla flourishing in the US. I cannot think of any other country in the world that would support and encourage someone like Elon Musk who nurtures dreams of putting man on Mars. NASA has supported Space-X like no one else. I cannot even think how India’s ISRO would support a private player had it been in the race to do something similar or even a private player in China aiming or dreaming to do so. It can happen easily in the US. The markets welcome any new innovation with open arms. The country’s economy is bolstered by its financial institutions.

US also happens to be the second most industrialized nation (after China, today). China has set new standards when it comes to industrialization and open economy for global giants to set shop. Its Ease of Doing Business index ranking stands at No. 3, only behind New Zealand and Singapore and ahead even of the US, Britain and Germany. India’s ranking is at 63. However, India’s GDP surpassed that of the UK and France in 2019. What makes India’s GDP PPP lower than most developed nations in spite of its high GDP is its overwhelming population that burdens the government heavily. The US with its size and quantum of natural resources that far surpasses that of India and a population way below it, naturally has a GDP PPP much higher than that of India.

Factors that impact GDP of a nation

Earning and spending is all that it boils down to when calculating a country’s GDP. However, a good 6 factors impact the GDP of any country.

  1. Natural Resources: It is impossible to produce anything worthwhile without the oil, petroleum, the minerals, coal and gas, cement and stone and even water for that matter.
  2. Physical capital (infrastructure):All those roads and dams, the smart cities and the airports, ports, bridges, huge markets and buildings, large factories and stadiums that governments and private players invest in, go on to create more wealth for the nation.
  3. Population (Labour): Countries like India and China that were bursting at the seams with their ever increasing population, now make hay owing to the availability of cheap and abundant labour to do the tasks in their factories and markets. In fact, India also enjoys the demographic dividend of having more than 63% of its population is in the age group of 15 to 59 and is expected to peak by 2026 with 65% of its population below 35 years of age.
  4. Human Capital:The US scores on this front hands down, which becomes a key determinant of its high GDP. Having skilled workforce ensures that the country has the hands that produce goods and services that add up to high value.
  5. Technology: All those labs and business incubators that serve as a sandbox for the country’s talented men and women produce technology that boosts the country’s economy like nothing else. Vehicles, telecom, computing power, space, agriculture, electronics and communication and so many other sectors benefit from advanced technological know-how.
  6. Law: One cannot comment easily on the strength of the law of a nation without understanding its implications on people’s lives in general. The clogged arteries of a country’s judicial system and its media are a broad indicator of how justice is perceived in a country. Instances of racial abuse and injustice meted out to minorities of any country do not show the country in a positive light. However, laws pertaining to the corporate sector, ones that assist in the smooth setting up and functioning of its industries and organizations, transfer of money and attracting investment, all aid in its rapid development.

It also takes into account the rate of inflation, agricultural yields being impacted by rainfall and lack of it and such other criteria.

Is GDP the only measure of a country’s economic health?

Well, currently yes. But experts have for long being debating if that should be the case. Keya Acharya, a Bangalore based journalist and President of the Forum of Environmental Journalists of India says, in an article of hers “Simon Kuznets, the original founder, had said over fifty years ago that to assess a nation’s welfare, economists need to ask not how much the economy is growing, but what is growing and for whom, points out Canadian political scientist Ronald Colman (associated with Bhutan’s Gross National Happiness index).Robert Costanza of Australian National University says GDP ignores social costs, environmental degradation, income-inequality, something even the OECD’s (Organisation for Economic Co-operation and Development) head of national accounts, Francois Lequiller concurs.

In 2008, the then President of France, Nocholas Sarkozy, set up the Commission on the measurement of Economic Performance and Social Progress to guide the new economic policy of the country. Chaired by Joe Stiglitz and advised by Nobel Laureate, economist Amartya Sen. Sarkozy wanted to change the way we measure growth of a nation. He felt that the indicators used currently may not be enough to capture the way people live, earn and spend in current times. Ex. Traffic jams result in increased use of fuel or high pollution levels may increase consumption of electricity for cooling, but they may not increase standard of living. They argue that Net National Product which considers effect of depreciation or Real Household Income could be more relevant indicators for calculating progress of a country.

The current form of calculating GDP also doesn’t take into consideration unpaid work, like volunteering and childcare or geriatric care at homes which significantly impact the standard of living of a country’s people. Ex: In countries like India and Japan with close knit family structures, the primary caregiver for infants and the elderly as also the infirm, is most of the times the woman of the house. In developed nations on the other hand, it would have been the responsibility of the state or the family would have to shell out extra for availing these services. It also does not include the shadow economy or the black market where financial transactions do happen, money changes hands but escapes the radar of the government and is hence not accounted. A large percentage of all economies fall in this category.

Already, several alternatives have been suggested as alternative to GDP. These include

  • Gross National Happiness (As calculated by Bhutan, officially)
  • Thriving Places Index
  • Happy Planet Index
  • Human Development Index
  • Green Gross Domestic Product
  • Genuine Progress Index
  • Better Life Index

Countries, such as the US, also determine the country’s economy by measuring the Gross National Income (The GNI) which slightly differs from the GDP. The GNI is the total domestic and foreign output claimed by residents of a country which takes into account the GDP as also incomes earned by foreign residents minus income earned in the domestic economy by non-residents. Comparing the two gives a ratio of the nation’s international activity.  GDP also does , or rather cannot, consider the shadow

GNI= GDP + Money flowing from foreign countries to my country Money flowing to foreign countries from my country

How GDP impacts you?

In many ways, for that matter. It affects our personal finance in more ways than one would think. Investors, whether domestic or foreign, always glance at the country’s GDP to make key investment decisions. Why would they invest in a country with a flailing economy rather than one that is being bolstered by the nation’s economic policy and a strong government? Lack of foreign investment in your country’s industries means that you lose out on getting easy capital. That in turn, impacts the country’s job growth rates. More industries straight away translate into more job opportunities for the local population which has a direct bearing on the standard of living of the people so employed.

 

Conclusion

Whether an indicator of a nation’s progress or development (or both), GDP has stayed for now to determine how a country fares on economic indices. Until there are better and more comprehensive measures that take into account other factors which may or may not include money alone, we have to gauge a country’s status by its GDP. And work hard so that our country stands ahead of most. As a responsible citizen, that is the least we can and ought to do.

Are there any other metrics you think that could provide more clarity about a country’s growth? Comment below. I would love to hear from you.

Disclaimer: This is just a depiction of my understanding of the financial concepts and this is in no way a financial advice.

 

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