GDP is fundamentally flawed as a measure of economic and societal success and human wellbeing

GDP is a measure of ‘economic throughput’. Since the Second World War, it has become synonymous with measuring economic success. There are many, many books about economics that tell us all there is to tell about GDP. But it’s only in more recent texts that its shortfalls are set out in more stark terms. These point out its many flaws.

I won’t delve into very much detail here. But I do need to describe how flawed it is as a metric for “success”. GDP is a throughput measure, like an income and expenditure statement, except that many expenditures are tallied as plusses as well as the incomes being pluses.

Yes, you read that correctly – in GDP, income is a plus and many costs are also a plus. An activity that generates income is seen as being equally as “good” as one that creates a cost, even if that cost could have been avoided, and the cost reduces the value of something in an associated balance sheet.

GDP was created that way because one of the main objectives after WW2 was to generate activities, and therefore jobs.

GDP is a measure of throughput. Worse than that, it doesn’t distinguish particularly between throughput that is productive and throughput that is destructive (eg damaging natural and other assets).

The way GDP is currently configured, it actually promotes activities that drive us further towards, or into, overshoot re planetary boundaries, without improving human wellbeing. Obvious examples are (arguably) preventable costs such as those relating to cleaning up oil spills, armaments generating an arms race or supplying an active (aggressive) conflict. GDP treats all these as positives, because they create paid work, rather than as negatives. If GDP was altered, so that it represented something akin to net profit (income less expenditure) in a set of accounts, then all those things would be on the "expenditure" side and there would be an economic reason to minimise them.

The equivalent of "income" would be sustainable harvests from nature. Looking at it that way, GDP is counterproductive and damaging as a metric. It was only beneficial for a time after WW2 to promote economic activity and jobs (on any legal activity) rather than to promote the most sustainable future growth, in an environmental sense.

There are numerous texts that point out these and other flaws in using GDP as a measure of economic success.

For example, Hynes et al (2020) describe very starkly the prevailing approach to GDP and growth, in the time from shortly before I was born through to today's era. It’s sobering for me, personally, to reflect on the fact that this economic reality is the backdrop to my entire life so far:

“In 1961 the newly-created OECD, encouraged by ‘classical’ economists, proposed to turbocharge the economy. They championed an unsustainable and delusional new target for something they named “growth”, 50 percent over the decade. They also pushed policies for financial liberalisation, although it would take several decades for these changes to be fully implemented. These policies led to a series of credit booms – regarded as ‘infinite booms’ by for example, traders in sub-prime mortgages and collateralised debt obligations. The situation was one of “all competition and no control”, both as regards demand-side measures, such as limits on loans-to-value ratios, and supply-side actions, including lending and interest rate ceilings, reserve and capital requirements, and supervisory guidance. Policy and regulation require boundaries, but finance capital abhors boundaries. The result is an international monetary system run by the equivalent of the Sorcerer’s Apprentice. In the absence of the Sorcerer – regulatory democracy – financial risk-takers and fraudsters have, since 1971, periodically crashed the global economy and ruined the lives of millions of people.”

One major flaw in GDP is that not only does it encourage activities that should actually be seen as costs (such as armaments production driven by conflicts, clean-up operations to address human-caused environmental disasters etc) but it encourages increased financial risk-taking and distracts everyone from what is going on in the relevant balance sheets, and from the bad stewardship that is part and parcel of the GDP approach.

To stretch my comment about a "profit and loss" style of improvement over current GDP configuration, some expenditures should not be in the profit and loss account at all, because they would be an investment in nature and its future ability to provide for us in perpetuity. Such investment costs should be added to the value of natural assets in a balance sheet instead of putting them in a profit and loss account as a cost (that is a basic accounting principle at play).

But what balance sheet to show the carrying value of such natural assets in?

Firstly, National balance sheets need to be improved by including Natural Capital (the UK SNA – “System of National Accounts” - is going down this route).

Ultimately, a World Balance Sheet, with proper Natural Capital accounting for all of the planet's natural assets (among other assets) added together, would be required. I say more about that in my book "Beyond the Bottleneck".

If these flaws are so bad, why has GDP been so embraced and prevalent in the post-WW2 world?

The simple answer is that many countries sought to reconstruct national and regional economies after the major destruction of the Second World War. Expansion of economies, involving increases of industrial production, its associated jobs and the ‘multiplier effect’ were (quite rightly) seen as laudable objectives. Consumerism (about which there are also many books) further ratcheted up the expansion, through encouraging people to buy things they wanted but didn’t need, and to throw them away quickly so that new replacement products could be sold to them.

GDP was an excellent tool for supporting all of those objectives. At the time, the environmental consequences of that growth and expansion were considered (incorrectly) to be either immaterial or absorbable by the Earth and its ecosystems.
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For several decades now, we have known that some of the assumptions about lack of impact on the environment were sorely mistaken. Unfortunately, GDP and the industrial and commercial systems it most favours, have their own inertia. And that’s where we are, still - generating more and more growth in things we want but don’t need. Generating profits but not properly accounting for the costs (by counting many of them as positives to be increased rather than disbenefits to be reduced), and not looking at the relevant balance sheets to see how our civilizational health is being eroded by the very things we do more and more of.