Understanding GDP and its Growth | Dr Kamal Monnoo

There is a lot of talk about the GDP (Gross Domestic Product) growth number not only in our average daily discussions on the economy, but also in the official hand outs – on the health of the economy – released from time to time by the government itself, the lending institutions (such as the IMF, WB, etc), and by various economic analysts. Given Pakistan’s high population growth rate, a large percentage of its eligible youth still looking for ‘proper’ jobs, and a high number of its fresh young employables entering the job market every year, it is generally believed that the country needs to add at least 125,000 jobs every year; a level achievable only if its economy grows by 7% or more annually – At present the GDP growth rate is at best 4.50%!

However, before accepting this rather simplistic correlation between GDP growth rate and job creation in an economy let’s do a bit of deep diving to determine the precise manner in which this equation works. The exercise is also important as it can help us understand that how a government can achieve certain GDP growth benchmarks, but still end up missing the real desirables in an economy. GDP is in essence a measure of the value of total work undertaken in an economy, i.e. in production related activities and services rendered within the country.

The alternate economic measure to the GDP and the one most commonly used in the pre Bretton Woods era, was the GNP (Gross National Product), which essentially looked at the value of ‘total’ work of production and services by all (locals and residents abroad) citizens of the country. GNP = GDP + Net income from assets abroad – Net payment outflows on assets held by foreign holdings. However, since modern day economists and international financing institutions these days tend to be more concerned with the economic activity that actually takes place within the geographical boundaries of a country, the measuring reliance over time shifted mainly on to the GDP as the preferred indicator to determine the real size of an economy. This is why in this article we will primarily focus our discussions around the measure of the GDP. The rationale being that it is GDP growth and not the GNP growth that more accurately captures the effects of economic growth on an average person. For example, while the American multinationals may be performing very well globally and adding to the U.S. GNP, but unless their success can regenerate economic activity in the US itself, it achieves precious little in terms of growing the US economy or creating jobs at home.

Still, the trouble is that despite the GDP being a good measure of the economy it overlooks a number of elements; a weakness that in-turn raises concerns on the true productivity of GDP’s growth in a given economy. Implying, that even when a country’s GDP is growing significantly, it may not necessarily be touching the lives of its people meaningfully. Sadly, as one conducts an in-depth analysis of Pakistan’s GDP growth, one fears that this is exactly what may be happening with us. Given that our accounted-for consumption has more or less been flat in the last 3 years, inflation has moved below the 5% mark, private investment (both domestic and foreign) in the last 2 years has been amongst the lowest over the previous 10 years, and that our exports are declining rapidly, the only factor that in such a case would be driving the GDP would be ‘government spending’. And assuming that the government is indeed spending so heavily to singularly prop up the GDP growth rate, then this in itself tends to be a very dangerous phenomenon.

First, the government is never the most optimum user of capital and second, especially in case of Pakistan, where most of the government spending is being spurred by borrowings, unless the spending is done in a very prudent and transparent manner, and on projects that are efficient and self-sustaining in the long-term, the process can inevitably result in squandering of resources and opportunity, ultimately leading to a vicious debt trap. Ironically, there also hangs a big question mark on the prudence and spending-prioritization of this PML-N government!

Further, the GDP or its growth numbers exclude certain important aspects of governmental spending. And again given our history of whimsical and politicized spending by successive governments, this for us tends to be cause of serious worry. Some of these key exclusions being,

Transfer Payments: This refers to redistribution of income to potential consumers. As an example, the BISP (Benazir Income Support Programme) spending or its misspending will not directly reflect in the GDP growth rate.

Interest Payments on Government Debts: We already know that not only is the government the largest borrower from the Pakistani commercial banks (crowding out the private sector), but also that its debt portfolio is rather unhealthy from a cost perspective, meaning it carries expensive debt. Since interest payments do not reflect in the GDP calculations, they therefore can easily escape attention when GDP or its growth rate is rather simplistically adopted as the sole barometer of economic performance.

Financial Market Transactions: For example, if the government indulges in bond transactions or their expensive servicing, the transaction will not be picked up by the GDP equation.

Public and Private Transfer Payments like social security contribution, gifts etc: So, for example, if you play havoc with the EOBI (Employees Old Age Benefits Inst.) funds and erode national wealth and savings of the majority of the working class, the same will not affect GDP growth rate calculations and where it will still be business as usual!

Last, but not least, GDP can be calculated in three different ways and the one recommended for countries like ours is to use the output approach, as this focuses on production, output and employment; to be then cross checked with the results of the Expenditure and Income approaches. However, if you do it the other way round, the output figures are often be adjusted to arrive at the results of the expenditure approach. It appears that we in Pakistan are making this mistake, because the touted 4.50% growth does not seem to be visibly translating into equivalent jobs’ creation?

Point being that yes, while it will be nice to one day see the government achieve a 7% GDP growth rate, but for now, even the claim of 4.50% growth does seem to be, a) non-transparent, b) un-encompassing, as it fails to fully incorporate the rulers’ economic mismanagement in key areas of the economy, and c) missing out on the desired objectives of employment generation and equitable distribution of opportunity in the Pak economy. More importantly, what we need to understand today as a nation is that years of unequal intra-country development has in-effect created a divide by creating rich and poor regions in the same country, leaving a big segment of the population in poverty.

Those people who have been left behind would like better lives, and that is putting enormous pressure on the boundaries between the poor areas and the rich areas. More often than not this extreme pressure lets itself out in shape of hatred, extremism and terrorism. And the challenge here is not merely developing an understanding of this very difficult problem facing Pakistan today, but to instead dispense quality governance that can lead to long-term solutions for addressing genuine grievances of this unhappy segment of our population. The trouble though is that as we look at the governance record of this government over the last two and a half years, it doesn’t hold them in very good light!

Source: http://nation.com.pk/columns/18-Nov-2015/understanding-gdp-and-its-growth