The GDP Scorecard

Even amidst all the mishaps that have dotted this year, and there have been plenty of those thus far, Aug 31 surely stood out for Indian journalists, reporters and anyone who did not live under a rock. It was the day India’s GDP growth rate for the first quarter of Financial Year 2021 (April to June) came to light. And as soon as it did, pandemonium spread like wildfire. The figure was 23.9 and the sign was negative. For the first time in 40 years, the Indian GDP had contracted. While a lot has been said about the causes and effects of this steep slump, it is important to understand the quintessence of GDP to truly appreciate this piece of news.

GDP: Gross Domestic Product

GDP, according to its textbook definition, is the grand total of all goods and services, quantified in monetary terms, produced, over a specified time period (annually or quarterly), within the physical boundaries of a country. The last part needs to be emphasised as it marks its methodological departure from its predecessor – GNP or Gross National Product. GNP includes the income of a country’s citizenry – both residents and expatriates included. While GDP includes the revenue earned by foreigners situated within their boundaries and omits the income of its non-resident citizens, GNP excludes the foreigners altogether while encompassing the entire population of the country – irrespective of whether they reside within or without the country’s physical borders. GNP was the preferred measure of economic well being until it was abandoned in favour of GDP during the United Nations Monetary and Financial Conference (1994) in order to herald a new international monetary order. Although the Conference was held in Bretton Woods, USA, the United States was one of the last countries to complete the transition from GNP to GDP.

While the GDP definition may be universal, the same cannot be said for its method of estimation. There are three different methods that are employed often in conjunction in different countries namely, Production Approach, Income Approach, and Expenditure Approach. In theory, irrespective of the method adopted, one should arrive at the same GDP figure. However, minimal discrepancies are tolerated. India uses the Production Approach and the Expenditure Approach for GDP calculations. The Expenditure Approach is used to shed light on the performance of different economic sectors. It employs a simple formula that adds Consumption, Investment, Government Spending and Balance of Trade (gross exports minus gross imports). However, for the purpose of estimating the overall economic health of the country, India uses the Production Approach, more popularly, the Value Added Method. As the name suggests the method reflects “value” generated in every stage of the supply chain. It sums the GVA (Gross Value Added) of each of the 8 sectors under consideration, namely: agriculture, mining, manufacturing, construction, power, transport and communication, business services, and community services. GVA is in turn defined as the gross value of output less the cost of materials and supplies. Sum of the GVAs from these 8 sectors is termed as GDP at factor cost in India.

If you think there are too many methods to calculate GDP, you will be dumbfounded to find the number of ways in which it can be expressed. Let’s begin with the easier ones: nominal and real GDP. The former is evaluated at prevalent market prices while the latter is merely an inflation adjusted form of the same. A close cousin of these two is GDP paired with Purchase Power Parity (PPP) which makes it easier to compare the GDPs of two countries by ironing out the differences in currency, cost of living and local prices. Another popular measure that is used to gauge the standard of living in a country is GDP per capita which as the name suggests is the country’s GDP divided by its population. Apart from turning your head, this may bring to your mind a question: which GDP measure are we referring to when we say ‘GDP has fallen to -23.9%’? That brings us to the most popular measure: GDP growth rate.

This measure is the most highlighted one as it indicates the direction in which a country’s economy is headed. A high positive value indicates great potential and attracts foreign investment while a negative value signals that the economy is heading into recession. 2 Successive Quarters of negative growth is the litmus test for declaring whether a country has entered into recession or not. However, despite its universal acceptance GDP growth rate is hardly without variations. All countries publish quarterly figures and annual figures. It is with the former that one observes slight variations across countries. Broadly speaking, quarterly GDP can be calculated as:

Quarter on Quarter (QoQ): Growth in GDP over successive quarters divided by the GDP of the previous quarter.
Year on Year (YoY): GDP growth of a quarter in relation with that of a corresponding quarter in the previous year expressed as a percentage of the latter. This measure helps to account for seasonality to a great extent.

