The Shortcomings of Gross Domestic Product
Real GDP per capita is used in practice as a reasonable description of economic well-being. However, in this role it has significant disadvantages.
First, the valuation of so-called negative factors (air and water pollution, noise, overcrowding, etc.) should be subtracted from the value of GDP. These factors are associated with production, overstating the level of our material well-being. In order to establish the national economy it is essential to solve the problem of accounting of any kind of economic activity in the macroeconomic indicators. Environmental pollution raises significant methodological issues, one of which is the reflection of activities that are related to environmental management. In general, the usual economic growth indicators of national income and net product do not take into account the results of environmental activities, distorting its effects and dynamics. For example, a manufacturer pollutes a river and the government spends money on its cleaning (increases the GDP), but the cost of pollution is not deductible (Investopedia, 2008).
Second, GDP does not include the cost of non-market operations (for example: working housewives; carpenter’s work, who has been repairing his own house; free volunteer work). All of these activities are appropriate from an economic perspective; however, in accordance with the common methodology, they are not included in the calculation of GDP (Hoag & Hoag, 2002).
Third, GDP, unfortunately, does not include the valuation of leisure activities (as an increase of free time, which is disposed by people) and does not fully reflect the quality improvement (or deterioration) of the goods. The quality of goods and services is certainly one of the measures of economic well-being (Investopedia, 2008).
Despite the fact that GDP is the main indicator of international comparisons of economic well-being, it should be understood that the size of the economy and GDP that is created by this economy are not equivalent concepts. For example, GDP does not include such operations as:
intermediate product;
industrial operations, which cannot be taken into account (barter transactions, product unaccounted households unaccounted shadow economy, etc.);
non-production operations (transfer payments);
financial and credit transactions (except for net income, such as interest).
The main disadvantages of this indicator lay in the following facts:
It is an average indicator (for example, if one person has two cars and another one has no car, then, on average, each individual has one car).
2) It does not account for many of the qualitative characteristics of well-being (for example, two countries with the same level of GDP per capita may have different level of education, life expectancy, morbidity and mortality, crime rate, etc.).
3) It ignores the different purchasing power of the United States dollar in different countries ($1 in the US and, for example, in India has different purchasing power);
4) It does not take into account the negative effects of economic growth (the degree of pollution, noise, gas concentration, etc.).
In this context, we cannot make accurate conclusions about the size of such sectors as financial and credit system, the stock market, state budget, etc, using only GDP as a measure of economic strength. Since these sectors redistribute GDP, it is believed that registration of these transactions is not required. However, in developed economies, these sectors concentrate huge amounts of capital.
Another shortcoming of GDP as an indicator that expresses the strategy of socio-economic and governmental development is that it does not reflect the negative effects of scientific and technological revolution and economic growth, and the most importantly - the quality of life, level of prosperity, which, as international experience shows, are growing more slowly than GDP. In fact, the improving of the quality of life and well-being of the majority of the population must express the essence of both the strategy and tactics of socio-economic development of the country.
References
Hoag, A., & Hoag, J. (2002). Introductory economics (p. 239). River Edge, NJ [u.a.]: World Scientific.
Investopedia,. (2008). Limitations of GDP and Alternative Measures - CFA Level 1 | Investopedia. Retrieved 6 January 2016, from http://www.investopedia.com/exam-guide/cfa-level-1/macroeconomics/limitations-gdp-alternative.asp
