Streamline Training & Documentation: Shortcomings of GDP as a Measure of Value

Tuesday, October 06, 2009

Shortcomings of GDP as a Measure of Value

You only have to glance at any large newspaper to recognize how closely changes in the gross domestic product — GDP — of countries around the world are followed. And, assuming there are no dramatic changes in the composition of a countries' output, generally a safe assumption in the short run, this makes good sense.

If, on the other hand, you're trying to measure the value of a country's output in its own right (rather than focusing on economic growth), there are substantial problems with using GDP as your metric. For example, all underground and non-market economic activity (such as work done by homemakers) is excluded. Also, changes in the quality of products, such as high-tech items, are poorly captured, and output that one would happily avoid if it were possible, such as spending on war materiel, is treated the same as spending on benign goods.

There are various alternative measures that have been designed in an effort to develop a more meaningful measure of national output. For instance, the Levy Economics Institute of Bard College has developed the Measure of Economic Well-Being, and the country of Bhutan gauges its socioeconomic situation with Gross Domestic Happiness.

Another perspective on the shortcomings of GDP as a measure of the value of national output appears in the Fall 2009 issue of the MIT Sloan Management Review. Erik Brynjolfsson, a professor at MIT's Sloan School of Management, and Adam Saunders, a lecturer at the University of Pennsylvanias Wharton School, argue that the information sector (software, publishing, motion picture and sound recording, broadcasting, telecom, and information and data processing services) is seriously undermeasured in GDP. Why? Because the prices of modern digitized information sources are so low (zero in some cases) relative to the prices of the physical information sources (e.g., encyclopedias and CDs) that they substitute for.

Brynjolfsson and Saunders say:

The irony of the information age is that we know less about the sources of value in the economy than we did 25 years ago. GDP is a more accurate metric of value in industrial-age industries like steel or automobiles than in information industries, and can miss most of the value in information goods.

Brynjolfsson and Saunders recommend looking instead at consumer surplus, "the aggregate net benefit that consumers receive from using goods or services after subtracting the price they paid."

Measuring consumer surplus is harder than measuring GDP because the amount of consumer surplus must be inferred. This is done by running price experiments from purchase data, running lab experiments, and conducting surveys.

Brynjolfsson and Saunders walk their readers through an example taken from the music recording industry that clarifies the concept of consumer surplus and how it can give a more accurate picture of value being created in an economy — with specific focus on the information sector.

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Labels: Business acumen

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