What Is GDP?

Posted on: 02 March 2009 by Gareth Hargreaves

Independent financial advisor Peter McGahan analyses the current UK economy as well as explaining the use of GDP statistics.

Gross Domestic Product (GDP) is the most commonly used indicator of national income.

It attempts to measure the sum of incomes received by the various wealth-creating sectors of the economy, from manufacturing and retail to agriculture and service industries.

In the UK, this data is published and revised every three months by the Office for National Statistics.

Essentially, it tells us how much money was made in the economy over a certain period of time.

The figures are "gross" because GDP does not allow for the depreciation of physical capital - wear and tear on factory machines, office equipment becoming outdated etc.

I often hear about the ‘economy' and wondered exactly what it is. GDP is often referred to and I never understand it.

Can you explain?

The economy, or GDP, is basically the same. GDP is the gross domestic product of a country and is a measure of the output of that country. Let me explain.

Headlines read, ‘we are now technically in a recession’. What does that mean? A recession is defined as a period of economic downturn. Its exact definition is two consecutive quarters of negative downturn in GDP. So today we are actually in recession, not that that would be a surprise to anyone.

GDP is really a broad measure of a country’s output of goods and services. Data will be gathered on the UK’s personal consumption of goods, government expenditures and incomes received by the relevant sectors of an economy such as agriculture, banking, mining, and manufacturing to name a few.

It is simply an attempt to measure the income an economy is receiving over a set period of time i.e. its domestic product. The word ‘gross’ is used, as physical wear and tear on capital such as factory machines, office equipment etc are not taken into account.

Gross national product (GNP) is slightly different in that it measures overseas income which is also added back into GDP.

Is it any use? Well, it depends what you use it for. When we had our last quarter of growth (Jan- April), were we in a good economy that we should invest into? Hardly.

Like everything, information is what you make of it. The last quarter of 2008 showed the largest drop in any quarter since 1980. (1)

Is it any measure of what you should do, or is it simply a report that your stable is empty, and the dust in the distance is a horse. The latter is my view.

I don’t want to know about history, and GDP is simply a reflection of what has happened and where we are, as opposed to where we are going.

A large proportion of the UK’s GDP comes from banking and financial services (31%), 18.2% from public admin and teaching, and 13% from manufacturing.

Its easy to see what has happened in the banking sector and why the UK GDP has been battered. Add in a global downturn and manufacturing is troubled. But it’s all a reflection of where we are, the equivalent of driving by looking behind you or at your lap.

In the US for example, there is a belief that GDP is misleading in terms of our well being, and they have designed a genuine progress indicator (GPI).

This indicator looks at whether or not the output of services and goods is positively impacting the well being of a population. For example expenditure on criminal justice and pollution clean up are deducted from total increases in spending to assess if there is a net improvement or decline in social welfare.

Interestingly this graph parted company with GDP back in 1965 with GDP on a reasonably constant rise and GPI falling over that period.

GDP also ignores the drawbacks of living on foreign borrowing. So whilst we, as a nation, through our government borrow from abroad, this is not factored in.

Deciding where we are is a futile argument. Deciding where we are going is another.

There are simple measures to look at when making these choices. Do we value the noise of house price indices? They are as useful as a spade when you are trying to knit spaghetti. They all pointed to house prices rising at least a year after I had pointed out that completions in property had plummeted. For advice on your mortgage speak to an independent mortgage broker.

Consumer and global expenditure is key as it’s a sign of confidence and you can often see that in advance by walking round the shops – an investment of your time superior to reading about GDP, as you will be there long before the information.

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