To what extent is GDP useful when comparing different countries?
Growth Domestic Product (GDP) refers to the value of a country’s total output of goods and services before depreciation.
Nominal GDP refers to the final output of goods and services valued at current prices. Real GDP is the nominal value of output of final goods and services discounted by the increase in price level. Human Development Index (HDI) measures the average achievement of a country in various dimensions of human development, including life expectancy at birth, adult literacy rate, and child mortality rate. Lorenz curve measures income inequality within the population.
While GDP is useful to a certain extent when comparing the nominal economic size of different countries, since GDP can only measure the economic activity that has been officially recorded, economic activities that do not pass through regular market channels such as outputs sold at parallel market are excluded from the computation of GDP. This can be a problem, especially for developing countries that may have significant part of their economy involved in productions and transactions in the parallel market, in which case the GDP figure will underestimate the actual economic size and activity of an economy. This makes accurate comparison between different countries quite difficult.
Also, Nominal GDP is useful to a limited extent when comparing different countries. This is due to the fact that it does not take inflation into account. This poses a measurement problem, as the Nominal GDP doesn’t not separate the contributing factors that caused the changes in the quantities of output produced, and the changes in the prices of goods and services. In April 2014, South Korea had a Nominal GDP of $1,156,000, while the Real GDP in 2014 price was $21562.26. Therefore, Real GDP is more useful in comparing the different output levels of a country over time, excluding the effect caused by price level changes. This is why we use Real GDP levels in measuring the annual economic growth rate of a country. By eliminating the influence of changing prices on the value of output, Real GDP can help make meaningful comparisons over time in the value of output, or expenditures, or income.
GDP only provides an indication about the overall economic size of a country. However, it does not provide any information about the level of economic welfare of average people. For the effect to individual life, GDP per capita is a better estimate. For example, China’s GDP level is next only to the US’ as the number two economic power in the world. Nonetheless, its GDP per capita is even less than Malaysia’s, which means economic welfare that individuals can enjoy is much lower than what the world GDP ranking implies.
Another limitation to using GDP is its exclusion of many standard of living factors. For example, GDP neglects counting the loss of natural resources and losses in the environmental quality caused by negative externalities, such as pollution, and toxic wastes. By doing so, this results in the overestimation of the true value of national output and standards of living.
Another limitation in using GDP is that it includes expenditures undertaken for the purposes of cleaning up pollution as increases in the value of national output. For example, when Mexico experienced a Galveston oil spill in March 2014, the funds of $7.8 dollars spent to clean up the pollutants from oil spill and health care expenditures for treating people who suffered were added to the value of output. By doing so, Mexico looks better after the oil spill and treating people from pollution-related diseases than if it had not occurred. Due to this factor, the true value of output and well-being is overestimated.
GDP may not be considered useful in part because it does not give a good indication of the quality of life such as the achievements in levels of education, health and life expectancy. According to CIA World Factbook, in 2012, Monaco’s life expectancy was 89.57 years. This may be due to technological improvements, improved health and higher income levels that have contributed enormously to a higher standard of living, but these are not accounted for in GDP. Also, in 2012, Chad’s literacy rate was 35.4%. Low income may be a contributing factor to Chad’s low literacy rate. However, these remain unaccounted for in measures of GDP. Therefore, GDP may overestimate or underestimate the true changes in the population’s standards of living depending on such factors mentioned above.
Most importantly, the GDP is not able to provide any information on income distribution of different countries. GDP only provides information about the entire output of a country. However, it fails to convey an information on how income is distributed across people within a country.
All in all, while GDP can be useful when comparing national economic size of different countries, there are shortcomings to using GDP, as it does not take into account of many standard of living factors, outputs sold at parallel market, income distribution, negative externality and its cost, and is affected by inflation.