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Economic Metrics: Time To Dump The GDP?

The roots of the Gross Domestic Product measurement of economic health are in World War II. Even in 1968, RFK had doubts, and now criticism is growing about GDP's real value.

How did we end up using a war index in times of peace?
How did we end up using a war index in times of peace?
Itai Lahat

The formula used for assessing countries' economic growth has now been around for 71 years, and has become "the mother of all indicators."

The calculation of a nation's or region's gross domestic product, or GDP, is known for having far-reaching implications for markets as well as monetary and fiscal policymakers the world over.

When the GDP drops, markets go berserk and investors start shaking; when the GDP rises, it reflects a beautiful world full of prosperous, happy citizens. Life is considered good when the GDP increases by 3% or more. When growth is lower — or, God forbid, when it's negative — it spells catastrophe.

Life today could hardly be more quantified.

Yet, does the mathematical theorem of private consumption plus investment plus government expenditure plus export, minus import, really offer an accurate accounting of economic prosperity?

Even critics of this indicator, whose voices have become increasingly louder over the past decade, often forget to mention its roots.

The GDP was born in the shadow of World War II. During the war it was used as strategic index, as important as the allies' battlefield conquests. It was developed in 1934 by the economist Simon Kuznets for the U.S. Department of Commerce.

Kuznets warned that his index was not meant to measure welfare: "The welfare of a nation can scarcely be inferred from a measure of national income," he stated at the time.

Former chief economist of the World Bank Professor Joseph Stiglitz, like others, argued that the GDP outlasted other indices because it was well-suited for war. It allowed decision makers to estimate the tax they can impose on the public and, accordingly, the state's potential military power. In other words, how much stuff can be produced — especially tanks, bullets, guns and bombs.

But how did we end up using a war index in times of peace? Mainly because in 1962 economist Arthur Okun stipulated the golden rule according to which, for every three points that rise in GDP, unemployment would drop by one. But it is hardly clear that this rule is still valid today.

The World Bank is one of the organizations that deal with the global addiction to GDP figures, and its president Jim Yong Kim wrote in one of his books that instead of leading to better life, "the quest for growth in GDP and corporate profits has in fact worsened the lives of millions of women and men."

Economists at the Organization for Economic Co-operation and Development (OECD) have also written that GDP growth is not synonymous with progress.

Interestingly, we can go all the way back to 1968 to hear a full airing of the doubts about the GDP, (then referred to as Gross National Product, or GNP), courtesy expand=1] of then U.S. presidential candidate Robert Kennedy:

"Our Gross National Product, now, is over $800 billion dollars a year, but that Gross National Product — if we judge the United States of America by that — that Gross National Product counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage.

"It counts special locks for our doors and the jails for the people who break them. It counts the destruction of the redwood and the loss of our natural wonder in chaotic sprawl.

"It counts napalm and counts nuclear warheads and armored cars for the police to fight the riots in our cities. It counts Whitman's rifle and Speck's knife, and the television programs which glorify violence in order to sell toys to our children.

"Yet the gross national product does not allow for the health of our children, the quality of their education or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials."

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