The Importance of GDP

In the previous article, we understood why the GDP number was created and what purpose is it supposed to serve. However, this does not state the importance of the GDP number. The average person begins to believe that GDP is one of the many numbers that economists use. However, this is not the case. The Gross domestic product (GDP) is central to the subject of macro-economics. This article is dedicated to understanding the applications of the GDP number. Once we know how widespread the use is, we can understand how the system will be gravely affected, if the number is incorrectly defined!

GDP: Building Block of Macro-economics:

The Gross domestic product (GDP) number is the building block of macro economics. This is the case because modern day macro-economics is more or less about government making policies to help better the performance of the economy. Now, we are aware that the government extensively uses the GDP number to create policies and hence this number is the basis upon which many of our policies are made.

GDP: Identification of the Present State of Economy:

The official definition of the current state of the economy is based on the GDP number. For instance recession is defined in terms of GDP number. If the GDP number records a fall for two consecutive quarters, we call it recession. On the other hand, if the GDP number records a decreasing rate of growth for two consecutive quarters we call it a slowdown.

Hence, any economy officially identifies itself on the boom bust cycle based on the GDP number and so does the entire world.

GDP: Objective of policy formulation:

The Gross domestic product (GDP) number is not only the basis for diagnosing the problem with the economy. It is also useful in correcting it. Any government policy’s objective is measured in terms of the effect that it has on the GDP. For instance, if the GDP number is falling, the objective of the government policy would ideally be to reverse this position and create a situation where in the GDP number is rising. The government policy will define in clear quantifiable terms, what change they intend to bring to the GDP number. The success or failure of the government policy will be measured against this number that they have mentioned in their stated objectives.

GDP: Comparison between Economies:

The GDP number helps us make cardinal and ordinal comparison between economies. We can rank the economies of nations or regions by considering their GDP number. We can also draw conclusions about the relative size of the economy based on the GDP number. For instance, we can state that the economy of USA is 14 times larger than the economy of India. This statement really means that the GDP of USA is 14 times larger than the GDP of India.

GDP: The Root Cause!

Now, as we can see above that the GDP number is really the only thing that matters as far as macro-economic policy formation is concerned. Hence, the GDP number is of massive importance. Now, if this number was possibly defined wrongly or there were loopholes in the definition, it would allow for a massive misallocation of taxpayer resources and the policies that were created for a certain purpose could end up having the exact opposite effect.

This is the case today, if you believe many eminent economists. The people criticizing GDP are not some conspiracy theorists. Rather they belong to the realm of Nobel Prize winners and other mainstream economists. They believe that the wrong definition of GDP has a lot of unintended consequences. To a large extent, they attribute the recent economic crisis to the wrong decisions made as a result of this GDP misunderstanding.

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