Why GDP is no longer a good measure

The February security conference in Munich saw US Vice President Mike Pence deliver a stern lecture to European members of Nato. The western alliance would be eroded, he said, if so many countries continued to shirk their fair share of defence spending, which is supposed to be at least 2 per cent of their GDP. Here was a reminder of how the big number with the little name can creep into every corner of life, including international relations.

Soon after the Munich conference, a humbler gathering of statisticians and economists took place in south Wales. Organised by the Office for National Statistics (ONS), which is based in Newport a few miles away, its title was Economic Statistics in a Digital Age. Quite a lot of the proceedings were about the ONS itself and its attempts to restore a reputation tarnished by mismeasurements in areas such as investment, trade and construction.

The main thread running through the conference, however, was a much bigger question. Gross domestic product—the total value added in an economy within a given period—rules the roost of economic indicators; a Google search for GDP throws up 112m results. GDP is used as the prime gauge of economic achievement both in the short and the long-term. Beyond its use by Nato, it is deployed to rank countries’ spending on health, the size of their banking sectors or debt burden, and a host of other measures.

But is GDP fit for purpose? It has long had its detractors. Half a century ago, Robert F Kennedy famously lamented the shortcomings of closely related gross national product (GNP), which counted everything “except that which makes life worthwhile.” A decade ago a commission backed by the French government and chaired by Nobel prize-winner Joseph Stiglitz called for less focus on the economic production captured by GDP and more emphasis on a broader set of measures covering “well-being.”

The latest bout of soul-searching is even graver than these earlier critiques since it calls into question the reliability of GDP as well as its relevance for modern economies. One number recurred during the conference: the revision to Irish GDP made in July 2016, which lifted growth in 2015 from a frothy 7.8 per cent to a preposterous 26.3 per cent.

Statisticians insist that the new figure was technically correct. It reflects the effect of corporate manoeuvres by a few multinationals, which assigned some of their assets, including intellectual-property rights, to Ireland. However, it revealed nothing about the underlying state of the Irish economy. Indeed, in 2015 the output of sectors dominated by foreign multinationals—such as pharmaceuticals and information technology—grew by 101 per cent, whereas the rest of the economy grew by 4.4 per cent. Even so, the new higher level of GDP is being used to measure the burden of Irish public debt, conveniently lowering it from the previous 2015 estimate of 94 per cent of GDP to 79 per cent.

The Irish growth figure is the canary in the coal mine. In particular it highlights the difficulty of working out the national measure of GDP in a world of international companies that can seamlessly move activities from one country to another. National accounting was devised in the 1930s and 1940s for largely closed economies, not least to guide war production. It is ill-suited to pin down the contributions to national output from modern multinationals using global supply chains and exploiting the opportunities to minimise the taxes they pay.

The national accounts were also developed for industrial economies producing a range of goods whose output was by current standards relatively simple to estimate. They have long been struggling to adapt to the shift towards a bewildering array of services that are often difficult to measure. Measuring the production of plates is easy compared with capturing the provision of pilates.

In economies where services predominate “intangible capital”—investments that do not take physical form—matters more and more, yet it is incorporated inadequately in the national accounts. It took until 2014 for Eurostat to treat research and development as investment in its measure of GDP in the European Union. But that still leaves out many other forms of intangible capital such as design, brands, the training of workers by firms and “organisational capital,” essentially the application of managerial best practices.

The deficiencies of GDP have become glaringly apparent in the digital age. Vast social-media companies such as Facebook provide their services free, but GDP excludes zero-priced products. People are increasingly making their travel arrangements online rather than through an agent, yet their efforts do not count towards GDP any more than other unpaid work at home.

Whatever the merits of GDP in principle, its flaws are more and more salient in practice. Working out the value added in domestic economies is ever trickier in a digitally connected world straddled by multinationals. Maybe national accountants can fix its accumulating deficiencies but they face a daunting task. In the meantime, we should all treat GDP with much less deference.