Sunday, November 9, 2008

How Good Is GDP As Measurement Of Development?

GDP may be the best single measure to measure the value of output produced in an economy, yet it is not a perfect one.

Problems of using GDP as measurement of development:

(1) Does not take into account income distribution. The GDP of a particular country could be high but that doesn’t mean that everyone is better off. It could be few of the very rich individuals who actually inflate the figures, leaving the rests in deep poverty

(2) Ignoring informal economy. GDP does not take into account any activities that are not traded in the organised markets. These include DIY jobs & underground economy such as smuggling, drugs, and prostitutions. This has always been an ongoing problem for developing countries as large proportion of its economic activities consists of subsistence farming. Here the agriculture output is meant for personal consumption, hence will not be traded in the market. This has undermine the true value of GDP

(3) Depending on inflation. If inflation is underestimated, then the value of real output will be overestimated. This will cause the value of GDP to be unreliable

(4) Different methodologies. Different governments may employ different method of measuring GDP. Some could be more efficient than the others. Also some countries may include illegal activities such as prostitution. As such comparison between countries could be meaningless

(5) Ignoring quality of goods. Over the years, quality of technological goods such as video camera, personal computers etc have improved significantly & yet their prices have gone down a lot. Including these into the calculation of GDP may cause its value to fall & yet many people have benefited from it. Therefore GDP is a quantitative measurement rather than qualitative

(6) Ignoring externalities.
Pollution & other industrial activity actually impose costs onto society & yet these costs are not subtracted from the market value of final goods when GDP is calculated. For instance, a chemical firm produced £3 million worth of output but pollutes the environment & decreases its value by £5 million. Rather than indicating a loss to society, GDP will show an increase of £3 million

(7) Different level of development. 2 countries could have an almost equivalent level of GDP per capita, but one having a higher HDI (Human Development Index) than the other. This means on the average it has higher literacy rates, higher level of education attainment & longer life expectancy

(8) Differing exchange rates. Different countries have different exchange rates, thus there is a need to denominate GDP in a common currency, normally US $. Even after doing, there remains the problem of different purchasing power e.g. $1 in US will not buy the same amount as $1 in Indonesia. This leads to the usage of PPP (purchasing power parity)

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