Sunday, July 3, 2011

The Unintelligent Investor's Definition of the Week: GDP

GDP

Oxford dictionary definition: abbreviation, gross domestic product
Gross domestic product: the total value of goods produced and services provided in a country during one year.

The Unintelligent Investor’s Explanation

There are a few ways to determine a country’s GDP you can look at their output, their income or their expenditure. Production is measured regardless of their uses.

GDP is often used as an indicator of a country’s standard of living. In Australia, a technical recession is when the country’s GDP shrinks for 2 quarters in a row. In China, you hear about GDP growth of 10%, 13%, etc and some people are calling it the next economic miracle. So GDP has always been used as a rough gauge of how the country is doing.

Another term used is GDP per-capita, which is the GDP divided by the population, giving you an average of how much money each person have in the country.

However, like most things in our world, many exceptions and assumptions apply which forces to think twice about a country’s economy when looking at their GDP.

As some of you might already know, I’m in the middle of a Global Health Conference in Sydney. This conference ends tomorrow and it is followed by AMSA Convention, which is a much bigger and general medical student convention.

So I was in one of the lectures in this conference and the speaker gave a very nice example. He said, lets assume that this lecture hall is a country, you are all students and lecturers don’t get paid much, we all don’t have money, hence our GDP will be very low. Lets say if suddenly Bill Gates came into the lecture theatre, our GDP growth will suddenly go through the roof, our GDP will sky rocket and our GDP per-capita will jump from a few dollars to a few million dollars. So in the newspapers, it will seem like our country is doing very well when in actual fact we are just as poor as before. (No unfortunately Bill Gates did not come into the room on cue)

Another thing that is great for GDP are natural disasters. GDP does not take into account the destruction caused by the disaster but accounts for all the reconstructions that occurs after. Unfortunately some people lose their lives in a disaster but this is fortunate for GDP per-capita because it decreases the denominator.

In paediatrics, one of the most important thing to do when looking after a child is to take serial measurements of their height and weight. Height and weight on its own is fairly useless but when you have old data to compare it with, suddenly you’re able to gauge if the child has been growing well, at the right rate, is he failing to thrive, etc. I guess the same applies to GDP. On its own, it might not be so useful but when used with other indicators and historic data, it might give us an idea of what the economy is doing.

In an ideal world, I can grow gold on a tree and GDP will include all externalities but I don’t have a tree that produces gold and GDP does not include externalities like pollution and domestic work. China’s GDP might be growing at an amazing rate but so is its pollution, in a world where I can grow gold on trees, that would be accounted for because pollution will ultimately cause poor health and decrease productivity and increase health costs.

These are just some of my thoughts and things that I’ve heard or read from various sources. So let me know what you think about GDP. Is it a useful indicator? What other indicators would you rather use?

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Next post Tuesday!

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