What Does GDP Measure

For many, the debate over economic growth goes on as if we all are in agreement on what economic growth is. Usually, economic growth is measured in terms of the rate at which GDP increases. GDP is a monetary measure of an economy's output, but it is not necessarily a good indicator of economic well-being. And it's not meant to be.

Here's a short list of some of the things missed by GDP. Because only products sold through the market are counted, we sometimes ignore environmental quality, red cockaded woodpeckers, and leisure. Even things that are made for personal use, such as food grown in a garden, are not counted, and goods and services associated with the "underground economy" are left out of the count.

Economic "bads" such as pollution control equipment, police protection, and medical facilities to deal with health problems caused by pollution, are not subtracted, although as these costs increase we are worse off. Replacement of homes and other possessions that are destroyed by natural disasters such as hurricanes and tornadoes are added to GDP. Similarly, the production of cleaning materials and the salaries paid to clean up workers from the Exxon Valdez oil spill were added to GDP.

As human-created capital wears out (machinery), the depreciation value is subtracted from GDP to get Net National Product. GDP does not subtract the natural resources that are depleted. A nation could be ripping through the natural resource base and showing strong economic growth, but not sustainable growth. This may be a very serious problem in developing nations where economic growth policies get such high priority. A 1989 study showed that when depreciation of Indonesian forests, petroleum reserves, and soil assets were included in GDP calculation, growth rates fell significantly below conventional figures.6

Nordhaus and Tobin attempt to remedy these deficiencies by adding in those things left out and subtracting the economic bads in their Measure of Economic Welfare calculation. Some suggest incorporating sustainability into a measure of growth. Daly and Cobb have proposed an Index of Sustainable Economic Welfare (ISEW). The ISEW measures personal consumption and adjusts for the degree of inequality in income distribution, depletion of natural capital, pollution costs, and increases in foreign debt, among other factors.7

GDP, however, does include all goods and services that are environmental in nature. For example, smokestack scrubbers, catalytic converters, and new sewage treatment plants are included in GDP. So in this sense, economic growth (that is, a rise in GDP) is compatible with a rise in environmental quality. Therefore, rising demand for environmental quality can lead to more investment in environmental protection, higher GDP, and higher environmental standards. In the United States we have experienced both rising GDP and higher levels of environmental quality.

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