GDP should be corrected, not replaced

It has long been recognized that Gross Domestic Product (GDP) is less than adequate as a measure of the economic health and welfare of our societies. Many prominent experts have argued that we need to reconsider our fixation with GDP, and yet we don’t seem a whole lot closer to a feasible alternative.

For example, one of GDP’s well-known flaws is its disregard of the value of housework, including childcare. A possible solution is to monetize such activities within the GDP measure. It would certainly correct for the created value which is currently ignored. However, this would lead GDP to fail on another criterion, for which it is already heavily criticised. Often, it doesn’t adequately reflect what members of a society experience.

While including household work would “correct” - in this case inflate - GDP, it would make no real difference to the living standards of the stakeholders. In the case of housework, the (mostly) women would continue to be treated as volunteers in real life.

Another instance of GDP's failure is value destruction. It does not indicate when societies mismanage their human capital, whether by withholding education from certain groups, or by depleting natural resources for immediate economic benefit. GDP tends to be imprecise in considering assets and often fails to account for liabilities.

There is no international consensus on an alternative to GDP yet. But encouraging progress has been made towards a more considered way of thinking about economic activity. Many frameworks have been introduced over the years, from Nordhaus and Tobin’s 1972 “Measure of Economic Welfare” to China's recently announced “Green Development Index”.

Today, decision-makers in both private and public sectors have more tools to make sophisticated choices with. On the investor side, the demand for environmental, social and governance data is rising steeply. On the public side, organizations such as the World Bank already consider metrics other than GDP to assess quality of life, including life expectancy at birth or access to education.

Recently, debate around Gross National Income (GNI) has grown. Though it shares fundamental elements with GDP, GNI introduces a correction which matters in our globalized age. It adjusts for the income generated by foreign-owned corporations and foreign residents. Accordingly, while countries with significant manufacturing or asset ownership by foreign corporations (see graph below) will show an inflated GDP, GNI reflects how much income is actually retained by each country.

Ireland is a prominent example where GNI has been used to correct the picture drawn by GDP. In 2015, a reported 26.3% increase in GDP rightly caught the attention of experts. It provoked a discussion around the “ability of the conceptual accounting framework used to define GDP to adequately reflect economic reality”, as a working paper by the OECD recounted.

GDP is not a reliable indicator of a country’s material wellbeing, the paper concluded. In the case of Ireland, this was due to multinational corporations’ (accounting) relocation of economic activities, especially the returns on intellectual property. To account for the growing disparity between actual economic development and reported GDP, a modified version of GNI named GNI*was introduced by the Irish Central Statistics Office.

But the gap between GDP and GNI may soon close in some jurisdictions. In a recent paper, Khan, Nallareddy and Rouen highlight a misalignment of US economic growth and corporate profits growth between 1975 and 2013. During the assessed period, profits of US-based multinational companies outpaced GDP whenever the domestic corporate income tax rate exceeded that of other OECD countries.

In late December 2017, this disconnect was addressed by the signing into law of H.R.1 (formerly the “Tax Cuts and Jobs Act”). By lowering corporate tax to a globally competitive level and granting better terms for the repatriation of profits, corporate earnings are expected to shift back to the US. As a result, the divergence between GDP and GNI is likely to close in both the US and Ireland.

Going forward, I suggest focusing on three points. First, several weak aspects of GDP metrics are already being addressed and relevant stakeholders are taking measures. This is encouraging. Second, public and private decision-makers now have a multitude of instruments at hand. These enable a superior assessment of their actions and how they impact societies and the environment.

Finally, in business, we learn not to let the great become the enemy of the good. We have not solved all the challenges GDP presents, but we have come a long way in reducing many of its distortions. Instead of aiming for a new, disruptive framework to replace current techniques and data, a more powerful strategy may be to make thoughtful, incremental changes to the existing system.

A version of this article also appeared on Project Syndicate