F R E Q U E N T L Y   A S K E D   Q U E S T I O N S

● ● ● FAQ 1: What does GDP measure?

GDP -gross domestic product- is the most frequently used indicator of market activity. It lies at the heart of the entire System of National Accounts, and its methodology is rigorously defined and standardised, enabling international comparison and aggregation.

GDP combines in a single figure the total market value of all final goods and services produced within a country’s economic territory during a given period. In most cases, it is calculated quarterly and annually.

The change in GDP over time is the principal indicator of growth in macroeconomic activity.

● ● ● FAQ 2: What are the limits of GDP and mainstream economic indicators?

Because of the implicit link between economic growth and elements of well-being (e.g. employment and level of consumption), GDP is often regarded as a proxy indicator of human development and well-being. However, the relationship between economic growth as measured by GDP and other societal and environmental dimensions is not straightforward.

Since the creation of the concept, the interpretation and use of GDP as a proxy of social welfare has received much criticism, which has come from some of the most well-known economists, including Nobel laureates (e.g. Simon Kuznets, Daniel Kahneman, Robert Solow, Joseph Stiglitz, Amartya Sen and Muhammad Yunus). The limits of GDP are that it does not include a number of factors that determine the well-being of people, such as the value of non-market goods and services (e.g. natural resources), informal and unpaid activities and leisure. Also, GDP emphasises average income and in fact puts weight on the expenditures of the wealthy rather than focusing on similar income development of the poor. Finally, GDP focuses on short-term economic activities or flows, rather than the developments in the assets of natural, economic and social capital, which are important from a long-term sustainable development perspective. Other mainstream economic indicators also face limitations in what they reveal about non-economic dimensions of progress and well-being.

● ● ● FAQ 3: What are additional measures beyond GDP and mainstream economic indicators?

In order to compensate for the limits of GDP, a wealth of alternative and complementary measures are available. These indicators can be grouped in many different ways, for example, by the aspect of societal progress they cover or by the way these indicators are constructed. Some indicators expand economic calculus by correcting GDP for those aspects that it does not cover (e.g. the Genuine Progress Indicator) or looking at long-term capital accumulation, including the value of the assets of natural, economic and social capital (e.g. the Genuine Savings approach). Another approach is to compose a single index by weighing underlying indicators, which the Human Development Index does through combining measures of life expectancy, literacy, education, and GDP. Indicator sets (e.g. those comprised of environmental, economic and social indicators) are yet another way of complementing the single use of GDP. A recently started effort – the Canadian Index of Well-being – is under development in Canada.

An increasing number of countries have implemented the Handbook of National Accounting: Integrated Environmental and Economic Accounting 2003 (SEEA 2003) as a satellite system of the System of National Accounts. It brings together economic and environmental information and indicators in a consistent framework.

● ● ● FAQ 4: What is the role of indicators in policy?

All indicator initiatives are designed to somehow measure progress for better policy making. But what is the role of these indicators in policy making? A well-known model to frame the subsequent steps in policy making is the policy cycle (see Figure 1).

Figure 1 shows clockwise, starting at the left, the subsequent steps in the policy cycle and the associated indicator approaches are as follows:

Problem recognition and solution identification. The phase of problem recognition is typically served by aggregated indices. They serve as a strong signal or flag that should ‘stick’ to the minds of policy makers, politicians or general public. These indicators generally require modelling or data manipulation efforts. Next, forward looking indices, from forward looking assessments, are important to investigate future developments of the problem at stake and can serve as a base line for the next phase of identifying possible solutions. These indicators generally require forward looking models, or in the case of cost-benefit analysis, estimates of how to discount future costs to present values. Some indicators that are potentially geared toward these two phases of the policy cycle include: HDI, extended economic indicators, Environmental Performance Index, Genuine Savings, and Ecological Footprint.

Policy options. When it comes to the next phase of selecting concrete policy proposals and the analysis of their impacts, cost-benefit analysis (CBA) play an important role. CBA allows comparison across different categories of costs and benefits of a policy proposal with one another. Its overall result, a single number or index, also serves as a strong signal to recognise whether a new policy pays off or not. Alternatively, typically a selection of non-monetary indicators (covering social and environment aspects) is used to evaluate the impact of policy proposals. Some indicators that are potentially geared toward these two phases of the policy cycle include: thematic cost benefit analysis, thematic/sectoral indicators.

Monitoring and evaluation. Finally, tailored sets of indicators serve to monitor and evaluate progress of policies. Typically this approach does not require modelling but is derived directly from descriptive accounting. Some indicators that are particularly geared toward these two final phases of the policy cycle include: MDGs, EEA core indicators, structural indicators (EU’s Lisbon Strategy), EU-SDS indicators, SEEA).

● ● ● FAQ 5: What are important people saying about GDP and measuring progress?

Read interesting Quotes on GDP and measuring progress, true wealth and well-being.

Further background information is under Indicators - Development.