January 23, 2018
GDP Should Be Corrected
The hazards of relying solely on gross domestic product as a measure of overall economic activity have become obvious over time, especially as corporate profits have outpaced GDP growth in key economies. But none of the flaws in GDP are fatal, and policymakers should focus on fixing them, rather than seeking an entirely new framework.
ZURICH – Respected economists have long pointed out that gross domestic product is an inadequate measure of economic development and social well-being, and thus should not be policymakers’ sole fixation. Yet we have not gotten any closer to finding a feasible alternative to GDP.
One well-known shortcoming of GDP is that it disregards the value of housework, including care for children and elderly family members. More important, assigning a monetary value to such activities would not address a deeper flaw in GDP: its inability to reflect adequately the lived experience of individual members of society. Correcting for housework would inflate GDP, while making no real difference to living standards. And the women who make up a predominant share of people performing housework would continue to be treated as volunteers, rather than as genuine economic contributors.4
Another well-known flaw of GDP is that it does not account for value destruction, such as when countries mismanage their human capital by withholding education from certain demographic groups, or by depleting natural resources for immediate economic benefit. All told, GDP tends to measure assets imprecisely, and liabilities not at all.
Still, while no international consensus on an alternative to GDP has emerged, there has been encouraging progress toward a more considered way of thinking about economic activity. In 1972, Yale University economists William Nordhaus and James Tobin proposed a new framework, the “measure of economic welfare” (MEW), to account for sundry unpaid activities. And, more recently, China established a “green development” index, which considers economic performance alongside various environmental factors.
Moreover, public- and private-sector decision-makers now have far more tools for making sophisticated choices than they did in the past. On the investor side, demand for environmental, social, and governance data is rising steeply. And in the public sector, organizations such as the World Bank have adopted metrics other than GDP to assess quality of life, including life expectancy at birth and access to education.
At the same time, the debate around gross national income has been gaining steam. Though it shares fundamental elements with GDP, GNI is more relevant to our globalized age, because it adjusts for income generated by foreign-owned corporations and foreign residents. Accordingly, in a country where foreign corporations own a significant share of manufacturing and other assets, GDP will be inflated, whereas GNI shows only income the country actually retains (see chart).
Ireland is a prominent example of how GNI has been used to correct for distortions in GDP. In 2015, Ireland’s reported GDP increased by an eye-popping 26.3%. As an October 2016 OECD working paper noted, the episode raised serious questions about the “ability of the conceptual accounting framework used to define GDP to adequately reflect economic reality.”
The OECD paper went on to conclude that GDP is not a reliable indicator of a country’s material well-being. In Ireland’s case, its single year of astonishing GDP growth was due to multinational corporations “relocating” certain economic gains – namely, the returns on intellectual property – in their overall accounting. To address the growing disparity between actual economic development and reported GDP, the Irish Central Statistics Office introduced a modified version of GNI known as GNI*) for 2016.
The gap between GDP and GNI will likely close soon in other jurisdictions, too. In a recent working paper, Urooj Khan of Columbia Business School, Suresh Nallareddy of Duke University, and Ethan Rouen of Harvard Business School highlight a misalignment in “the growth in corporate profits and the overall US economy” between 1975 and 2013. They find that, during that period, average corporate-profit growth outpaced GDP growth whenever the domestic corporate-income-tax rate exceeded that of other OECD countries.
In late December, this disconnect was addressed with the passage of the 2017 Tax Cuts and Jobs Act. By lowering the corporate-tax rate to a globally competitive level and granting better terms for repatriating profits, the tax package is expected to shift corporate earnings back to the United States. As a result, the divergence between GDP and GNI will likely close in both the US and Ireland, where many major US corporations have been holding cash.
Looking ahead, I would suggest that policymakers focus on three points. First, as demonstrated above, the relevant stakeholders are already addressing several of the flaws in GDP, which is encouraging. Second, public- and private-sector decision-makers now have a multitude of instruments available for better assessing the social and environmental ramifications of their actions.
And, third, in business one must not let the perfect become the enemy of the good. We have not solved all of the problems associated with GDP, but we have come a long way in reducing many of its distortions. Instead of seeking a new, disruptive framework to replace current data and analytical techniques, we should focus on making thoughtful, incremental changes to the existing system.