GDP is not valid anymore?

map_of_countries_by_gdp_nominal_in_us

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Gross domestic product (GDP) is “the monetary value of all the finished goods and services produced within a country’s borders in a specific time period” (Investopedia, 2016). The value of GDP is often used as an indicator of a country’s economic performance. It is measured annually (sometimes quarterly) to determine the expansion or growth of economy within a country, and thus the nation’s standard of living. The result will then be compared internationally for evaluation or decision making. As for measurement, GDP can be calculated using the following formula:

GDP = C + G + I + NX

Note:

  • C = private consumption or consumer spending in the country
  • G = government spending
  • I = Investment of the nation, including businesses capital expenditures
  • NX = net exports (Exports – Imports)

The question is whether GDP will still be a valid and reliable indicator of economic performance in the future. The answer is unlikely, and here is why.

Referring to the formula, GDP is calculated by accumulating the sum of consumptions (C), government spending (G), investment (I), and net exports (NX). For this particular explanation, however, the assumption of constant G, I, and NX is made. Therefore, in this case consumption (C) will be the only factor affecting GDP.

The consumption is equal to the sum of all private consumption or consumer spending, including spending on goods and services and other consumptions, such as electricity. Using the case of China, Rose (2016) reported that the total power use by residential group in 2015 was 727.6 billion kWh. In 2011, the average cost of electricity in the country was US$ 0.08 (OVO Energy, 2016). Assuming a 2-percent inflation, the price of electricity by 2015 will be at approximately US$ 0.09/kWh. Hence, the consumption of electricity at residential level might have contributed roughly US$ 65.48 billion to China’s GDP in 2015.

In the future, however, the GDP of China may slump exponentially (Assumption: GDP is solely driven by consumption). The main reason is due to China’s commitment to reduce carbon emission in response to the issue of climate change, as discussed during the summit in Paris (Kinver, 2015). One of the approach is through mega investment in renewable energy, including solar panels and wind turbines, to replace coal and fossil fuel as the source of electricity. As the issue of global warming has spread to the consumer level, it is probable that residents will also install solar panel on their houses. It is particularly possible as Tesla introduced “solar rooftop” which would provide the whole house with indefinite electricity supply at an affordable price; Elon Musk actually mentioned that the price of Solar Rooftop would be lower than the price of normal roof (Randall, 2016). Taking it to the extreme, given that all houses use solar power to run electricity, the consumption of electricity, which worth US$ 65.48 billion, will fall significantly. It is important to note that this scenario is only possible if constant (G+I+NX) is made. In the real term, GDP will not fluctuate drastically as the investment will compensate the movement or change in the consumption. But still, the investment’s level would gradually falling in the long run as more solar panels are installed.

Back to the topic, the fall of electricity consumption will reduce the China’s GDP substantially. But it does not necessarily mean that the economy has slowed down, as suggested by the definition. The matter of fact, the overall welfare of Chinese people should increase as monthly electricity bill decrease, probably to zero dollar, and thus increase the monthly net income.

However, it can be argued that the rise of green energy will subsequently decelerate the economy in longer term. As more consumers adopting solar panel, the demand for electricity, which currently provided by energy companies, will decline. It consequently deteriorates the sales performance of the energy companies, which could lead to losses. As a result, energy companies may be forced to make radical changes, such as cut productions or perform job cuts, and consequently worsen the unemployment rate, and thus impact the overall economy. Nonetheless, it can be counter-argued that the adoption of green energy is at gradual pace, and thus energy companies will have time to make changes, such as investing in renewable energy, to avoid potential recession, and keep expanding in the long run.

Ultimately, GDP should not be used as a sole indicator to measure the economic performance of a country. The overall welfare, unemployment rate, and other indicators should be included in the equation. Furthermore, factors impacting the fluctuation of GDP should be investigated thoroughly to truly understand the nature of the variabel. If the factors decrease GDP, but turns out offering substantial benefits as explained in the scenario above, the fall of GDP cannot really be considered as a bad thing. Hence, the paradigm of declining GDP as a negative indication should be stopped because it may not truly represent the condition of the economy.

What is your opinion about this particular topic? Leave your comment below or contact us for further discussion.

References:

Gross domestic product (2016). Investopedia. Retrieved on December 20, 2016, from http://www.investopedia.com/terms/g/gdp.asp.

Kinver, M. (2015, December 14). COP21: What does the Paris climate agreement mean for me?. BBC. Retrieved on December 20, 2016, from http://www.bbc.com/news/science-environment-35092127.

OVO Energy (2016). Average electricity prices around the world: $/kWh [Online] from https://www.ovoenergy.com/guides/energy-guides/average-electricity-prices-kwh.html.

Randall, T. (2016, October 31). No one saw Tesla’s solar roof coming. Bloomberg. Retrieved on December 20, 2016, from https://www.bloomberg.com/news/articles/2016-10-31/no-one-saw-tesla-s-solar-roof-coming.

Rose, A. (2016, January 17). China’s 2015 power consumption up 0.5 pct year-on-year. Reuters. Retrieved on December 20, 2016, from http://www.reuters.com/article/china-power-consumption-idUSL3N15104C.

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