The Lazy Economist: What’s the tea with GDP?

Exploring what GDP consists of, where it's helpful, and its shortcomings

While GDP is a useful tool, it doesn't represent every type of wealth.
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If you were to represent Canada’s economy with one number, it would be approximately 1.712 trillion.

That number is Canada’s 2018 gross domestic product, or GDP, in terms of US dollars—the common currency used to compare between countries. In case you don’t know: GDP’s a pretty big deal.

Even if you actively avoid learning about anything economics-related (and ended up here by accident), I’m willing to bet you’ve at least heard that term before—and you likely will again. So, here’s a crash course to help you understand a bit more about this important acronym. 

Let’s break down each word to get a clearer idea of what GDP represents. 

First, “gross”: in economics and business, this word doesn’t mean icky—it means before we deduct anything. For example, your gross income is your income before taxes and other deductions, just as your gross cost for medication is what you pay before any insurance or government deductions.

Next, “domestic.” This refers to our area of focus: we just want to look at Canada itself, and this is the same for every other country when they calculate their own GDP. If something was produced by a foreign company in Canada, it counts too.

Finally, “product.” This is where it gets interesting. In this context, product refers to the total market value of the output created by a given country in a given time period, usually one year. This encompasses all goods and services. 

There are two kinds of GDP: nominal and real. When you hear nominal, think of taking something at face value: it’s the value of GDP given by current prices, not counting for inflation.

Real GDP, on the other hand, accounts for inflation or deflation, or the increase or decrease in the price of goods and services. We can calculate that by using a “base year,” or a year whose market prices will be used when calculating GDP in later years.

As a result, a year’s real GDP will be lower than nominal GDP, if there’s been inflation. In other words, the actual output of the economy will be less if we account for higher prices, which may have made up part of a country’s growth.   

For year-to-year changes in growth, you would most likely look at the nominal GDP, and if you wanted to look at the impact of inflation or deflation, you could compare the two.

There are three ways to calculate GDP, and we usually look at nominal GDP, because we just take the prices as they’re given. By the magic of math, these three calculation methods will all equal one another.

The first is the expenditure approach. You would find this by adding all the country’s expenditures in the form of consumption, investment by firms and individuals, government spending, and net exports (just exports-imports) in an economy. 

Meanwhile, for the income approach, you’d add up the income that is earned from production, firm profits, investments, and personal income from labour. 

Finally, you can calculate GDP using the product method by combining the value added to the economy by the final goods and services produced in a given country. This only counts goods produced within the given period, so the sale of a second-hand book, for example, wouldn’t be included. 

Also, goods are only counted at their final stage, even if they go through many stages of production.

The intrinsic appeal of these calculations is they give us one number that can effectively represent all an economy has experienced over the course of a year. The GDP packages this information into a single data point—similar to how the market “knows all” and can gather together dispersed information like no other. 

It’s quick and dirty, and that may be why it’s so popular. To see how much a country’s economy has grown from year to year, you only need to compare this year’s GDP to last year’s, and voila, you’ve got the percentage of growth. It’s how we calculate a recession, based on GDP falling for two quarters (or two three-month periods) in a row.

Basically, this black-and-white idea—that GDP growth is good because it represents a rising standard of living, and a decline is bad for the same reason—is attractive.

But it misses a lot along the way, and here’s why: quality of life doesn’t only depend on material wealth.

It isn’t even the cliché that “money doesn’t buy happiness”—there are lots of measures to a country’s success that we ought to consider, and they can get left behind if we call it quits after determining this single economic measurement.

Countries are made up of more than just their production. Their citizens may see better lives based on factors such as a strong rule of law, the freedom to express themselves, or the peace of mind that if they become terminally ill, their country will cover their care.

These factors may track GDP, but they also may not.

Additionally, GDP doesn’t encompass the distribution of wealth and income, so it may be the case that only a small percentage of citizens are seeing an improvement in their standard of living, even if it’s growing dramatically.

Ultimately, a “good” country is not all about money. If you’ve got more than five minutes to consider whether a country is improving for those who live there, GDP should only be a part of the conversation.

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