Effects of GDP

Is GDP a good measure of the health of a developing country’s economy? What else should be considered and why?

Introduction

GDP as a measure of the performance of the economy is based on a number of assumptions that may prevent the correct representation of the state of development in third world economies. One of the reasons why GDP is not a complete method of measuring performance is the complex nature of national economies. Due to the many economic units making up the national economy, it is difficult to account for every aspect of business transactions that every unit participates in. The broad scope of economic coverage that performance measurement at the national economy level means that, the correct tool to give the best results must involve all individual units.

However, GDP includes only a few economic factors that affect the national economy in a limited way. The limitation that GDP has implies that there are several economic measurement factors left out of the focus highlighted by this tool. In addition, there are weaknesses in the methods used to measure every factor used in GDP computation (Carbaugh 2010, p229). These weaknesses would therefore logically render all reliance on the GDP value as meaningless as the weaknesses go. In the following discussion, points are raised and explained, to illustrate that GDP gives the wrong image about economic performance in third world economies. To understand the GDP method of economic performance in a country, one of the methods used in computation is explained followed by the main points that illustrate the incorrect perspective taken from a GDP view of third world.

GDP and its Determination

It is perhaps important to separately define the meaning of every word represented by the abbreviation in order to obtain understanding from word usage to support economic usage. Firstly, GDP stands for Gross Domestic Product. Gross means the grand total quantity of the economic measure being described. The word domestic can be understood to refer to internal context of the economic aspect described. It also refers to area within the home boundaries, and the use implies that the national boundaries must not be exceeded in the economic description. Product is abbreviated in GDP to represent output or production (Frieden and Lake 2000, p384). In establishing the context of the usage of the three words, GDP represents the measure of total value of produced goods and services within the boundaries of the country in consideration within a specific duration of time. The duration of time applied in GDP calculations is usually one year across the world.

In economic definition, GDP is the calculation of collected information on the value of goods and services that the country consumes and sells outside the country. Private consumption is used in the determination of domestic production. The value of money that the government spends is considered as part of public consumption and is included in the computation. The amount of money that is invested in businesses within the year inside the country is also used in the calculation of GDP. Amount of products and services that leave the country in form of exports is balanced against external products and services entering the country in form of imports. Exports add on to the value of GDP while imports reduce the value of GDP (Marien 1991, p24).

Why GDP is not an Accurate State of Economy in Third World Economies

The computation of GDP is based on several assumptions and generalizations that may not enable the correct representation of the economic status of third world economies. There are three ways of computing GDP of a country, which include expenditure (illustrated above), production and income. The main theme of the computations however is production that enables the estimation of how an economy performs within a year. Based on the below discussed points, it is clear that GDP may not be the perfect method for the computation of economic performance of third world economy.

i) Reported Figures

From the above explanation on the determination of GDP, the only information that is included in the calculations is the officially available information on all factors such as consumption and investment. The official figures only record the reported data on economic production in form of goods and services (Black, Hartzenberg and Standish 2000, p353). As briefly mentioned in the introduction, it is difficult to collect all such information from across the country for use in the computation without leaving out certain information. As an illustration, the level of economic performance that national calculations come across involves huge sums of money for big spenders and investors and small units as well. However, due to practical reasons of collection of such data, it may not be possible to consider certain values in the computations due to their small nature that is negligible or insignificant to the huge values at the national level. For instance, a commercial farmer owning several thousands of hectares of plantations in different parts of the country is not at the same level with a producer of vegetables worth a few meals in the week. In such a setting, the huge difference in the quantity produced, spent or invested may not allow the collection of all details across the country.

Within the third world context, it is impossible for the government or authorities to collect certain production information due to the difficulty in accessing all areas in the country. In such an economy where a majority of the population is poor with high levels of inequality in resources distribution, production at the lowest level is much negligible. This makes it difficult for the collection of all information of economic activities going on at all levels of production. Since the availability of such data affects the calculation of the GDP, the reliance on the figures reported about third world economies performance is therefore wrong (Tucker 2010, p515).

ii) Definition and Quantification of Production

One of the challenges in reporting GDP variables is the definition of production in an economy. On one hand, there is not dispute in the definition major economic production activities and outcomes such as manufacturing and banking. Considering the huge gap in level of economic activities going on in a country, there are millions of economic activities that can be singled out. There are economic activities that are recognized as production whereas others are not recognized. As an illustration, there are certain activities that are not considered as economic activities such as looking after one’s baby, a service that attracts payment when someone else is hired to do that work. Taking a maternal leave does not constitute to transfer of productive capacity from workplace to domestic affairs because GDP does not have mechanisms to quantify that (Forrest and Mok 2009, p54).

