Does GDP Measure What We Want It To Measure?

Economists use GDP Opens in new window to measure total production in the economy Opens in new window.

For that purpose, we would like GDP to be as comprehensive as possible, not overlooking any significant production that takes place in the economy.

Most economists believe that GDP Opens in new window does a good—but not flawless—job of measuring production.

GDP Opens in new window is also sometimes used as a measure of wellbeing Opens in new window. Although it is generally true that the more goods and services people have the better off they are, we will see that GDP Opens in new window is not a comprehensive measure of wellbeing Opens in new window, and nor is it comprehensive in measuring total production.

Shortcomings in GDP as a Measure of Total Production

When the ABS Opens in new window calculates GDP it does not include the non-observed economy.

The non-observed economy refers to economic activities that are missing from the data sources used to calculate GDP.

The so-called non-observed economy includes two types of production:

  1. production in the home; and
  2. production in the underground economy Opens in new window.

Household Production

With few exceptions, the ABS Opens in new window does not attempt to estimate the value of goods and services that are not bought and sold in markets.

If a carpenter makes and sells bookcases, the value of those bookcases will be counted in GDP. If the carpenter makes a bookcase for personal use, it will not be counted in GDP Opens in new window.

Household production refers to goods and services people produce for themselves.

The most important type of household production is the services a homemaker provides to the homemaker’s family.

If a person has been caring for children, cleaning the house, maintaining the garden and preparing the family meals, the value of such services is not included in GDP Opens in new window.

If the person then decides to work outside the home, enrolls the children in day care, hires a cleaning service, hires a gardener and begins buying the family’s meals in restaurants, the value of GDP will rise by the amount paid for day care, cleaning services, gardening services and restaurant meals, even though production of these services has not actually increased.

The Underground Economy

Individuals and firms sometimes conceal the buying and selling of goods and services—a phenomenon known as underground economy, in which case their production won’t be counted in GDP Opens in new window.

Underground economy is the buying and selling of goods and services that is concealed from the government to avoid taxes or regulations or because the goods and services are illegal.

Individuals and firms conceal what they buy and sell for three basic reasons:

  1. they are dealing in illegal goods and services, such as drugs or prostitution;
  2. they want to avoid paying taxes on the income they earn;
  3. or they want to avoid government regulations.

Estimates of the size of the underground economy in Australia vary widely, but a recent study by the ABS estimated it to be 1.5 percent of GDP, or around $23 billion.

The underground economy in some poorer countries, such as Zimbabwe or Peru, may be more than half of measured GDP.

Is not counting household production or production in the underground economy a serious shortcoming of GDP?

Most economists would answer ‘no’ because the most important use of GDP is to measure changes in how the economy is performing over short periods of time, such as from one year to the next.

For this purpose, omitting household production and production in the underground economy won’t have much effect, because there is not likely to be much change in the amounts of these types of production from one year to the next.

We also use GDP statistics to measure how production of goods and services grows over fairly long periods of a decade or more.

For this purpose, omitting household production and production in the underground economy may be more important.

For example, beginning in the 1970s, the number of women working outside the home increased dramatically.

Some of the goods and services—such as child care and restaurant meals—produced in the following years were replacing what had been household production, rather than being true additions to total production.

Other than being used to measure a country’s total production, GDP is also frequently used to measure the country’s wellbeing Opens in new window.