Everyone talks about GDP. Economists of all sorts care about GDP. From a layman to the lover of economics, from a Globetrotter to a Geopolitical Strategist, GDP is a "go-to metric” to compare and examine the size and strength of nation-states. Despite its popularity, GDP is a misnomer and does not effectively capture what it is supposed to.
GDP (Gross Domestic Product) is one of the most extensively used measures of an economy’s output or production. It is defined as the total monetary value of goods and services produced within a country’s borders in a specific time period — monthly, quarterly or annually. GDP is considered an accurate indication of an economy's size by most economists and policy makers. The GDP growth rate is often advocated as the single best indicator of economic growth. GDP per capita is believed to be in close correlation with the trend in living standards over time. The Nobel laureates Paul A. Samuelson and economist William Nordhaus observed, “While GDP and the rest of the national income accounts may seem to be arcane concepts, they are truly among the great inventions of the twentieth century.” In their popular book on the subject of Economics, they praise the ability of GDP concept to present an overall picture of the state of the economy. GDP allows policymakers and central banks to judge whether the economy is contracting or expanding, whether it needs a boost or restraint, and whether a threat such as a recession or inflation clouding an economy.
GDP can be calculated either through the expenditure approach (the sum total of what everyone in an economy spent over a particular period; GDP = Consumption + Investments + Govt. spending + (Exports – Imports) or the income approach (the total of what everyone earned). Both should produce the same result. A third method – the value-added approach — is used to calculate GDP by industry. Notwithstanding the method employed for its calculation, GDP measure is primarily an aggregate monetary value of all economic output in a Nation. That means, most of the components included in the estimation should reflect the market prices of the respective economic outputs in various sectors. Apparently, the GDP estimates are supposed to reflect the volume of transactions/units outputs multiplied by their respective market prices in a given period. Of course, we also know that these total estimations are adjusted for inflation or deflation indices in reference to a base year to calculate the real GDP.
I would like to draw your attention to the limitations of GDP measure based on the following premises and address why we need to exercise caution in applying GDP to examine the emerging economy like India.
First, the market prices of many products and commodities do not reflect the real cost of production or the quality of the products, for the reason, marketing and pricing strategies in many industries are not really tied to the demand or cost (supply) factors, rather based on political, competitive, global, and long-term strategic interests. In short, prices may be overstated or understated not reflecting the real or intrinsic worth of the labor and other costs of factors of production. For instance, in several critical sectors of the economy like metals, agriculture, manufacturing, and electronics the prices have been declining steadily for the past few decades. Such declining prices might be due to over-capacity forcing the price wars, intense competition, trade wars or expanding global market size resulting in scale economies. Many industries have delivered tremendous volume of product output despite mounting losses. See the price trends of Electronics.
Even if the GDP estimations are adjusted with a inflation or deflation index, the estimate will not adequately reflect the price declining effect on the economic / volume output. Moreover, in recent decades, inflation does not appear to be stemming from the economic/production activities that account for employment, infrastructure and value creation in a society - rather mostly arising from speculative economic activities in industries such as real estate, stocks, and other financial services. Whatever the reason, if the prices are steadily falling while the output volume is rising in many critical sectors, what will be the net-effect on national GDP? What are the implications for policy making? May be, the real production and value creation activities are being undervalued and under-represented - which is a central problem arising due to inefficient markets.
In contrast, however, the rise in oil price may stunt the growth of an economy and have adverse consequences to several other sectors. Please see the chart of oil prices vs US GDP growth trends. The bottom chart depicts India GDP Vs Crude oil prices. Whenever the oil price goes up GDP gets stagnant.
Second, the GDP measures and growth rates are not addressed in light of the sectoral differences in terms of the volume of outputs /transactions or their respective periodic growth rates.
Third, often the GDP figures of nations are compared on the basis of US. $ value (after adjusting for purchasing power parity), since US Dollar is a dominant global currency. Such comparisons, neglect the power of volume of economic transactions within several critical sectors of a Nation. Within many emerging economies, the economic transactions in several industries do not enjoy premium prices because of the quality issues, inability of the products to reach global markets, or the stage of economic evolution is such that low price is the inescapable predicament. Thus, when we read, US GDP - $20 Trillion+, China GDP - $10 Trillion +, India - $3 Trillion and Australia - $ 2 Trillion - we have to exercise caution here. Do these numbers really capture the true size of the respective economies? For instance, consider the economies like Canada and Australia with populations less than 50 million people. How would these economies rank in parity with Nations such as India - a highly industrialized economy with 1.25 billion people? One can presume that India and Chinese economies can be several folds bigger and stronger than what the GDP figures would suggest (in terms of US $). For instance, in 2019, about 3 million cars and 21 million motorcycles sold in India - a figure comparable to any big industrialized economy.
