GDP is a flawed way of figuring out how well a country is doing, but it matters

A group of statesmen sat around a table 100 years ago to hammer out an agreement. World War 1 had just ended, and the

Treaty of Versailles

, signed in June 1919, was meant to make the loser pay. Germany would have to disarm, give up territory and pay reparations. The amount came to 132 billion marks — which would be $442 billion today.


Germany did not have that money. Their only way out was to print it. Germany printed so much of it that it led to hyperinflation: a loaf of bread that cost the equivalent of 26 cents in 1919 rose to $100 billion by the end of 1923. This was not just a tax on the poor, as inflation always is, but a war on the citizens of Germany. Out of the resultant bitterness and anger rose Nazism,

Adolf Hitler

and World War II: the unintended consequences of a poor treaty and bad economics.

Some saw it coming.

John Maynard Keynes

wrote a book called The Economic Consequences of the Peace in 1919, in which he explained why those clauses of the treaty would lead to disaster. He also pointed out one problem that economists of that time faced: they did not have a measure for national income. The concept of the gross domestic product (GDP) did not then exist.

There are two points I want to make in telling you this story. One, economics has humanitarian consequences. Two, metrics matter.

The original impetus behind measuring national income was statist. The state needed to know how much money it could extract from its subjects, often for the purpose of fighting a war. There had been efforts made to calculate national income from the 17th century, but this task gathered momentum during the

Great Depression

of the 1930s. President Franklin Roosevelt planned to revive the economy through increased government spending — but there needed to be a way to measure it first. A group of economists led by

Simon Kuznets

got to work. The metric was formalised just as WWII approached.

The creation of GDP has been described as ‘the Manhattan Project of economics’, but its utility extended beyond the war, and beyond economics. It became important in geopolitics, where the optics of the Cold War led the two sides to fight over whose economy was bigger. Any metric can be gamed, and there were ample geopolitical incentives to game the GDP: a high GDP could get you entry into exclusive groups like G8 and G20, and a low GDP could get you more foreign aid.

As far as domestic politics was concerned, how does one measure the economic performance of a government? The GDP is the obvious measure, which explains why arguing over the GDP has become, as the Greek economist Andreas Georgiou pointed out, “a combat sport.”

There are many things wrong with GDP. Its pioneer, Kuznets, felt that any such metric must measure welfare and not just output. He was opposed to government spending being counted in GDP, but was over-ruled by the government. That meant that bombs and biscuits are both counted in the GDP. The predatory state can divert money from productive uses in its citizens hands to useless ones in its own. Government spending, even if it leads to a net loss for society, will still be counted in the only metric we use, creating an illusion of progress.

Besides this, there is the question of what GDP cannot measure, summed up so well by the Widower Paradox: If a widower marries his domestic help, and thus stops paying her, the nation’s GDP goes down. GDP also cannot measure many of the intangible ways in which our lives are better: I might buy a cheaper mobile phone today than I did 20 years ago, but the value I derive from it is so much more because of technology. Even if GDP is not an accurate measure of welfare, it is a good indicator of it. It correlates with alternative metrics, such as the UNDP’s

Human Development Index

. But it does need to be measured accurately.

In India, GDP measurement has been shady. Firstly, the informal sector is most of our economy, and measuring this is hard. Secondly, the methodology the government uses is opaque, even arbitrary, and cannot be independently verified. We have to take the government’s word for it — and all governments in a democracy have an incentive to lie. If, despite this, our GDP growth rate has dipped so much recently, that is a cause for alarm.

Economics has consequences. Bad economics kept millions in our country poor for decades. The liberalisation of 1991, partial though it was, showed us the power of GDP growth. Today, we know that every one percent of GDP growth takes over two million people out of poverty. Thus, a falling growth rate is not just an economic problem but a moral failure.