ways to compute gdp and demand side economics
Updated: Mar 20
In this article I wish to share the various ways to compute a country’s Gross Domestic Product (GDP) and the philosophies/politics behind it.
The GDP is known as the value of goods and services produced by a country over a period (Month, Quarter, Year) and there are three main ways to compute it:
1) The value-added approach: Taking a nation’s output and subtracting its intermediate consumption (goods and services used to produce the output).
2) The income approach: The income earned by resources used to make stuff, mainly we have wages (labour) + rent (land) + interest (capital) + profit (entrepreneur), they form the bulk and the final number is made up by sales, property taxes, depreciation and net foreign factor income.
3) The spending approach: The total spending by consumers, investments, government, imports nett of exports: C + I + G + X – M.
(3) is the one most taught in econs and used in media due to its simplicity in computation, it also provides the picture to the classic remedy used by monetary policy authorities in handling recession.
By lowering interest rates, C and I will increase due to the lower borrowing rate and they will in turn boost consumption, create more jobs etc etc
By increasing G, it will boost momentum in the circular economy, create more jobs etc etc.
All good, however I feel this computation approach masks the angle of income inequality. There are countries that prescribe to the free market economy, believing that in a free economy there will be trickle down economics at work. This is now known to be not so true, in a real harsh capital market the next dollar earned is well split between the four factors of production. But wait, that’s when governments jump out and say “well that’s what we are here for, we will be in charge of collecting taxes and conduct social transfers!” All good, but unfortunately the presence of a large government is contradictory to the ideals of a free market though.
We have been favoring computation approach (3) due to the victory of demand side economics, relative ease in calculation and kind of helps justify the government as the recession savior. But I’m increasingly skeptical of its usefulness, compared to analyzing approach (2). Key element being how consumption had such a slow growth despite historically low interest rates since the Global Financial Crisis (GFC).
If we analyze the income breakdown of the 4 factors in (2), it is clear that (2)’s share has been declining for years (even before the GFC). Social transfers does not encourage consumption that’s required to rescue an economy and yes it is also important to grow the cake not just how to split it, the hard truth is that the cake hasn’t been growing much for years too.
Prices of goods (primarily housing) has increased at a pace faster than one’s wage, that obviously depresses the average person’s disposable income. On the other hand, it is true that one can have too much money – there’s only so many Bentleys, Bungalows that a towkay can buy. Past a certain point adding one more zero to his bank account adds little value to society.
Demand side economics coupled with business-friendly policies favors laborers the least. It is time we have a serious rethink of these social compacts. I agree with Howards Marks that a new wave of change is coming https://www.oaktreecapital.com/insights, I hope we can all be prepared for it.