Fourth, if we subtract or adjust for all the costs of risk, trash, and the externalities - that mounts due to mere speculative growth of assets value, consumer gratification, perfume-packaging, and credit card burden - from the GDP estimates, one would arrive at a different picture on the size, strength, stability, and soundness of an economy. One can surmise, even the GDP estimates of the mature American economy would not accurately reflect the true value and strength of the US economic output.
In light of the above observations, the recent misinterpretations and misapprehensions about India’s GDP are addressed here.
There is much a write and talk about Indian economy and its growth rate in recent times based on GDP statistics. Do such data, economic indicators and the opinions based on these numbers have any significance for a growing diverse economy like India? In my opinion, for most people, for most sectors and industries, and for most part, they are practically irrelevant in the long-term.
The data and interpretations of GDP and its growth rate on a short-term basis like quarterly or monthly has only relevance for short-term investors in money and stocks....and such information has no relevance at all for long-term investors and the whole economy in general especially diverse and self-reliant diverse economy like India.
However, I would like to express a caveat: Such short-term analyses and policies based on economic numbers and their quarterly fluctuations primarily catering to the interests of short-term investors will have adverse impact on the whole economy in the long-term....
1) First, the GDP numbers are subject to many biases, miscalculations, and misinterpretations, because they don't capture the sectoral or industry differences in terms of their respective volume of transactions and growth rates. For example, the steel, cement, and appliance sales have been growing at the rate of more than 10% per year in India...but the actual prices in these industries have not been rising in line with the inflationary trends...prices might be constant or even declining, despite heavy demand and volume growth, due to competition and spending power limitations of the consumers. In this context, GDP growth figure will appear smaller...probably, even much smaller after adjusting for inflation...
2) India is a diverse economy... Tribal, rural, agrarian, industrialized urban, real estate driven cosmopolitan and so on....No standardized or aggregate data would ever present a good complete picture of the whole economy. More than 50% of the economic activities and transactions (rural, tribal, agrarian sources) are neither driven by stock markets and fiscal investment policies nor dependent on their performance...On the contrary, the financial markets, cosmopolitan real estate markets tied to the global economy are dependent on the economic well-being of the rural, agrarian and tribal economies within India.
3) Quarterly numbers would not make any sense for a large nation like India which is subject to seasonal, yearly and geographical variations in terms of growth. Like North-South divide and East-West divide. Although it is agreeable that some measures taken by the current government like demonetization, GST and tax policies might have affected the purchasing power and in turn growth a little bit - not because of any policy error but due to poor implementation, if the govt. quickly implements policies and instruments (some tacit Keynesian measures) like health insurance, crop insurance, farm subsidies, irrigation, and rural infrastructure investments that will promote food production, construction, and development, Indian economy will easily rise above 10%.
4) Sales data from leading industries such as steel, oil, automobiles, motorcycles, construction, electronics, and appliances all suggest a growth about 5 to 20%. I guess, after taking into account their secondary and tertiary effects on the whole economy, India could be easily growing at a rate of more than 7%.
5) Spending for defense, space research, state-of- art technology, healthcare, public infrastructure, agriculture, and irrigation development generating growth opportunities for indigenous production capabilities should not be a cause of concern (like inflation); rather such govt. spending would be a source of advantage for everything in the economy in the long-term. In fact, it will result in higher quality of life, better standard of living, and help sustain the currency value. In this light, Moody's rating or IMF ranting should not be a major concern for policy making.
6) What I am saying is.. the actual production volume of goods and services and their long-term growth matters...more than the monetary and inflation-adjusted measures of GDP.. Of course, it does not mean inflation should not be contained. By maintaining adequate production and supply in critical sectors, and by sustaining the purchasing power, there should not be any major concern about economic growth.
7) If the savings, especially retirement savings are vested into the stock market with the guarantee of reasonable returns and effective governance, most of the public firms and Indian economy overall would not have to worry about the growth at all. Of course, on any ground, market value of such retirement funds should not be allowed to go bust in the guise of bear markets or volatility. Even American stock market - with all its inefficiency and the speculative blunders – is primarily sustained by retirement savings pouring into the market month after month in the form of mutual funds. (About $1.5 T flows annually from retirement accounts alone into the US stock market)
8) Can you believe data presented in the adjacent Chart?
This is because, we have the tendency to look at data like GDP in terms of US $, because of its power in global trade. The dollar based GDP numbers can be fundamentally wrong and might lead to misguided policies. There is a saying in economics - one can get more bang for the buck...The Indian GDP figure in US dollar term does not get the real picture....that is the volume of transactions....Given the limitations stemming from quality issues, price latitude, and global reach of Indian goods & services....the price based, dollar based comparisons of Indian GDP with that of economies like US or Canada cannot tell a complete story of the full potential of Indian economy, businesses or is people. Once the quality of infra-structure and economic transactions increase, Indian economy will soon hit high numbers and be ranked on par with big league.
Finally, Does GDP need to really grow-big in terms of money value? If most of the population is happy and self-content with simpler healthier life...Think about it...