Several activities that the poor people engage in to earn a living in the third world setting cannot be defined by GDP calculations since there is no evidence of money exchanging hands. In view of the definition of economy as the GDP calculations imply, there must be some level of similarity across the world in order for production to be recognized. However, there is a huge difference between a third world economy and a first world economy, from the definition of the activities that the populations engage (Ersson and Lane 2002, p57). It is not possible to quantify the economic value of certain production activities where there are no means of quantification. The failure of GDP to include non-market activities on the list of economically quantifiable production makes GDP a poor tool to measure every input across levels of production as important economic factors.

iii) Illegal Businesses

Business activities considered in the calculations of GDP must be in accordance with the legally recognized business activities. The collection of economic production is usually carried out through a particular government’s definition of production within its boundaries (Gans, Mankiw and Stonecash 2011, p555). Illegal businesses constitute a large fraction of business activities, which the government cannot recognize, and such businesses are closed down and owners prosecuted. This reason places legal definition of production on the way of GDP computation since certain types of business production are locked out of the computation on illegality.

In the definition of illegality, certain businesses are illegal on various debatable areas, which could hand certain economies an advantage over others. As an illustration, there are certain countries allowing the production of crops that are illegal in others, making it difficult to account for such production across global economies (Joseph, Kesselman and Kriegler 2009, p68). Additionally, certain products and services are fully allowed in certain countries and not allowed in others. In third world countries such as African countries, sex work for instance is prohibited whereas it is a legal multibillion-dollar industry in some western countries. Lack of a harmonized legal regime in the definition of production across the world may affect GDP calculation in the third world economies.

iii) Exclusion of Wellbeing

The heavy reliance on production in definition of economic performance is deceptive in certain aspects, since it may not capture the need behind production or spending. In terms of welfare in business, production is supposed to increase conditions of life to levels that respect human dignity by covering human needs. This can be interpreted as level of utility of production if human needs are satisfied in production (Jackson 2012, p42). In terms of determination of how economic performance represents the level of utility of production in the economy, GDP fails. To illustrate this, the overreliance on production figures without determination of the contribution made to improvement of livelihood and satisfaction human needs is a failure of GDP figures. After a disaster for instance, a country will be forced by, the difficulty to concentrate efforts in rebuilding the destruction caused (Anielski 2007, p28). Construction and other rebuilding activities that continue in such a scenario are expected to push up government spending and other consumption factors, which is recorded as overall increase in production.

The heavy reliance on the level of production as a means to determine economic performance in such a case appears to be incorrect since the destruction is the cause of the production. Failure to make provisions for contributions to the status of wellbeing and utility at the end of the production implies that such rebuilding activities will be recorded as economic improvement in GDP estimates (Chan, Ngok and Phillips 2008, p15). The most accurate economic performance in the third world countries faced with difficult humanitarian crises would quantify the net wellbeing generated after the rebuilding efforts. The application of gross estimation is not reflective of possible expenditure and reductions that make it necessary to consider net value of production.

iv) Globalization

Globalization has made it a necessity to perform business at the international level, which implies that the boundary limitation that the domestic scope defining GDP is not welcome. Increased cross-border business transactions are increasingly making it possible for businesses to open overseas subsidiaries and earn foreign income for the home economy. This form of investment must account for foreign earnings that are sent back to the economy sometimes making huge contributions to third world economies (Lomborg 2001, p68). Without recognition of such cross-border earnings in economic performance, it is not possible for the accurate representation of third world economies at the globalization level. Whereas exports and imports are factored in the GDP model of measuring economic performance, production occurring outside the boundaries of the country in consideration is not included in the GDP valuation of economic performance. This would be inaccurate for third world countries experiencing brain drain and labor movement across the borders and their earnings

v) Distribution of Resources

The best reflection of economic performance must capture the contribution made by every individual in the economy. GDP figures may be high to indicate possibility of a healthy economy but huge production activity being funded by a few individuals represents a different worse case. Failure of GDP to show the level of resources distribution across the population affects the interpretation of huge GDP figures. GDP per capita may attempt to theoretically distribute production outcomes across the population but does not represent the actual distribution of production capacity (Gupta 2007, p65). Third world countries are notoriously known for huge differences in distribution of resources, with a famous saying of a few owning millions of dollars at the mercy of millions of a poor majority. Production projects funded by a few wealthy people would be similar to several medium projects funded by several medium class investors under GDP, which is not reflective of the level of equality in distribution of resources.

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