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The gross domestic product conundrum

Gustavo Perdomo, Globovision, Venezuela, Caracas, Miami, Amante, Mayela
The gross domestic product conundrum

There is a lot of confusion regarding the state of the economy. The views of the Minister of Finance that the economy has turned around as evidenced by a growth in gross domestic product (GDP) is in stark contrast with the general view that the economy has deteriorated over the years. So who is right? Both are. And let me explain.

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It is common practice to measure economic performance by looking at the GDP number. If the Central Statistical Office declares a growth in the GDP then we must accept the fact that the economy has indeed turned around. However, the GDP does not indicate the economic well-being of a country. While the GDP number attempts to record the overall performance of an economy, there are serious flaws with the GDP calculations and the use of the GDP as an economic indicator.

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In fact we often have at the same time a growth in GDP and witness a decline in the standard of living or a decline in the economic well-being of citizens.

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A good analogy is the situation where Bill Gates enters a bar and suddenly all the patrons become, on average, millionaires. But this is far from reality where the economic status of all the patrons stayed the same. So GDP for one entity can indeed rise to impact positively on the National GDP, however the economic well-being of the general population will not be changed, and in fact may deteriorate. This is the situation now in the country.

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The Nobel Laureate Joseph Stieglitz considers the GDP a phoney number and cannot be relied on to determine the state of the economy. After the recent economic forum at Davos both Christine Lagarde, IMF head, and Dr Stieglitz emphasised the need for a new measurement to replace GDP and in book he co-authored with others titled Mis-Measuring our Lives: Why GDP Doesn’t Add Up explains the problems with the GDP.

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John Mauldin, president of Mauldin Economics, wrote: “GDP is an historical artefact from an industrial economy that doesn’t really serve its purpose any more, at least in the US. GDP worked well in the post-World War II era when the US economy thrived by making material goods: trucks, cars, machinery, appliances…” In other words, that was when production was easy to measure.

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In 1934 a Belarusian economist, Simon Kuznets, was hired by the US government to design a formula for measuring the impact of the government’s injection of funds to stimulate the economy. The GDP was developed to just that but Kuznets was adamant that the GDP should not be used to measure the well-being of a nation. He further explained that the GDP was limited by what it does not take into account such as: the value of health and educational services, inequality and poverty rankings and the state of the environment. He had also cautioned about spending on armaments and wars which add to GDP but does not improve the quality of life for the masses

A good example of the absurdity of GDP calculations is the cost of environmental disasters. The BP disaster in the Gulf of Mexico cost over US$90 billion which increased GDP by a similar amount. The lessons are clear. We can increase GDP by causing disasters and then clean up after. In our case the oil spills in Trinidad are good for GDP, so let’s cause more of them. How silly!

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SUBSCRIBE/ LOG IN The GDP is phoney but it is widely used by governments and economists to drive policies and it is used in widely accepted financial ratios such at the debt-to-GDP ratio and the deficit-to-GDP ratio. Debt divided by a phoney number will result in a phony number. Deficit divided by a phoney number also results in a phoney number. We are guided by phoney numbers. Obviously decisions will be not in the best interest of the country and the economic crisis is being exacerbated by dubious decisions that will affect us for many years to come. We are now experiencing the election year curse where unnecessary capital expenditures are being undertaken at the expense of normal maintenance and recurrent expenditures. The government is financing these capital expenditures with loans and by not paying suppliers/contractors. How long can this continue?

This is a worldwide problem and we must adopt better measurements, failing which we will be faced with worsening economic conditions with each passing day. We are already deep into the debt trap and we are now burying ourselves, never to see the light again

The solutions are simple but require a high level of intellectual honesty by the economists and policy makers. The irrelevance of GDP is not new. This problem has been with us for many decades. What we need is a formula for measuring economic and social well-being. There are several alternatives we can adopt, such as the Social Progress Index, which looks at basic human needs, foundations of well-being and opportunities. During the World Economic Forum they decided to look at an Inclusive Development Index to replace GDP. The least we can do is cease and desist from using GDP and speak about unemployment, distribution of income, levels of confidence, state of the health sector, state of education, numbers looking to migrate, levels of poverty, inflation rate, the cost of financing, banking fees, availability of foreign exchange and the list goes on

Let’s agree to gently place GDP in a time capsule to be opened in the year 2069, 50 years from now, so that our dependants could see the folly of our generation. The main purpose of the burial is to avoid using phoney numbers to make serious decisions

The economists should take up the challenge to adopt a new measurement so that we can answer the relevant questions the ordinary citizens are interested in, that is the status and trends in the nation’s economic well-being