The most important measure of economic activity in a country, the Gross Domestic Product is the crossing point of three sides of the economy: expenditure. output. and income .
As a measure of well-being of a country for international and temporal comparisons, it provides a good first approximation. Still, it ignores many crucial elements of general well-being, like environment conservation, safety, life expectance, and population literacy. In this respect, one should rather look at the Human Development Index.
To measure economic activity, one needs a meaningful aggregation of all kinds of productions. The territory's productions are the crossing result of 1) effective demand, 2) production capabilities, and 3) income. Income arises from payments distributed to production factors and it provides the necessary finance for demand.
A numerical example will explain the fact that GDP is expressive of these three sides or, in other words, of the contemporary action of buyers, sellers, producers and the income receivers.
Italy's GDP in 1996 can be computed as a sum from three lists of components [1 ].
In the first column, attention is given to the buyers. GDP is then measured as the sum of all domestic and foreign effective demand for national goods. Domestic demand is the sum of household, government, and firm expenditure (respectively called: consumption. public expenditure. and investment ). Foreigners buy national goods as exports.
Domestic demand is attracted not only by national goods but also by imports. which reduce the GDP sum. A minuscule additional element is the change in inventories (the goods that nobody wants at the moment).
The second column shows the position of the sellers and the kind of things they sell: GDP is now obtained by summing up "value added" over the economic branches of the economy. VAT revenue is added to obtain GDP.
The third column points at the remuneration of production factors (labour and capital) with the share of the state. The same income serves as source of finance for the demand of the first column.
This identity expenditure = output = income holds always as a matter of definition and national accountancy conventions [2 ].
The three sides of GDP interact to determine the aggregate. An increase of effective demand (consumption, investment, public expenditure, exports) will increase GDP, provided national producers can meet the quality /price requirements of buyers. If not, imports will grow instead. If national production cannot grow for physical reasons, firms producing already at full capacity probably will decide to raise prices, vanishing effective demand with inflation.
The diffusion of technological and organizational innovation can impact on productivity. on product/process quality and on costs (thus potentially on value added). Capital accumulation and the increase of labour quality and motivation are important ingredients for a growing GDP.
Short term business cycles and long term trends can be - to a certain extent - traced back to the individual growth path of heterogeneous firms, as this paper points out.
Impact on other
GDP can manifest manyfold interactions with its components, giving rise to positive and negative loops. One of the most important is the link between consumption and income. Other feedback loops are included in this interactive map .
Movements in GDP have a number of effects on specific markets. For instance, energy consumption and greenhouse gases' emissions can be linked to it, unless proper strategies are undertaken.
Never is GDP at the same level year after year. The most common GDP trend is a continuous growth with periods of acceleration and deceleration. Some episodes of absolute fall are afterwards overwhelmed by further growth. Decades can be quite different in terms of average rate of GDP growth.
In many countries, especially small and in the Third World, growth is hectic and irregular, with frequent and deep absolute falls and booms.
Wars are a distinctive source of GDP sinking. Oil crises have exerted recessionary pressure all over the world (with the partial exception of oil producer countries).
On a global scale, the distance between the richest and the poorest countries is increasing, whereas locally there exist "convergence clubs" in which distances are getting smaller. A few developing countries have taken off and reached a high development stage.
Business cycle behaviour
To a large extent, GDP evolution "is" the cycle. It is in fact with respect to GDP dynamics that other variables are defined as pro-cyclical (if they follow a similar path) or anti-cyclical. A recession is often defined as a two-quarter absolute reduction of GDP.
Growth in GDP is particularly pronounced during expansionary and booming phases, culminating in peaks, which open the gates towards recession or even depression. They last until a trough is reached, often thanks to specific policies and favourable international conditions, which is followed by recovery. when the losses cumulated are reverted back.
Beyond GDP: the proposal of the Quality Domestic Product and its nowcasting
The GDP has a number of evident limitation as main indicator for economic policies. Our institute is on the forefront of the research on alternatives. The EWI has not only been quoted as a reference source by the EU Parliament Background Report on "Beyond GDP - Alternative progress indicators to Gross Domestic Product (GDP) as a means towards sustainable development". and assured the presence to the starting conference. but has participated, in the person of his director, to the reflections, building blocks, formulas, simplifications and empirical estimation of the Quality Domestic Product - the share of GDP which is of "good quality" (according to a multi-criteria definition), carried out by the Scientific Commitee on behalf of the Italian Foundation "Symbola". This work, which is on-going across the years, produced in 2007 this report [in Italian language] and can lead to industrial, territorial and other policies to improve the composition of GDP in mature and developing countries.
In 2014 we published here a nowcasting technique for the Quality Domestic Product.
Please feel free to contact us for further details and possible cooperation.