The COVID-19 pandemic disrupts global economies and changes how companies think about everything from remote work to international supply chains. As countries around the world reconsider their business processes, some experts challenge another long-accepted practice: using GDP (gross domestic product) as the primary metric for assessing international economies.
This post examines why countries use GDP, its role in the international economy, how the pandemic has exposed its flaws, and three alternative metrics for measuring economic viability.
What is GDP?
GDP is defined as “the total monetary or market value of all the finished goods and services produced within a country’s borders.” In simpler terms, GDP measures an economy’s productivity.
In 1934, Simon Kuznets introduced the modern concept of the GDP in a report written for the U.S. Congress. Kuznets intended to create a single metric that could account for a country’s entire economic output. However, he warned leaders to remember that GDP was a measure of economic productivity, not the wellbeing of a country’s population. “The welfare of a nation can scarcely be inferred from a measure of national income,” Kuznets said.
The U.S. implemented GDP to track its economic recovery following the Great Depression. In 1944, the U.S. presented the metric to world leaders at the historic Bretton Woods Conference, which was held to establish international economic rules following World War II. The conference featured 44 nations and marked the founding of the IMF (International Monetary Fund) and World Bank. Both these institutions adopted GDP as the standard for evaluating international economies, leading the metric to become accepted worldwide.
Today, experts rely on GDP to track how economies are growing and contracting, and how countries compare to one another in terms of economic strength. Policymakers follow GDP to make decisions on interest rates and tax and trade regulations. Governments use GDP when deciding how much to invest in public services. And business leaders see GDP as an indicator of which foreign markets are worthy of investments. Economists, policymakers, and business leaders associate high GDP with economic strength and a high standard of living.
Two Ways COVID-19 Reveals GDP Limitations
Though the pandemic severely damaged economies across the world, some countries see record GDP gains. Diving deeper into the numbers reveals these GDP gains are misleading—and show why GDP is insufficient as a standalone measure of a country’s economic welfare.
The Truth Behind Record Q3 GDP Growth in the U.S.
The third quarter of 2020 marks the fastest three months of economic growth in U.S. history. GDP increased at a 33.1% annual growth rate between July and September. This rate nearly doubles the previous record, a 16.7% increase in the first quarter of 1950.
While numbers suggest the U.S. economy is quickly recovering from the pandemic’s damage, putting the situation in context tells a different story. The U.S. GDP fell sharply in the first two quarters of 2020. Though the 33.1% increase from Q2 to Q3 may seem like a significant rebound, the gains came from a smaller sample size. As a result, the U.S. GDP is still about 3.5% lower than it was at the end of last year.
To understand this concept in simple terms, consider starting with one dollar. Losing 50% of your money leaves you with 50 cents. Increasing that amount by 50% gives you an additional 25 cents, leaving you with 75 cents—considerably less than the dollar you started with. Through this example, we see that Q3’s record GDP growth does not mean the U.S. economy has exceeded—let alone met—previous levels of economic activity.
The Disconnect Between GDP and Employment Numbers
Even more problematic, GDP measures a given country’s total economic output but does not account for how that economic activity is distributed. The drastic GDP rise in Q3 took place while the U.S. unemployment rate hovered at 9.7%—more than double its pre-pandemic level. At the same time, job gains trended downward over Q3. While 1.8 million Americans gained jobs in July, that number shrank to 1.5 million in August and 660,000 in September. A decreasing job growth rate means the U.S. is years away from reaching its pre-pandemic levels of employment.
Putting GDP growth into perspective reveals its limitations as a measure of a country’s economic wellbeing. Jean-Paul Fitoussi, a professor emeritus at the Paris Institute of Political Studies, notes: “You can have a very important growth rate of GDP, but if it goes to only 1% of the population, it has no meaning.”
Three Metrics to Replace GDP
Fitoussi is part of a growing number of experts advocating alternatives to the GDP. In October, the World Economic Forum released a report proposing that experts use GDP in context with other progress indicators, like how a country uses energy or provides public health access. Following are three additional measurements suggested by experts across the world:
Degrowth: Proponents of the Degrowth model believe countries must worry less about GDP and more about addressing long-term threats like climate change and biodiversity loss. Degrowth advocates think that economies will ensure long-term success if they balance economic growth with preserving essential resources. Furthermore, because populations are decreasing in many developed countries, reducing GDP does not mean individuals must see a loss of income.
Wellbeing Index: By introducing its “wellbeing budget” in 2019, New Zealand’s government focused on making the country “both a great place to make a living and a great place to make a life.” New Zealand’s initiative replaces GDP with various measurements, including emissions levels, mental health, child poverty, and citizens’ skills and opportunities. New Zealand Prime Minister Jacinda Ardern says these criteria “will give us a true measure of our success.”
GDP and Beyond: The U.S. Bureau of Economic Analysis suggests updating GDP to consider a more holistic view of a country’s wellbeing. In doing so, the Bureau takes a “dashboard” approach: “Just as a car not only has a speedometer, it has a dashboard of other necessary meters, such as a fuel gauge, battery charge alert, and engine temperature warning light.” The Bureau proposes that countries evaluate GDP alongside factors such as education, healthcare access, and wealth distribution.
What GDP Tells Us About Global Expansion
Despite GDP’s long history as a standalone measurement of international economies, the pandemic exposes its limitations. That’s why forward-thinking policymakers and business leaders consider a variety of factors when evaluating foreign markets.
The same concept is true for companies planning international expansion. Just as there is no all-encompassing metric representing a country’s economy, there is no universal approach to growing a global business. Instead, companies must carefully consider various factors—from the resources at their disposal to their long-term goals—to create a sound growth strategy. Partnering with a global expansion expert helps companies account for every angle of their growth plans.
Contact Velocity Global today to find out how we can help your company plan every step of your global expansion.