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GDP growth does not equal a quality Australian economy.

November 3rd, 2009 · Greg Atkinson · 12 Comments

It would be easy to get the impression by listening to the Government, the Reserve Bank, the Treasury, financial journalists and many economists that it is undeniably good if Australia’s Gross Domestic Product (GDP) expands, but is that entirely correct? Is there such as thing as bad GDP growth?

GDP is simply (and I emphasise the word simply) the market value of all final goods and services produced within national borders. In other words GDP is just a measure of economic activity in Australia, it is not a measure of what we as Australian’s produced or how our companies are doing because even foreign owned companies operating in Australia contribute to GDP.

We could have for example a foreign owned mine in Australia using only workers from overseas and the output from that mine would still contribute to our GDP. The national economy would benefit from the mine via royalties, taxes, capital investment and the money spent in Australia by the miners etc., but GDP does not indicate if we we are getting a fair return in exchange for allowing a foreign company to tap into our resources.

GDP is basically calculated using the following formula:

GDP = C + I + G + (EX – IM)

where:

C = private consumption. (e.g. food, rent, medical expenses etc.)
I = private investment. (e.g. new mines, factories or private housing etc.)
G = government expenditure. (e.g. salaries of public servants, new school halls, military spending etc.)
EX = exports of goods and services.
IM = imports of goods and services.

What is fairly clear from looking at how GDP is calculated is how easily it is for a Government to give it a nudge. For example;  if I were the King of Australia and I wanted to give GDP a boost (without caring what I spent the money on) I could simply hire more public servants, build some rather large military bases, commission the construction of a large monument to myself and give everyone in the land $900 to spend.

If exports and imports remained the same then my actions would drive GDP growth upwards. The question is: would my actions significantly assist long term GDP growth or improve the overall economic health of the nation? Not really and in fact they may actually damage the economy over the longer term. (especially if I had to borrow money to fund my GDP boosting frenzy)

I could however justify the actions I took by ranting on about how many jobs would be created or how the nation’s defences would be enhanced. If  I got the timing right, people may even praise me for what I did and I would look even better if other kings were doing the same thing. We could even hold a meeting of all major 20 kingdoms and tell the world what a wonderful job were were doing at a K-20 gathering.

This highlights the problem with using GDP as some sort of magic key performance indicator (KPI) by which we can quickly asses if the economy is doing well or not. GDP actually tells us very little about how well the economy is really doing and conveys nothing about the quality of what we produce or consume.

In fact GDP does not even tell us if our economy is heading in the right or wrong long term direction. For example the GDP of Nauru looked great until the phosphate ran out. This highlights another problem with GDP in that it receives a boost if a nation uses it’s natural resources to produce goods or simply export them, but it does not take into account the fact that these resources are possibly being depleted over time.

I am not an economist and therefore I do not pretend to be an expert on the subject of GDP, however what I do wish to highlight is that as a measure of the health of an economy GDP alone is not what we should be focused on. Perhaps we should also be looking at other economic indicators such as Gross National Product (GNP) and factoring into our assessment of the economy the depletion of our reserves of coal, iron ore and natural gas etc.?

If you have time let me suggest you watch this video clip of  Nobel Prize-winning economist Joseph Stiglitz explaining in 2008 why be believes we should look beyond GDP. It is only about 8 minutes long and well worth watching in my opinion.

In this clip Stiglitz is obviously focused on the U.S. economy but all of what he says is applicable to the Australian economy as well.  Of particular interest to me was the point he made about U.S spending on healthcare and actual outcomes. In other words it isn’t how much a nation spends that is important, but but rather what the nation actually receives for the money it has spent in reaching outcomes.

For me this is the single biggest problem with focusing on GDP growth alone. As a nation if we simply focus on growth we are likely to focus less on outcomes and this is already happening.

The Federal Government for example has detailed few specific outcomes in terms of how it would fix the public hospital system and instead simply outlined where it will spend more money. GDP will get a boost and it will look like something is happening, but will the extra money deliver quality outcomes?

The focus on GDP leads us into an economic trap because once most people are convinced that GDP growth is good, that is what governments will strive to give us.  Quality of life issues, diversifying the economy and a whole  host of other factors we should be taking into account in terms of managing the economy don’t get much attention.

But for now it seems we are hooked on GDP and this is why the Government (and other G-2o governments) has been dressing up the GDP figures by pumping billions into the economy. But was the  money well spent, what will be the outcomes and is our economy healthy?

My view is that Australia has wasted a golden opportunity to position our economy for the decades ahead. I believe the majority of the stimulus money that has been pumped into the economy has not been well spent, I  see few clearly defined outcomes and reckon the Australian economy has a cold which could easily become something a lot more nasty.

But maybe I have it all wrong. Perhaps all we need to do is a focus on GDP? Perhaps the spending by the Rudd Government was good policy and an effective use of taxpayers money? Maybe Australia’s natural resources will push the economy to new heights and so it is pointless worrying too much about outcomes?

In the years ahead the answers to my questions will be revealed. Until then I  will just have to live with GDP love parade.


12 responses so far ↓

  • 1 Ralph // Nov 5, 2009 at 10:40 am

    Well said, Greg.

    I’m sure GDP is not the best measure of economic activity, but that’s what we have for now. Much of it is political games, as you say. It looks like a bit of an exercise in churn. People in work, money spent, trinkets produced – it’s all good if the conveyor belt of the modern economy can be kept spinning and everyone can purchase more stuff. Genuine longer term outcomes for society are all secondary really.

