Formulating economic policy is impossible if we don’t know what the economy looks like and how it’s doing. Once we have a basic idea in our heads of how the economy works, we need to figure out where it is at the moment before we tinker. That requires measuring key variables such as output, employment and inflation. Perhaps the most commonly cited economic measure is Gross Domestic Product (GDP). GDP is considered one of the best measures of economic performance because it is a good barometer of the economy’s ups and downs.
What is GDP?
GDP is the country’s total income: if we add everyone’s income, from household wages to business profits and government surpluses we get GDP. GDP can also be measured as the value of all the goods and services produced in the economy. In New Zealand this is the preferred the measure of economic activity.
To measure the value of goods and services we can calculate the total expenditure on consumption, investment and exports, less the spending on imports. This is probably the most intuitive way to think about the economy: our production is determined by how much people are willing to spend.
The chart above breaks GDP down into its component parts: private consumption, government spending, investment, exports and imports. Note that imports are a negative contribution because the money goes overseas. You can see that investment is not a big part of the economy but it can have a big influence on the direction of economic growth because it is very volatile.
Strengths and weaknesses
GDP is an excellent measure of how much we produce, but it is important to remember that production and spending are all it measures. It is not a measure of the standard of living, although it is often used as such. Standards of living also depend upon the amount of leisure time we have and the wage rate. In addition, GDP tells us nothing about how the incomes are distributed: it may be that most of it goes to only a few people.
These are not reasons to ignore GDP, which is a vital economic measurement, but it is important to realise that the state of the economy is too complex to be summed up with a single number.
For the latest GDP figures go to Statistics NZ.
For a detailed investigation of GDP as a measure of standards of living see the recent report commissioned by the French government: www.stiglitz-sen-fitoussi.fr