Since each country’s national statistical body has complete discretion over the method of calculating and expressing this ever so popular metric, comparing them without heeding necessary caveats can often lead to embarrassing episodes, as was seen on many Indian TV channels that sought to compare India’s GDP growth for the last quarters with that of the USA without understanding the fundamental differences between their ‘reported figures.’ In India, we use a YoY basis for the calculation of quarterly GDP growth rate. So, the -23.9% shrinkage in GDP in the April-June quarter of FY2020 is in comparison with the GDP as reported for the April-June quarter of FY2019. On the other hand, in the USA, they use a QoQ basis for the calculation of quarterly GDP growth rate which is subsequently annualised by the BEA (Bureau of Economic Affair), their equivalent of India’s CSO, before being released to the public. Therefore, the -31.7% GDP growth figure as reported by the American press, though lower than India’s reported figure at first glance, is hardly comparable to our -23.9% slump in GDP growth. Prior to annualisation, the American figure would stand at -9.1%*. The difference caused by annualisation is substantial as it follows the exponential formula: (1+rate of growth)4 – 1. In fact, India’s annualised QoQ GDP growth rate would be around -75%. Surprising as it may seem, annualisation is a childishly simple process that paints a picture for the audience based on the assumption that the quarterly growth in question continues unaltered for the entire year. For example, in India’s case, the annualised figure would imply that should our economy continue to shrink by -23.9% every quarter, we will, by the end of the year, end up with an economy reduced to a quarter of its former size.

Drawbacks and Criticisms

Though the most popular measure, GDP is far from flawless. While GDP figures, as and when they are published, generate a lot of buzz, they have often been misinterpreted as hallmarks of holistic progress. GDP has come in for a lot of criticism from environmentalists for its failure to account for environmental damage that accompanies the activities that constitute the P in GDP. The late Robert Kennedy, in one of his impassioned speeches, criticised GDP for measuring ‘everything in short, except that which makes life worthwhile.’ He goes on to mention how GDP can never encapsulate ‘the beauty of our poetry’ or ‘the intelligence of our public debate’ and thereby conclude that any bid to quantify a nation’s well being merely on the basis of its GDP is intrinsically flawed. While one may decry such harsh criticism as far-fetched, it is impossible to sweep his more salient points related to education and healthcare under the carpet. Belgian-Indian economist Jean Dreze and Nobel laureate Amartya Sen, in their book An Uncertain Glory, outline the dichotomy between the size of a country’s GDP and the standard of living it afford to its citizens. In no country is the difference starker than in China, which boasts of the world’s second-largest economy but has countless curbs on political liberty: a factor that adversely affects the well-being of its citizens. Similarly, low literacy rates and the lack of access to healthcare affect the standard of living adversely in India – one of the world’s largest economies.

Defenders of the faith, however, claim that this represents a textbook case of comparing apples to oranges. That is not to say that economists have no qualms about the world’s growing over-reliance on GDP. For starters, GDP being a gross measure does not account for depreciation. British economist John Kay also argues that as GDP measures the value of what is produced within a country’s boundaries without taking into account who produces it or for whom, resource producers are made to look “richer than they are.” Moreover, GDP can never measure how much money will flow directly to multinationals operating in a country instead of accruing to the local population. This invariably brings us to the biggest thorn in GDP’s flesh: its negligence of inequality that lurks beneath the shadow of apparent growth. Even GDP per capita fails to give a fair picture of a country’s average standard of living because of this. For example, Apartheid-era South Africa could boast of a high GDP per capita, but the stark difference between the races was evident for everyone to see.

For India, these fault lines assume graver proportions. As GDP does not account for non-remunerative work, housework escapes scrutiny. While it is true that it may not possess any obvious monetary value, it can be evaluated as a substitute for goods and services that would have been produced in its stead, in the given time by the same population. With 64% of its urban female population engaged in housework, it stands to reason why India is all the more adversely affected by this defect. India’s massive unorganised sector also aggravates the problem. The quarterly GDP growth rate is accurate only if the organised and unorganised sectors grow at the same rate as the rate for the organised sector is extrapolated to the unorganised one. Since by all accounts demonetisation and GST tax reforms have broken the backbone of India’s informal economy, the chances are high that our present GDP figures are misleading by a large margin as the 2011-12 revision of the GDP series pegged the contribution of the unorganised sector at 47%.

Despite its myriad flaws, GDP, in its many shapes and forms, remains the most popular economic measure. Over the years, various economists have tried to popularise different metrics such as HDI (Human Development Index) introduced by Pakistan’s economist Mahbub-ul-Haq; ISEW (Index of Sustainable Economic Welfare) or GPI (Genuine Progress Indicator) by Herman Daly and John B. Cobb; or Bhutan’s famous GNH (Gross National Happiness). While none of these methods has managed to dethrone GDP, the method of GDP calculation has undergone repeated revisions over the years as it continues to evolve.

– Shambo Basu Thakur