Gross Domestic Product - Externalities

Externalities

GDP is widely used by economists to gauge economic recession and recovery and an economy's general monetary ability to address externalites. It is not meant to measure externalities. It serves as a general metric for a nominal monetary standard of living and is not adjusted for costs of living within a region. GDP is a neutral measure which merely shows an economy's general ability to pay for externalities such as social and environmental concerns. Examples of externalities include:

• Wealth distribution – GDP does not account for variances in incomes of various demographic groups. See income inequality metrics for discussion of a variety of inequality-based economic measures.
• Non-market transactions–GDP excludes activities that are not provided through the market, such as household production and volunteer or unpaid services. As a result, GDP is understated. Unpaid work conducted on Free and Open Source Software (such as GNU/Linux) contribute nothing to GDP, but it was estimated that it would have cost more than a billion US dollars for a commercial company to develop. Also, if Free and Open Source Software became identical to its proprietary software counterparts, and the nation producing the propriety software stops buying proprietary software and switches to Free and Open Source Software, then the GDP of this nation would reduce; however, there would be no reduction in economic production or standard of living. The work of New Zealand economist Marilyn Waring has highlighted that if a concerted attempt to factor in unpaid work were made, then it would in part undo the injustices of unpaid (and in some cases, slave) labour, and also provide the political transparency and accountability necessary for democracy. Shedding some doubt on this claim, however, is the theory that won economist Douglass North the Nobel Memorial Prize in Economic Sciences in 1993. North argued that the encouragement of private invention and enterprise due to the creation and strengthening of the patent system became the fundamental catalyst behind the Industrial Revolution in England.
• Underground economy–Official GDP estimates may not take into account the underground economy, in which transactions contributing to production, such as illegal trade and tax-avoiding activities, are unreported, causing GDP to be underestimated.
• Asset Value–GDP does not take into account the value of all assets in an economy. This is akin to ignoring a company's balance sheet, and judging it solely on the basis of its income statement.
• Non-monetary economy–GDP omits economies where no money comes into play at all, resulting in inaccurate or abnormally low GDP figures. For example, in countries with major business transactions occurring informally, portions of local economy are not easily registered. Bartering may be more prominent than the use of money, even extending to services (I helped you build your house ten years ago, so now you help me).
• GDP also ignores subsistence production.
• Quality improvements and inclusion of new products–By not adjusting for quality improvements and new products, GDP understates true economic growth. For instance, although computers today are less expensive and more powerful than computers from the past, GDP treats them as the same products by only accounting for the monetary value. The introduction of new products is also difficult to measure accurately and is not reflected in GDP despite the fact that it may increase the standard of living. For example, even the richest person from 1900 could not purchase standard products, such as antibiotics and cell phones, that an average consumer can buy today, since such modern conveniences did not exist back then.
• What is being produced–GDP counts work that produces no net change or that results from repairing harm. For example, rebuilding after a natural disaster or war may produce a considerable amount of economic activity and thus boost GDP. The economic value of health care is another classic example—it may raise GDP if many people are sick and they are receiving expensive treatment, but it is not a desirable situation. Alternative economic estimates, such as the standard of living or discretionary income per capita try to measure the human utility of economic activity. See uneconomic growth.
• Sustainability of growth– GDP is a measurement of economic historic activity and is not necessarily a projection. A country may achieve a temporarily high GDP from use of natural resources or by misallocating investment.
• Nominal GDP doesn't measure variations in purchasing power or costs of living by area, so when the GDP figure is deflated over time, GDP growth can vary greatly depending on the basket of goods used and the relative proportions used to deflate the GDP figure.
• Cross-border comparisons of GDP can be inaccurate as they do not take into account local differences in the quality of goods, even when adjusted for purchasing power parity. This type of adjustment to an exchange rate is controversial because of the difficulties of finding comparable baskets of goods to compare purchasing power across countries. For instance, people in country A may consume the same number of locally produced apples as in country B, but apples in country A are of a more tasty variety. This difference in material well being will not show up in GDP statistics. This is especially true for goods that are not traded globally, such as housing.
• As a measure of actual sale prices, GDP does not capture the economic surplus between the price paid and subjective value received, and can therefore underestimate aggregate utility.