    And I think you’re spot on re the lack of interest in the rate of depletion of natural resources. That’s something that never ceases to amaze me – that we are in a hurry to exploit finite resources that by their very definition will run out at some stage in the medium term.

    Take peak oil for instance. No one disputes that it will occur – just a matter of when. Even if we’re optimistic and say it occurs in 2040, that’s only 30 years to completely overhaul the fundamental building block of the modern economy. And no-one seems to care – we’ve got time, we’ll find more oil. Forget climate change, I just find that incredible.

  • 2 Greg Atkinson // Nov 5, 2009 at 11:45 am

    Ralph the problem we have now as I see it is most of the public cheer when GDP grows but really have no idea why they are happy. They are simply told that positive GDP is good and so that is the end of the debate.

    Few in the media bother to look behind the numbers and even some of the leading financial journalists don’t seem to really think about the quality of economic growth.

    Your point about Peak Oil is important for two reasons because:

    1. We don’t seem to have an energy policy in Australia aimed on getting us weaned off oil and;

    2. There is actually a point at which the world’s C02 emissions will start to decline anyway because we begin to run out of oil and coal.

    Maybe we can solve a lot of future problems by simply focusing on reducing the use of oil and coal? We could stop exporting and using coal over the next 20 years and that would make a big difference but ooops, I forgot about “clean coal”, silly me 😉

    I also don’t buy into the “poor China needs cheap fossil fuels to develop” story. If they can spend a fortune building up their military then they can afford to invest in cleaner energy generation.

  • 3 Ralph // Nov 5, 2009 at 11:56 am

    Yep, climate change is a red herring. I reckon the world talks big about climate change because it’s too $hit scared to fess up about peak oil. And peak gas, and eventually, peak coal. It’s all just too big to contemplate.

    It’s taken us probably 150 years to build the modern economy based on cheap and abundant oil. Now we’ve got 30-40 years max to find something else to power the global economy. And we’re in no hurry.

    I agree that climate change is spurious at best – something that we can quibble about and that our grandkids may get to witness. But peak oil is something that is geologically provable, will affect us in our lifetime and no one wants to talk about it. Probably a good enough reason to jump into oil exploration stocks.

  • 4 Niko // Nov 5, 2009 at 4:27 pm

    Great post. Good to see someone seeing through the spin.

  • 5 Greg Atkinson // Nov 6, 2009 at 10:24 am

    Thanks Niko. I just try and raise some views that don’t get a lot of airtime in the mainstream media.

  • 6 Dave L // Nov 8, 2009 at 5:29 pm

    But the RBA & Treasury will continue to focus on GDP. I am not sure if they have enough depth to contemplate the merits/demerits of focusing on GDP growth alone.

  • 7 Greg Atkinson // Jan 16, 2010 at 7:05 pm

    The latest unemployment figures have me a little puzzled. Where are the new jobs being created I wonder? I will look into this over the next few days.

  • 8 Mervyn Jacobi // Oct 6, 2010 at 6:39 am

    I know it is hard for people to understand, but the economical value of a country is more determined by the top personal tax applied, If you look at the tax applied by the US over the years, “History of US tax”, you will see the tax has been through chaotic changes, and the recesssions or depressions in the 1930’s and today, show that trend, “Stop the uncontrolled CEO’s and others, from taking obscene incomes and forcing high costs of goods and services on low income earners, and poor economy on industries to force closurers”, by appling a higher top tax, it was 66.6% in australia in the years from1950-1971, and the economy was in a prosperous situation. The low income employees, would have to have a no tax probable $30,000, to keep within the 30% of GDP or the government would have to spend much more – not on themselves as they had been doing previously, but on protecting our country from preditors – as mining export corporations, the reciprocal imports destroys our own manufasturing industries and much farming.

  • 9 Vince L // Nov 8, 2010 at 8:20 pm

    I think we pretty much destroyed the manufacturing sector in Australia all on our own.

  • 10 Greg Atkinson // Apr 10, 2011 at 10:22 am

    I have been talking about how the mining boom has been covering over how the rest of the Austrlaian economy has been sliding backwards for quite some time. Finally it seems a lot more people are talking about this issue now as per this article in the SMH on the 7th April 2011: No debate as Australia hollows out

    The longer the mining boom runs the more damage it does to the rest of the economy and our policy makers seem asleep at the wheel.

  • 11 Ned S // Apr 12, 2011 at 5:45 pm

    Excellent link – Thanks Greg. Time to have a think (if one hasn’t already done so) about how one’s investments and job and income security and such like are tied to the broader economy as opposed to mining maybe?

  • 12 Greg Atkinson // Apr 14, 2011 at 12:41 pm

    It really is a mixed picture out there Ned. I saw on Bloomberg TV last night that Goldman Sachs were saying it was time to sell out of commodities and lock-in some profits but plenty of others reckon commodities prices will just keep on rising.

    I can’t see much to be positive about except if China keeps powering ahead but to be honest, I don’t believe that China can power the global economy alone. Yes there is always India but the trade between India and China is now so large now that if the Chinese economy slowed it would also drag India down and the effects would ripple across the other BRIC economies.

    Anyway I will write more on the subject when I am back in sunny Japan. Right now I am in the airport in Shanghai where the free wi-fi service is probably quicker than the NBN back in Oz 😉

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