What Are the Best Measurements of Economic Growth?

Economists and statisticians use several different methods to track economic growth. The most well-known and frequently tracked metric is gross domestic product (GDP). Over time, however, some economists have highlighted limitations and biases in GDP calculation. Organizations such as the Bureau of Labor Statistics (BLS) and the Organization for Economic Co-operation and Development (OECD) also keep relative productivity metrics to gauge economic potential. Some suggest measuring economic growth through increases in the standard of living, although this can be tricky to quantify.

Gross domestic product is the logical extension of measuring economic growth in terms of monetary expenditures. If a statistician wants to understand the productive output of the steel industry, for example, he needs only to track the dollar value of all of the steel that entered the market during a specific period.

Combine the outputs of all industries, measured in terms of dollars spent or invested, and you get total production. At least that was the theory. Unfortunately, the tautology that expenditures equal sold-production does not actually measure relative productivity. The productive capacity of an economy does not grow because more dollars move around, an economy becomes more productive because resources are used more efficiently. In other words, economic growth needs to somehow measure the relationship between total resource inputs and total economic outputs.

The OECD itself described GDP as suffering from a number of statistical problems. Its solution was to use GDP to measure aggregate expenditures, which theoretically approximates the contributions of labor and output, and to use multi-factor productivity (MFP) to show the contribution of technical and organizational innovation.

Those of a certain age may remember learning about gross national product (GNP) as an economic indicator. Economists use GNP mainly to learn about the total income of a country's residents within a given period and how the residents use their income. GNP measures the total income accruing to the population over a specified amount of time. Unlike gross domestic product, it does not take into account income accruing to non-residents within that country’s territory; like GDP, it is only a measure of productivity, and it is not intended to be used as a measure of the welfare or happiness of a country.

The Bureau of Economic Analysis (BEA) used GNP as the primary indicator of U.S. economic health until 1991. In 1991, the BEA began using GDP, which was already being used by the majority of other countries; the BEA cited easier comparison of the United States with other economies as a primary reason for the change. Although the BEA no longer relies on GNP to monitor the performance of the U.S. economy, it still provides GNP figures, which it finds useful for analyzing the income of U.S. residents.

There is little difference between GDP and GNP for the U.S., but the two measures can differ significantly for some economies. For example, an economy that contained a high proportion of foreign-owned factories would have a higher GDP than GNP. The income of the factories would be included in GDP, as it is produced within domestic borders, but not in GNP, since it accrues to non-residents. Comparing GDP and GNP is a useful way of comparing income produced in the country and income flowing to its residents.

The relationship between production and spending is a quintessential chicken-and-egg debate in economics. Most economists agree that total spending, adjusted for inflation, is a byproduct of productive output. They disagree, however, if increased spending is in itself an indication of growth.

Consider the following scenario: In 2017, the average American works 44 hours a week being productive. Suppose there is no change in the number of workers or average productivity for 2018. However, Congress passes a law requiring all workers to work for 50 hours a week instead that year. The GDP in 2018 will almost certainly be larger than the GDP in 2017. Does this constitute real economic growth?

Some would certainly say yes. After all, total output is what matters to those who focus on expenditures. For those who care about productive efficiency and the standard of living, this question does not have a clear answer. To bring it back to the OECD model, GDP would be higher, but MFP would be unchanged.

Suppose instead the world becomes mired in a third world war in 2018. Most of the nation's resources are dedicated toward the war effort, such as producing tanks, ships, ammunition and transportation, and all of the unemployed are drafted into war service. With an unlimited demand for war supplies and government financing, the standard metrics of economic health would show progress. GDP would soar, and unemployment would plummet.

But would anyone be better off? All of the produced goods would be destroyed soon after, and high unemployment is not worse than high mortality rates. There would be no lasting gains from that sort of economic growth.

(For related reading, see: Is Infinite Economic Growth on a Finite Planet Possible?)