Definition of the Gross Domestic Product

GDP – Gross Domestic Product. It is the total economic output of a country in a given year. All products bought and sold, and services delivered and used. To put it in the words of Investopedia:

Gross domestic product (GDP) is the monetary value of all the finished goods and services produced within a country’s borders in a specific time period. Though GDP is usually calculated on an annual basis, it can be calculated on a quarterly basis as well (in the United States, for example, the government releases an annualized GDP estimate for each quarter and also for an entire year). GDP includes all private and public consumption, government outlays, investments, private inventories, paid-in construction costs and the foreign balance of trade (exports are added, imports are subtracted). Put simply, GDP is a broad measurement of a nation’s overall economic activity – the godfather of the indicator world.

Governments Love It

Governments love publishing GDP data. All the time the strength of the economy is measured by its GDP. GDP growth by a few percentage? Perfect! That is what we need. GDP shrinks? Recession! Panic! The economy is crashing down!

There is some truth to that logic, but it also creates a very false image.

GDP is important, but it is important for governments more than anyone else. Especially governments with poor spending habits. For the inhabitants of a country, GDP is not necessarily very meaningful. The government debt for example, is often measured as a percentage in ‘Debt to GDP’. The EU maintains that governments should have a debt to GDP ratio of no more than 60%.

Debt to GDP

The government debt is an important measure of its health. Too much debt and a government will see its interest rates, meaning the cost of financing itself by loans, increase. Now, it makes sense that the debt should be measured against the GDP. A big country with a big economy will be able to handle a larger debt without difficulties than a small country with a small economy.

However, it also gives governments a perverse incentive. Rather than reducing their debt, they can let their debt grow as long as their GDP grows as well. This way, governments can run continuous deficits, while keeping the ‘debt to GDP’ percentage at roughly the same place.

Growing GDP, still, does not mean all the people are becoming richer. Countries with growing populations often see its GDP grow alongside the population growth. This is easy to understand, more people buying food, housing and all other items, will grow the economy. A rich family with one child is not consuming most of its income, but putting it in investment accounts instead. If that family would have five children, they’d be forced to consume a lot more. For the economy consumption, at least in the short-run, will lead to economic growth.

After all, GDP is merely people making transactions between one another. The more transactions that are made, the smaller the debt becomes in comparison.

GDP per Capita

More interesting for the inhabitants of a country is the change in GDP per capita. That is the total GDP divided over the citizens. This does not show their incomes, and it does not show equality, but it does give a better estimate of the wealth per individual in a country. Luxembourg for example has a small GDP, but also very few people, so their GDP per capita is extremely high.

A growing GDP with a stable, or even shrinking, population will mean GDP per capita is growing. A growing GDP with an even quicker growing population? Their GDP per capita is shrinking. The government finances may be in a better position than before, but the average person is getting poorer.

This begs the question, why does the media always report GDP? Why don’t they adjust it for changes in population to show the GDP per capita? That would be far, far more relevant for the people to know.

The influence of migrants

It is often said migrants are good for the economy, even that they boost the GDP. Well, it may be true that receiving a lot of migrants will boost the GDP of a country, the government expenses related to them alone will increase the GDP. However, does it increase the GDP per capita? Or does it drag the average wealth of the country down?

Unless migrants boost the GDP per capita, they are in fact impoverishing the country. Regardless of GDP moving up or down!

Migration Watch UK has shown that despite immigrants increasing GDP, their contribution to GDP per capita is either neutral, or possibly even negative. Economics Help has reached the same conclusion. Yes, immigrants boost GDP, but they do not boost GDP per capita! And even for the GDP boost, it of course matters what type of migrant is entering the country.

Nonsense GDP numbers

To add to the nonsense GDP can be, we will give a few examples. In 2006 Greece decided to include the ‘black market’ in their formal GDP numbers. This way, their debt to GDP percentage would be lower. By estimating the size of the black market, their GDP grew by 25% in a single year.

If someone throws a rock through your window, you need to buy a new window. That consumption is part of GDP.

The costs related to an asylum seeker entering a country, are all part of government consumption. This is all part of GDP. Even if the government has to borrow the money that it is spending. For example in the Netherlands, this added 1.6 billion euro to the GDP of the country.

GDP, we can see, is not a great predictor of wealth, or of how nice it is to live in a country. GDP is an absolutely useless number if we do not adjust it for population size. And still, governments try to argue that migrants benefit GDP and are thus good for the economy, and above all good for the citizens. It is logical that the government will say this, because government has a huge incentive to hide its deficits by letting GDP grow. For the government, it doesn’t matter if the GDP growth comes from population increase, or a wealthier citizenry.

Aligning incentives

The goals of the government and of the people are not aligned. Government cares about GDP, the people care about GDP per capita. Governments across Europe have shown they care more about following their own incentives, rather than try to do what is the best for the people.

In a sense, government is no longer a government for the people. Governments are serving their own interests.