Does High GDP Mean Economic Prosperity?

Economists traditionally use gross domestic product (GDP) to measure economic activity and national prosperity. If GDP is rising, the economy is considered to be in solid shape, and the nation is moving forward.

On the other hand, if gross domestic product is falling, the economy might be in trouble, and the nation may be losing ground. Two consecutive quarters of negative GDP typically indicate an economic recession.

Is high GDP truly a reliable sign of a nation's economic health and well-being? According to some, it may not be as useful as the Genuine Progress Indicator (GPI).

What Is GDP?

Gross domestic product is the total monetary value of all finished goods and services that have been produced within a specific country (economy) over a set period of time.

GDP includes private and public consumption, government outlays, investments, additions to private inventories, paid-in construction costs, and exports (imports are deducted from GDP).

While GDP measures in the trillions of dollars, the percentage figure usually seen in published reports refers to changes in that amount. That is, the growth or decrease in GDP from one period to another.

GDP, by state or the country as a whole, is used to determine how fast the economy is growing and how it compares to other economies. It is assumed to reflect the economic well-being of American households.

There may be logic in the belief that wealth can measure well-being. Free-market prices are determined by supply and demand that can relate to how much better off individuals believe a good or service can make them. Greater wealth can mean greater access to things that can improve everyday life.

And, it's conceivable that those who produce wealth in an honest way create the most value for others, in an economic sense.

So, higher GDP might equate to greater human progress, because it means a greater amount or greater value of goods and services has been created.

But does economic growth really mean that people are better off? Scratch a little deeper and you may find that GDP does not reflect this traditional view or actual economic value and health very well.

What Is GPI?

Genuine Progress Indicator (GPI) is considered an alternative measurement of a country's economic well-being. While GDP measures economic activity, GPI considers the economic, social, and environmental costs and benefits of that activity and adjusts GDP for them.

It nets out the positive and negative aspects of conventional economic growth to provide a potentially more suitable measure and view of a nation's economic welfare.

GPI isn't officially calculated or used by the U.S. government yet. However, various states as well as interested parties in the academic realm and advocacy communities do apply and/or estimate GPI.

Supporters of GPI believe that it provides a truer picture of the health of the country. Critics argue that quantifying GPI variables and their related adjustments is difficult and therefore renders the result unrealistic or unreliable.

A bill to establish GPI as an official alternative measurement of economic activity in the U.S. was introduced to Congress in 2021 but since then, no further action has been taken. The bill calls for the combined use of GPI and GDP by federal agencies when assessing the U.S. economy and economic growth.

How GDP Misses the Mark

GDP can increase after a car accident or a major flood. It can grow rapidly during a war or after a terrorist attack. If all of Chicago caught fire once again and burnt to the ground, the rebuilding effort just might boost GDP.

This is because GDP is very susceptible to the broken window fallacy—false signals of rising prosperity when obvious destruction has taken place.

From the perspective of a citizen living with the day-to-day realities of life, GDP can be misleading. It doesn't take into account externalities such as crime, pollution, inequality, depletion of natural resources, and other negative (and costly) social and environmental aspects of existence.

This is why the genuine progress indicator was created in 1995 by a socially responsible think tank called Redefining Progress.

GPI Adjustments

Although GPI and GDP calculations are based on the same personal consumption data, GPI adjusts GDP by applying monetary values to non-monetary aspects of the economy. These adjustments fall into the following general categories:

Personal Consumption

This number is the same data used to calculate GDP.

Income Distribution

GPI is adjusted upward when a greater percentage of the nation's income goes to the poor because an income increase provides a tangible benefit to the poor. GPI is adjusted downward when the majority of a nation's increased income goes to the rich. 

GDP is only concerned with the value of all goods and services, not the distribution of their proceeds. If five individuals each earn $200,000, GDP treats that the same as one individual earning $800,000 and four individuals earning $50,000 each.

Housework, Volunteering, and Higher Education

GPI factors in the value of the labor that goes into housework and volunteering. It also factors in the benefit of an increasingly educated populace.

Service of Consumer Durables and Infrastructure

Money spent on durable goods is treated as a cost, while the value the purchases provide is treated as a benefit.

Long-lasting goods that provide benefits without having to be frequently repurchased are viewed positively. Goods that wear out quickly and drain consumers' wallets when they must be replaced are viewed negatively.

Infrastructure spending by the government is treated similarly: If spending provides a long-lasting benefit, GPI views it as a positive. If spending drains the government's coffers, GPI views it as a negative.

Again, GDP views all spending as positive. If the U.S. government spends $2 billion developing a new jet warplane that never lifts off the ground, GDP treats that the same as a hospital delivering $2 billion of medicine or a tech entrepreneur selling $2 billion worth of new software.

Crime

Rising crime costs money in legal fees, medical bills, replacement costs, and other outlays. GDP views this spending as a positive development. GPI views it as a negative.

Resource Depletion

When wetlands or forests are destroyed by economic activity, GDP views the events as good news for the economy; GPI views these events as bad news for future generations.

Pollution

GPI views pollution as a negative. Pollution is good news for GDP. Industry gets paid once for the economic activity that creates pollution and again when money is spent to mitigate the pollution.

Long-Term Environmental Damage

Global warming, nuclear waste storage, and other long-term consequences of economic activity are factored into GPI as negatives.

Changes in Leisure Time

Prosperity should lead to an increase in leisure time. Most modern workers would disagree with this theory. GPI views an increase in leisure as a positive and a decrease in leisure as a negative.

Defensive Expenditures

Defensive expenditures refer to medical insurance, auto insurance, health care bills, and other expenses that are required to maintain quality of life. GPI views these as a negative. GDP views them positively.

Dependence on Foreign Assets

When a nation is forced to borrow from other nations to finance consumption, GPI factors in the result as a negative. If the borrowed money is used for investments and benefits the country, it is viewed as a positive.

Assigning Value to GPI Variables

Genuine progress indicator calculations use economic statistics and mathematical formulas to place value on the social, economic, and environmental variables. The final result is then added to or deleted from the GDP figure.

The amount of money that foreigners invest in the United States is subtracted from the amount Americans invest overseas. A five-year rolling average is used to determine whether the U.S. is becoming a lender or a borrower.

If the economy is healthy enough that we are a net lender, the resulting number is added to GDP. If we are borrowing to sustain our economy, the resulting number is subtracted. 

Adoption of GPI

While GPI factors in many of the variables that have a direct impact on peoples' quality of life, capitalist economies tend to focus strictly on making money. Because of this, GPI has not yet been widely adopted in such economies, although its proponents note that it has been reviewed by the scientific community and recognized for its validity.

A growing number of states in the U.S. use GPI whereas the federal government does not.

GPI-type measures are in use in Canada and in some of Europe's small and more progressive nations. Over time, other nations might slowly adopt the concept as environmental concerns move into the public's consciousness.

The Bottom Line

GDP has its strengths and weaknesses. While the number is closely watched by economists and widely followed by the financial media, the calculation is sometimes flawed where well-being is concerned. That's because GDP can add some items that are actually destructive to an economy, rather than productive.

On the other hand, GPI includes a host of economic, social, and environmental variables that are subtracted or added to gross domestic product based on their costs and benefits, resulting in a truer indicator of economic strength or weakness.

Perhaps together, they can provide a more even-handed, and thus useful, picture of the prosperity and health of a country.