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Gross Domestic Product (GDP) is defined by John (1999) as the total market value of all the final goods and services produced within a nation's borders in a given time period. Each goods and services produced and brought in the market has a price. The price of the total output is called as GDP. It can be measured by either cumulating all the income earned in the economy or all the spending in the economy and both measures should roughly equate to the same total. Real GDP is the total GDP has been adjusted to remove the effects of inflation. This allows one to compare GDP figures and changes from one country to another other time and thus evaluates what a country's economy is actually worth in terms of particular year's product prices.
In nowadays, real GDP is widely used by policymakers, economists, international agencies and the media as the primary scorecard of a nation's economic health and well-being. People believe that the standard of living is closely tied to the real GDP. This generally signifies that the economy is wealthier and producing more, individuals are better off, and that living standards are higher. However, people more recently argue that real GDP in certain circumstances could not fully represent people's standard of living. In this essay, I am going to examine the extents in detail by analyzing the real GDP from different perspectives. However, the essay will mainly address the limitation of real GDP to show that real GDP could not represent the correct value of the economy; therefore it may not adequately measure the standard of living.
Real GDP only includes the total domestic production of an economy and the output of some goods and services are unrecorded, which in the long run results understate the total real GDP. We can view this problem from national and international perspective. First, we look at the national level. In a country, items which are not made to sell in market are excluded from the real GDP as there is no money exchange in hands. For in stance, someone plants vegetable for himself and does not take the vegetable to market, the value of the vegetable is not included in the real GDP. However, if this person sells the vegetable in the market, the value of the vegetable adds to real GDP. Another situation is black market. Many self-employed people normally undertaken their job privately, therefore they are usually paid by cash. If they don't declare their income for tax purpose, then this type of income is excluding from real GDP as well. Consequently, real GDP may even not be able to reflect the correct value of a country's economy as a whole from national perspective. It is hard to say it could adequately measure the standard of living.
From the international perspective, real GDP measure the output of the home economy of a country and thus excludes over-seas enterprises that may be taking place. In a world which is increasingly globalising and in which Trans-National countries are becoming increasingly important, this can be significant in some cases. For example Japan has many over-seas enterprises; particularly car-factories which often locate in the EU to produce cars for the EU there at a lower cost inside tax barriers imposed by the EU. However, these companies act somewhat as a drain to these EU economies and a boon to the Japanese economy as they send back considerable profits made to Japan to be used in further investment rather than directing money earned into the economy where the factory is located. In effect, consumer spending in the EU countries is still sent to the firms as expenditure for their services, but it is Japanese firms that the money is being sent to: it is foreign spending boosting the Japanese companies and thus indirectly their economy. These external monies earned over-seas are excluded from Japan's total real GDP figures as they are not domestic output, but this over-seas output is still a significant output by Japanese companies which earns monies for usage in Japan.
In this situation, the external monies excluded from real GDP may lead the real GDP of Japan relatively lower than it should have been and as a result the standard of living in Japan should also have been reasonable lower than it should have been. However, in the practice, the living standard of Japan is still high in the world. This is because although overseas earning is excluded from Japan's real GDP, the profit brought from overseas to Japan could help Japan to boost its economy. Thus the economy gets wealthier; the standard of living gets higher. People may argue that the standard of living in Japan is high because its real GDP has always been high. Whilst it is true that real GDP of Japan is always high in the world, we should not ignore that with the overseas output added to Japan's real GDP may result even higher real GDP but same standard of living. It gives us a logical conclusion that a country with its most income from overseas entities may result a pretty lower real GPD but good standard of living. Consequently, real GDP could not adequately measure the standard of living from international perspective.
GDP is only focus on a nation's production, but the production may be a poor indicator of people's standard of living. It is because production does not equal to consumptions. Production only provides basis for people to consume, but the right to consume is held by the people in the country. If GDP rises as a result of an increase in investment, this will not lead to a rise in current standard of living. It will, we only can say it helps to raise the future consumption. If production increases, this may be due to technological advance. However, if the increase is as a result of people having to work harder or longer hours; its net benefit will be less. This is because although the real GDP is raised as a result of increase in production, people are living more stressed and tired which is not improving the living standard but make its worse.
Furthermore, real GDP figures can be misleading, for example, a growing economy may have rising production levels but also may have a large or growing population which works against any positive effect on the standards of living. The most specific case is China. China has one of the fastest growing economies, with average 7% GDP growth for 11 years in the world. China's real Gross Domestic Product (GDP) in 2002 was more than eight times that of 1978, the year when Deng Xiaoping launched the country's economic reform program. Its real GDP growth, which has averaged 10% per year during 1980 - 2001, had slowed to a range of 7 - 8 % per year during 1998 - 2002 (IMF Survey 2003). Standards and Poor's DRI, a private international forecasting firm, projects China's GDP to grow at an average annual rate of 7% over the next 15 years (Morrison 2000).
