What It's All About: A Short Primer on GDP

A Political History of GDP

P H I L I PP L E P E N I E S

1 WHAT IT’S ALL ABOUT A Short Primer on GDP

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n conceptual terms, gross domestic product is a product, although in mathematical terms it is actually a sum total.

The idea of GDP is based on the supposition that one can grasp all the goods produced and services provided in a country as a single aggregated asset, the monetary value of which can be calculated. That also explains why the term is used in the singular and one never talks of a country’s “gross domestic products.”

The simplest definition of GDP is that it is the “value of the total domestic economic output of a particular country’s economy over a specific period.”1 It refers to all “goods produced and services provided domestically (value added), inasmuch as these do not take the form of inputs for the manufacture of other goods and services.”2 Here, “value” simply means monetary units. It is not quantities or the quality of products or services that are relevant for GDP, but the accumulated price of all goods produced.

It is, however, not the final market price of, for example, a car that is recorded, but only the value that the automobile

WHAT IT’S ALL ABOUT

manufacturer, as the last in the production chain, adds. The value of all the inputs the car manufacturer made use of to produce the car (commodities, services, or intermediate products, the so-called intermediate consumption) must be deducted from the price of the vehicle. This avoids cases of double counting, as the value of the inputs has already been charged and recorded by the particular producers, be it the tire manufacturer or the tanner who provides the leather seats for the car.3 A valuation on the basis of prices implies that only goods and services that are traded on the market are included in the calculation. Goods and services provided without a market price attached to them are of no significance for GDP. These include, for example, unpaid housework or the use of natural resources, which from the point of view of market logic are available free of charge.

“Growth” is determined by the rate of change in GDP from one period to another. It is expressed as a percentage and is price adjusted, meaning an attempt is made to exclude inflation. Otherwise, a mere rise in price would appear to be growth in GDP, even if there had been no increase at all in the volume of goods produced or services rendered.4 “Gross” means that the decline in value of the utilized capital during the production process (in particular the wear and tear on the machines) is not taken into account. Should this value impairment be calculated in the form of depreciation, the gross domestic product would become the net domestic product.

We speak of the domestic product because only the economic activities performed by individuals in a specific Q

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economic area (frequently, within the borders of a particular nation-state) are factored into the calculation (“domestic concept”). The individuals’ nationality and domicile play no role whatever. The value added of a Chinese company producing in the United States is just as much included in the GDP of the United States as the work of a commuter who travels from Canada to his workplace across the border. However, GDP does not include the value added of an American company producing in the People’s Republic of China, nor the income of an employee who lives in Detroit and works in Canada.

In terms of how it is computed, gross national product (GNP) is basically identical to GDP (here, again, the focus is on the sum total of value added). The important difference is that gross national product is based not on a concept of what is “domestic” but on a notion of what is “national” (“national concept”). In other words, gross national product records the value added achieved by all the people permanently domiciled in a specific country, regardless of whether this is achieved within the boundaries of the country in which they live, in neighboring countries, or in other parts of the world.

Increasing globalization has made it even more important to determine the economic output generated by a country within its own territory. This data—which GDP provides— seems more informative than gross national product for short-term analyses of a country’s economic situation. For this reason, in 1991 the United States altered its method of calculation, from gross national product to GDP; in Germany, the switch took place six years later.

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The method of calculating GDP (and this also applies to gross national product) is special because GDP can be determined in three different ways. By definition, the results of all three approaches must concur, and thus the value of GDP can be verified in various ways, making the calculated figure more coherent and plausible.

GDP is calculated by focusing on production (“production output”), on expenditure (“expentiture approach”), or on income (“income approach”). With regard to production, GDP is calculated using producers’ gross value added, as described above. By contrast, the expenditure approach highlights what end consumers spend on goods and services— that is, the value of the goods and services they procure through the market. This approach focuses on the demand side. Private consumer spending, government expenditure, gross capital formation, and exports are added up, and the value of imports (or what is known as the balance of trade) is deducted. This method of calculation also results in GDP. The third method of calculation, the income approach, is based on totaling up the income generated by the production process during the period under review. This involves first aggregating employee compensation (in accordance with the national concept) and adding it to corporate income and property income. This produces the national income, which is also referred to as the “net national income at factor cost.”

Put simply, it is the sum total of the income available to the people living in a particular economy.

Adding to this figure depreciation and taxes and duties on production and imports, while subtracting state subsidies, we arrive at gross national income. It is arithmetically identical Q

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to gross national product but is calculated via the income side.5 If we then deduct from the so-called primary income, which is received from or paid to the rest of the world (and includes labor income and interest received), the national concept becomes the domestic concept, and the amount calculated in turn corresponds to GDP. In Germany, GDP calculation is based only on production and expenditure. There is a lack of data relating to property and entrepreneurial income, and this prevents GDP from being computed from the income side. Instead, the data is calculated as a residual value.6 GDP and the way it is calculated are part of what is known as national accounts. They are intended to provide “as comprehensive and comprehensible a picture as possible of the economic activities� of a country.7 It is a system of accounts and tables that express, in figures, the course of the economy and the economic activities of people and institutions. Only by using these accounts and tables can GDP be calculated at all.

National accounts are based on a system of double-entry bookkeeping: a change in assets (use) on one side must correspond to a change in liabilities (resources) entered on the other. The data are compiled by drawing on current surveys of economic statistics, business statistics, the annual financial statements of major corporations, surveys of private households, and information from industry associations.

The calculation of GDP represents the most prominent section of national accounts. The other sections include input/ output calculations, national wealth accounts, and employment accounts.

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The method of determining GDP by means of national accounts is harmonized internationally. In the European Union, the European System of Accounts (ESA), dating from 2010, applies; this largely concurs with the United Nations’ 2008 System of National Accounts (SNA), which is used worldwide. National accounts are part of official statistics, the compilation of which is a public duty of each sovereign nation, and for this reason is conducted by public agencies.

National accounts enable us to get a picture of the interrelations among all economically active people in a society. Economics textbooks often begin with a graphic representation of the economic cycle. At its simplest, it comprises the relationship between companies (the economy) and the working population (if, for simplicity’s sake, we exclude the state as an actor and cross-border trade). The cycle is described vividly in the form of two currents, flowing in different directions, between the economy and the population. One current represents the productive side of the economy: the workforce provides companies with manpower, which producers use to create goods and services, which in turn are consumed by the population. The current moving in the other direction describes monetary flows: companies pay employees wages and salaries for the work they perform, which employees in turn use to acquire goods and services from the companies.

These currents are visualized and quantified in the production, expenditure, and income approaches of calculating GDP. GDP is the pooled, aggregated variable moving in one or the other direction along the relevant trajectories of the economic cycle.

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Despite the different methods of calculation (production, expenditure, or income distribution), GDP is primarily a measure of production. For this reason, growth—the rate of change in GDP—is also primarily defined as an increase in production. For decades, the criticism leveled against the idea of GDP and growth has been that GDP has do with goods, and growth implies an increase in production. In other words, GDP is a materialistic concept.

It was of historic significance when, in the prevailing political mind-set, gross national product (as the precursor of GDP) and a focus on production replaced the older idea of national income based on income flows. Only when the focus shifted from income distribution to produced goods did the concept of GDP become politically relevant. With the focus on production, a statistical construct became a matter of politics; gross national product became the single most powerful political number. At the same time, gross national product became a tool intended to achieve far more than mere expansion of the volume of goods and services.

The success of gross national product and GDP is based on the fact that, with them, politicians were from the outset able to pursue a whole array of goals beyond just documenting economic processes.

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