GDP Doesn’t Tell the Whole Economic Story

By Gregory Simpkins

When we read articles about the economic health of countries, we often encounter one recurring item: Gross Domestic Product (GDP). It supposedly describes the overall wealth of a country, but in reality, there are more than a few countries with rising GDP that still have massive poverty.

So, what is GDP really, and how should we regard it?

Simply explained, GDP measures the monetary value of final goods and services – that is, those that are bought by the final user – produced in a country in a given period of time (say a quarter or a year). It counts all of the output generated within the borders of a country.

GDP is composed of goods and services produced for sale in the market and also includes some non-market production, such as defense or education services provided by the government. An alternative concept, Gross National Product (GNP), counts all the output of the residents of a country.

So, if a Kenyan-owned company has a factory in the United States, the output of this factory would be included in U.S. GDP, but counted within Kenyan GNP.

Not all productive activity is included in GDP. For example, unpaid work (such as that performed in the home or by volunteers) and black-market activities are not included because they are difficult to measure and value accurately.

That means, for example, that a baker who produces a loaf of bread for a customer would contribute to GDP, but would not contribute to GDP if he baked the same loaf for his family (although the ingredients he purchased would be counted).

In theory, GDP can be viewed in three different ways:

• The production approach sums the “value-added” at each stage of production, where value-added is defined as total sales less the value of intermediate inputs into the production process. For example, flour would be an intermediate input and bread the final product; or an architect’s services would be an intermediate input and the building the final product.
• The expenditure approach adds up the value of purchases made by final users – for example, the consumption of food, televisions, and medical services by households; the investments in machinery by companies; and the purchases of goods and services by the government and foreigners
• The income approach sums the incomes generated by production – for example, the compensation employees receive and the operating surplus of companies (roughly sales less costs).

GDP in a country is usually calculated by the national statistical agency, which compiles the information from a large number of sources. In making the calculations, however, most countries follow established international standards.

The international standard for measuring GDP is contained in the System of National Accounts compiled by the International Monetary Fund (IMF), the European Commission, the Organization for Economic Cooperation and Development, the United Nations, and the World Bank.

GDP calculations are faulty

So, there are two issues involved that prevent uniform calculations of GDP globally. First, many developing countries do not have accurate accounting of economic activity.

Just as in the example of the baker who uses inputs to bake for his family, much of the agriculture in developing countries is for subsistence, i.e. is uses inputs such as seeds to grow food that will not be sold and thus that final product will not accounted for in national statistics – even if a national statistical agency was able to accurately calculate GDP or had the will to do so.

That brings me to the second issue, which is that over the decades of colonialism, many indigenous producers found ways to undervalue production to escape taxes and continued this practice after independence. This apparently became a concern for African countries considering whether to ratify the African Continental Free Trade Area (AfCFTA).

After operating largely or completely off the economic grid, many important interests were skeptical about how plugging into a continent-wide system that focused on gathering financial information transparently would affect their operations.

While GDP is supposed to show how economies are growing and ostensibly benefiting their citizens, that usually is not the case. For example, the West African nation of Equatorial Guinea has an IMF-estimated GDP growth rate of 5.8 percent, and by averaging the country’s economic activity, the GDP per capita (per person) comes to US$8,100 annually.

In reality, however, poverty is rampant in a country that is oil-rich with a relatively small population.

The Borgen Project, an international nonprofit organization that addressing poverty and hunger, estimates that Equatorial Guinea is a small country with a population of approximately 1.3 million located on the west coast of Central Africa. Although the country has become one of sub-Saharan Africa’s top five oil producers, poverty in Equatorial Guinea remains a major issue.

Oil revenues have funded the luxurious lifestyle of elites, while large populations still lack access to clean water and health care. The United Nations Development Programmer (UNDP) ranked Equatorial Guinea 144 out of 189 countries in its recent Human Development Report, combining life expectancy, education and per capita income data. The rate of poverty in the country was last estimated to be 76.8 percent – and that was in 2006, the last year it was calculated.

It has long been acknowledged that many citizens around the world, especially in developing countries, are unhappy with their circumstances despite the GDP in their country being high. University of Southern California Professor Richard Easterlin has studied the correlation between GDP and citizen satisfaction for quite some time.

In 2013, he published a report entitled Happiness and Economic Growth: The Evidence. His research covered 17 developed countries (14 European countries, the United States, Canada and Australia); nine developing countries, including overpopulated ones in Africa, Asia and Latin America, and countries with transitional economies, such as Russia and 10 other countries. He found that despite some efforts to increase incomes, citizens were not satisfied as one might expect.

Thus, the mere state of GDP growth does not guarantee satisfaction. You might have a higher income but prices outpace your income growth.

There have been discussions about replacing GDP as a performance indicator. As United Nations members gathered to celebrate the 50th World Environment Day in June 2022, Secretary-General António Guterres said it was time to abandon using gross domestic product as a measure of economic strength, as it rewards pollution and waste.

“Let us not forget that when we destroy a forest, we are creating GDP,” he said. “GDP is not the way to measure richness in the present situation of the world. Instead, we must shift to a circular and regenerative economy,” he told the gathering.

In a January 4 2023 article in Wired magazine, alternative measures worldwide were reported. For instance, China has long espoused the so-called ecological civilization measurement, setting explicit targets for nature and resource use.

China Daily, an official mouthpiece of the government, also hinted at a likely shift, floating the idea of the need for a new “development yardstick” and of additional indicators like employment and price stability.

A 2022 paper by the German Economic Ministry openly considered adding new indicators of welfare, including equality across local regions, as well as sustainability, employment, participation and social security. New Zealand’s Living Standards Framework, developed by the Treasury, includes a dashboard that measures a range of well-being indicators and is embedded as the organizing principle of its national budget.

It is vital that an acceptable GDP measurement be achieved since some programs at least partly exclude countries considered as having a GDP level that makes them considered to be developed. On 30 September 2015, the East African nation of Seychelles was graduated out of the African Growth and Opportunity Act (AGOA) effective 1 January 2017 due to the country gaining developed country status.

The definition of a developed economy is not iron-clad. Some economists consider US$12,000 to US$15,000 per capita GDP to be sufficient for developed status while others do not consider a country developed unless its per capita GDP is above US$25,000 or US$30,000.

Oil and mineral-rich nations may have a high GDP level but their populations may still be desperately poor. The high GDP level may mean that governments can afford to take care of the needs of their citizens, but what if they don’t?

Should the international community, using a country’s GDP level, end its development assistance? Can governments be forced to use its revenue to tend to the needs of their citizens rather than depending on foreign aid of some kind to fill the gaps?

These questions must be answered to prevent people in African and other developed countries from being denied assistance in meeting their needs just because their governments would rather split resource income among the elites rather than sharing their God-given natural wealth more broadly.

Gregory Simpkins, a longtime specialist in African policy development, is the Principal of 21st Century Solutions. He consults with organizations on African policy issues generally, especially in relating to the U.S. Government. He further acts as a consultant to the African Merchants Association, where he advises the Association in its efforts to stimulate an increase in trade between several hundred African Diaspora small and medium enterprises and their African partners.