Although China has a rapid growth GDP, China remains a poor country in people's standard of living. The Chinese leadership faces profound challenges as it seeks to sustain rapid economic growth and deliver rising living standards to its population. It must further cut tariff levels and eliminate non tariff barriers in order to meet WTO requirement. This opens up the economy to even more foreign competitions and stimulates structural changes that will add to the unemployment which at 2003 stood at 170 million (Wolf 2003). Apart from the unemployment issue, China's leadership must grapple with income inequality, which is increasing on virtually every identifiable dimension. Both unemployment and income inequality could trigger social unrest. This is because China has the largest population in the world and it is really difficult to make everybody rich at the same time with little money. Following the economy growth in china, many people have improved their standard of living but a lot people are still living poorly. The income inequity has made people live very differently in China and this could cost problem for the society as a whole. For instance, the poor people could commit crime like stealing, robbery, in order to cope with their life. Consequently, the growth of real GDP did not lead the improving of standard of living for the society as a whole. In another words, GDP sometimes could not fully represent the standard of living.
Moreover, the standard of living of country is always affected by the government policies, which have little relation to its real GDP. For instance, several countries have a high real GDP but are ranked comparatively lower down on the Human Development Index published by the UNDP. This is because although the governments have the funds, they are not utilizing them on improvement in the living standards. This is mainly noticed in the sub Saharan and Middle Eastern countries like Botswana, U.A.E, Qatar, Saudi Arabia, Iran, and Equatorial Guinea and so on.
On the other hand, many countries are following a free market policy today, which means minimum government intervention. In this kind of an economy, foreign investment increases and there is a greater flow of goods into the country. Some economists believe that when there is more investment and money is flowing into the economy leading to development there is bound to be an increase in the income of the entire nation, thus increase in the real GDP and leading to better standards of living. However, although there is an increase in real GDP, the rich get to cash in on the opportunities while the poor get even more impoverished. A large disparity in wealth can be observed in these nations, and although economy has increased phenomenally, living standards continue to remain disastrous. An example can be taken by Thailand.
Next, real GDP only evaluate the standard of living in the monetary term, which ignore the factors which are also important for people in the standard of living, such as environment. In view of the fact of the industrial revolution, world wide economic growth has been mostly based on the high consumption of natural resources and energy. This model contributed to the heavy cost of high consumption, low benefits and serious pollution. Although the increase of real GDP result the growth of economy of a country, the industry developed speedily and caused serious pollution to the environment, which was demonstrated by a series of environmental pollution incidents shocking the world. Development of resources, energy demand and the pollution that results have seriously reduced the amount and quality of natural communities of plants and animals all over the World. They have also led to a process of atmospheric warming which now causes a threat of climate change. Some people argue that Pollution has to be stopped at source. Economic growth has to be limited and the health and safety of the planet must become the main criteria in political and social development to maintain the quality of life which can be improved for all groups on the planet. In this situation, the growth of real GDP does not lead the increase in the standard of living. Quite oppositely, the more growth in real GDP, the terribly the environment get polluted and the worse the quality of the people's life is.
Another, real GDP ignores the distribution of income. If some people gain and others lose, we cannot say that there has been an increase in standard of living. Typical example is china. Following the fast growth of economy, a lot people grow very rich while others are left behind. In average, china still poor in living standard. In addition, employment is an important factor in evaluating living standard. Suppose everybody in a country is employed, then there would not be anybody leaving behind. A country with pretty high real GDP does not mean everybody is employed because the higher real GDP may be due to investment in road, office and etc, which is irrelevant to employment. In another words, the percentage the labour that could distribute from national income is an indicator to determine whether people in this country is rich enough to cope with their living. The more the labour is distributed from the national income, the more people get employed and the higher the living standard could be. In contract, the less the labour gets distributed from national income, the less people get employed and the poor the people might be. Consequently, the figure of real GDP does not decide the standard of living; the percentage of labour distributed to national income which is related to the total real GDP is the indicator.
In conclusion, it can be clearly seen that real GDP can not always adequately measure the standard of living of a nation from various perspectives. Firstly, Real GDP only includes the total domestic production of an economy thus understates the wealth of economy. Therefore real GDP could not show the full position of a country's economy, thus it is difficult to measure the standard of living. Secondly, real GDP ignore the income distribution. A country with higher real GDP may still present poor living standard because the situation that some people get richer but others get poorer does not show a high standard of living. Thirdly, real GDP only evaluate the standard of living in the monetary term, which ignores the factors which are also important for people in the standard of living, such as environment. A country's higher real GDP is based on the cost of environment could not indicate a good standard of living. Fourthly, the growth of real GDP does not always lead to improvement in living standards. All countries must place emphasis on balanced and sustainable development that also takes into account human needs centered development. Although the growth of real GDP is very important to every country, we should not ignore the people's living standard. All in all, real GDP could not adequately measure the standard of living in circumstances.