Gross Domestic Product (GDP) is an economic parameter that measures economic activity of a nation. Conventionally, GDP measures the market value of goods and services that a nation produces in a given time in terms of per capita. Per capita indicates economic welfare of people.
According to the World Bank, GDP is parameter that compares economic capacities of nations and economic welfare of their respective citizens (Para. 1). GDP is applicable as an indicator of economic welfare because it correlates with amounts of goods and services that people consume. However, GDP is not a sufficient parameter to indicate economic welfare of a nation because it measures activities that have monetary values only.
Wenzel (2009) posits that, the use of GDP as a normative indicator of economic capacity of a nation does not give quality measure of economic growth because it gives a distorted view economic welfare (p. 7). Fundamentally, GDP has several limitations because it does not consider intricate factors that determine economic status of a nation and economic welfare of populations.
The first limitation of GDP as an economic welfare indicator is that it measures overall economic activity of a nation, which indirectly indicate welfare of the population. Although a nation may have so many economic activities, it may also have low welfare status of its citizens.
Rationale of using GDP as a welfare indicator has it basis on the assumption that economic activities directly indicate economic welfare of citizens. Kahneman and Krueger (2006) argue that, economic activities of a nation and economic welfare of individuals are technically different entities that coincidentally correlate (p.6). Thus, it is assumptive to believe that GDP correlates with economic welfare of populations.
The second limitation of DGP is that it does not consider the distribution of wealth in a nation because it gives average production of goods and services in markets. Rogers, Jalal, and Boyd (2008) assert that, GDP does not take into consideration leisure facilities, depletion of natural resources, volunteer labour, household production and other underground economic activities that do not feature in markets (p. 302).
Since many goods and services are not present in markets, use of GDP as an indicator of economic welfare of the population gives an underestimated value of welfare status.
The fact that GDP indicates net production rather than gross production is a third limitation of GDP as an indicator of economic welfare. Riesman (2006) argues that, GDP examines the value of final products and thus exclude value of intermediate products or raw materials that are economically significant (p. 611).
Production of raw materials and intermediate products involve a substantial deal of economic activities that reflect economic welfare of the population, but does not appear in GPD. Therefore, GDP overlooks significant factors of production that deals with raw materials and intermediate products, hence does not reflect economic welfare of a nation or its population.
Fourthly, GDP limitation is that it does not differentiate beneficial production from detrimental production for it just measures overall economic activities.
Smith (2011) contends that, the value of GDP increases even in detrimental activities such as oil spill, pollution, road accidents, outbreak of diseases, and increase in crimes yet welfare status drops (Para. 3). GDP increases in the presence of detrimental activities because government spend a lot of resources in mitigating detrimental effects of varied activities but welfare of the population remains the same or degenerate. Thus, GDP does not sufficiently indicate welfare status of nations and their population.
References
Kahneman, D., & Krueger, A., 2006. Developments in the Measurement of Subjective Wellbeing. Journal of Economic Perspectives, 20(1), pp.1-24.
Riesman, G., 2006. The Value of ‘Final Products” Counts Only Itself: Today’s Gross Product Is Net Product. The American Journal of Economics and Sociology, 63(3), pp. 609-625.
Rogers, P., Jalal, K., & Boyd, J., 2008. An Introduction to Sustainable Development. London: Earthscan.
Smith, H., 2011. Limitations of GDP as a Measure of Economic Welfare. Finland Statistics. Web.
The World Bank. 2011. GDP and Actual Individual Consumption. International Comparison Program. Web.
Wenzel, T., 2009. Beyond GDP: Measuring the Wealth of Nations. Germany: GRIN Verlag.