Ideas & Debate

GDP is not best measure of household economic health

Using GDP to gauge the well-being of households
Using GDP to gauge the well-being of households does not capture the true picture of what homes go through during a particular period. FILE PHOTO | NMG 

According to the Kenya National Bureau of Statistics (KNBS), Kenya’s Real Gross Domestic Product (GDP) is estimated to have expanded by 6.3 percent in 2018 compared to 4.9 percent in 2017, the strongest economic growth in eight years. But the citizenry appears not to associate with this growth.

In fact, a remark by Akinwumi Adesina (current President of the African Development Bank) that people don’t eat GDP probably lends credence to this lack of association by wananchi. As a Nobel-winning metric, Gross Domestic Product has been described as a window to a country’s economic soul. So what is GDP anyway?

It can be defined as the total value of goods and services that are newly produced in the economy during an accounting period; generated incomes to the economy and are available for domestic final uses or for exports.

This definition provides three approaches for compiling GDP: the production approach, the income approach and the final expenditures approach (Quang Viet, 2009). Theoretically, these three approaches are identical and should produce similar results. In practice, however, there are deviations. Consider bread.

First, it costs a farmer Sh10 in labour to grow and harvest wheat. A miller acquires the wheat for Sh20. A baker acquires the flour at Sh30. The bread finally sells for Sh40. If an economy was solely driven by a single bread production, then its GDP would be Sh40, because each of the four stages is adding a value of Sh10 to the economy. When firms sell goods, it’s just goods transformed into money.

And where does the money being spent come from? It comes from income made from rent, wages, interest and profits. However, GDP as a measure of household economic wellbeing has profound shortcomings.

Diane Coyle in her book, GDP: A brief but affectionate history, did a brilliant job in profiling some of them. Broadly, a market economy has two sides, supply and demand acting on goods and services. The expenditure and production approaches to GDP are basically windows to demand and supply respectively. In this regard, GDP has the tendency to mask one side.

Take the case of bread and replace local production of wheat with imports. Importation creates other activities such as storage, transportation and packaging. As such, there will be growth in expenditure. However, this masks supply-side weaknesses such as exportation of jobs.

This is what has happened in the agricultural sector, the largest employer as well as contributor to Kenya’s GDP. In effect, you have a sector that constantly creates leakages in the circular flow of money (and paraphrasing Anzetse Were, a sector that loses money).

The 6.3 percent real GDP growth recorded in 2018 masked demand-side weaknesses; and you just need to look at some indicators: (i) household indebtedness is extremely high (ii) core inflation softened in 2018 suggesting weak demand and (iii) private consumption contracted, despite an expansionary monetary environment.

Ordinarily, monetary expansion is geared towards supporting private consumption, which should have triggered private consumption growth).

Secondly, GDP does not measure a country’s social wellbeing and GDP figures should be read with such a caveat. For instance, we have a very inefficient education and healthcare systems, in terms of virtually any other measure of performance, yet the budgetary spend is quite significant. Additionally, Kenya ranks top in defence spending, yet it is an expenditure with the least social returns. Sectors with least social returns should in principle be discounted in an economic wellbeing equation.

Finally, GDP doesn’t measure sustainability. Extraction of natural resources, such as oil drilling or gold mining, can be environmentally destructive yet they inflate GDP numbers. Isn’t there a strong case for green GDP?