The Gross Domestic Product (GDP) is the value of all goods and services produced within a country as estimated, for example, for a year or a quarter adjusted for inflation or deflation, or calculated by using current market prices. The first calculation of estimates of the total output of a country dates back to the 1930s.
EU Member States follow the rules and procedures laid out in ESA 2010 (European System of Accounts) for estimating GDP. ESA 2010 is broadly consistent with the System of National Accounts of the UN (SNA 2008). Within each country GDP is usually measured by a national government statistical agency.
The data used to estimate the components of GDP is largely gathered from surveys sent to businesses around the country and from government accounting sources. Not all data comes in punctually and for this reason GDP numbers are subject to regular and sometimes material revisions, with preliminary estimates being released and subsequently revised as more information is obtained. The GDP number for the same period does therefore change over time.
It’s important to understand that GDP is in fact not measured but, by far and large, estimated. Change the assumptions or recalibrate the model used and everything changes. Albeit used by governments to justify their actions in relation to the economy, we must appreciate it is just an estimate and only as good as the formulas and models that are used.
The success of governments is measured by the success of the economy, and the economy is considered successful if the GDP is growing. You may see how governments are highly motivated to produce, by any means, GDP numbers that are larger than the previous quarter or the previous year. This belief in a forever growing GDP is untenable as nothing grows forever.
Thousands of economists use GDP in their research. Governments use ‘Debt to GDP’ ratios to measure and justify government debt. They use ‘GDP percentage growth or percentage recession’ to compare economic performance in relation to the past or to other countries; ‘GDP per Capita’ adjusted for Purchasing Power Parity to assess relative wealth; ‘Tax to GDP’ ratio to shape policy or determine how much public spending is affordable. Its use is indeed widespread and its effects far-reaching.
I would argue that GDP estimates are not only widely used but also widely abused. How is it possible for government debt to grow year on year beyond levels that can ever be repaid and this is considered acceptable? The fact is that we are deceived by percentages. Percentages are a relative measure. If government debt is measured as a percentage of GDP, that is itself growing at the same or a higher rate than the debt, then the ‘Debt to GDP’ ratio will remain constant or even go down giving the illusion of a government debt that is not really growing or that is even getting smaller.
Contrary to such a popular perception, the Maltese government debt is in fact growing bigger. In view of the country’s high debt levels, a sudden and substantial drop in GDP would be disastrous for the economy.
Governments are also in the habit of guaranteeing third party debt with our future tax monies. At the end of 2015 the total value of third party debt guaranteed by the Maltese government amounted to €1.4bn or 16 per cent of GDP. Do the maths. Add that guaranteed debt to the government debt and see what it does to the debt to GDP ratio of our country.
How is it possible for government debt to grow year on year beyond levels that can ever be repaid and this is considered acceptable?
The EU rules in ESA 2010 stated that by September 2014 every EU Member State had to include undeclared or illegal prostitution and illegal drugs in their national accounts and in their GDP estimates. By definition these activities are not declared and so governments need to annually come up with more, truly nonsensical, estimates. I don’t think this point needs further comment.
Countries may also find themselves to be unduly punished by GDP estimates (that may later change). A fall in GDP numbers over two quarters is considered a recession. If a country is publicly considered to be in recession, this affects credit ratings and can have serious economic and political repercussions.
Economic (GDP) growth is considered to be synonymous with progress. Progress as estimated by GDP does not tell the whole story. It doesn’t take into account quality of life; it dismisses outright environmental degradation and loss of species and habitats; it ignores human values; it sacrifices stability and sustainability and gambles on the future; it promotes the delusion of the benefits of globalisation and conveniently forgets that the only jobs that matter are local.
GDP estimates have some value as one element in an array of economic indicators. However, GDP does not deserve the status of statistical royalty. I suspect its revered status has more to do with the flexibility it affords to produce desired results. We should be on our guard and be critical of any government argument that uses GDP, or one of its many derivatives, to justify actions that would otherwise not make sense.
I believe that the GDP estimates we hold so dear are not fit for purpose. Our goal should not be economic growth by any means. The economy may grow but that is not the point. Rather than pursuing the unattainable goal of a forever increasing output, we would be well advised to differentiate our country by having a sustainable economy that upholds human values within the context of accountability towards future generations and a respect for the environment.
Rather than allowing the government to control oversized budgets open to abuse which go beyond all rational justification, what we need is to lower taxes thereby providing government with smaller budgets. Such an economy would have deep roots and be able to weather the economic storms and winds of change.
This approach would go a long way towards improving the reputation of our country internationally. It would also attract towards our shores the right type of international business and foreign direct investment.
David Marinelli is the CEO of Portman International, a Maltese financial services company.