GDP and groupthink

Gross domestic product is a key measure of a country’s economic health. However, Graham Davies asks whether there is a more meaningful economic measure of progress and prosperity.

If your doctor judged your health solely on the basis of the mass of food you eat, or if a board judged company health solely on its turnover, you would be concerned.

Yet we take this approach all the time by using gross domestic product (GDP) as a measure of the health of our economy. This is not to say that GDP should not be measured, but it is worth questioning the relevance of the correlation between GDP, wealth and standard of living. Is GDP a valid key performance indicator (KPI) for an economy?

In 2011, Christchurch, New Zealand, was severely damaged by earthquakes and this required much effort and cost to rebuild, however, this tragedy increased GDP. In contrast, volunteer workers do great things for our society, but GDP ignores this. It also places no inherent value on our natural resources, which are handed to us on a plate “pro bono”.

While land purchases may reflect some of this value, in general, accounting practice only evaluates “improvements”. Disastrous projects such as Union Carbide, Deep Water Horizon and Montara off the Australian coast, that result in serious illness, capital write-offs and toxic runoff, require additional expense in the form of doctors, emergency workers, demolition, rebuilding and clean-up. All this extra work increases GDP.

Similarly, consumer products such as phones, appliances and fashion, with a short life and designed-in obsolescence, increase GDP because of the continual need to repurchase said items after “throwing them away”. Criminal activity, disasters and disposable products all add to GDP, but the Country Fire Service, charities, and natural water purification do not. GDP does not predict the future, though it is fair to say that prices go up based on demand and scarcity. However, economic forecasts do not easily consider delayed consequences and thus, can mask reality. This in turn leads to cycles and ultimately can lead to crashes.

UNQUESTIONED RELIANCE

So why is there this unquestioned reliance on GDP? The G20 Summit at great expense (which increased GDP) concluded with a commitment to economic growth (i.e. an increase in GDP) of 3 per cent. Is this groupthink in action?  Historically, when there was scarcity, GDP had some correlation with standard of living, possibly in the same way our ancestor’s health correlated with the amount of food eaten, or economically strong companies with large turnover. Perhaps this was the basis of GDP getting such credence, but given the list of companies with large turnover that no longer exist and the obesity epidemic, is it not time to question GDP as the only measure of the economy?
In 1968, Robert F. Kennedy said of gross national product (GNP): “We seem to have surrendered values to material things. GNP measures everything except that which makes life worthwhile”. In the context of this article, GNP, gross value add (GVA), gross national income (GNI) and gross state product (GSP) are considered to be of the same ilk as GDP.

In short, GDP does not measure value or even accumulated material wealth; it only measures economic activity — good and bad, and in fact, the developer of GDP, Simon Kuznets warned against its use as a measure of wellbeing or standard of living. And if we consider that labour productivity is effectively GDP per person, we then bring into question the productivity measure as well, and many other KPIs that are all based on GDP.

What is the alternative?

So what alternative measures or KPIs are there for an economy? There is no easy answer, but it may be better to have no KPI than a misleading KPI. What about net assets, net tangible assets, or gross equity? A measure worthy of consideration is the total net tangible assets less the total value of land, which aims to value “human improvements”. Further to this, what about subtracting the cost to rehabilitate damaged environments and displaced communities along the lines of the genuine progress indicator (GPI)?

There are numerous indices proposed that look at net wealth, wellbeing and standard of living. According to some of these measures, the “Western World” has not really progressed in the last 20 years, which appears consistent with anecdotal evidence and public surveys. So if there is a problem with the measures of GDP and productivity, what should directors do about it? Firstly, consider the fundamentals on which the modern economy is based; then review your KPI fundamentals, understand how the organisation is affected by the greater environment in which it operates, and strategise how this may change in the future.

Then do a risk assessment on various scenarios and where high risks may eventuate. Consider what the business opportunities are in the future and what happens to profitability and assets if/when growth (change in GDP) stops and how will this affect market capitalisation. Black Swan events are often cited, whereas in reality they were foreseeable and occur as a result of ostrich behaviour and/or groupthink. An economy depends on people and eco-systems and not GDP.  Is it time to don the “black hat” and reconsider GDP as a fundamental driver/lever of an economy?