GDP full form
Gross Domestic Product
The Gross Domestic Product is one of the best indicators of economic health and development of a country. Learn more about the GDP basics and the GDP of India now.
Gross Domestic Product or GDP is the sum total market or monetary value of the entirety of finished products and services. This should be within a specific country’s border in a certain time period. It acts as a very expansive measure of the overall production within the national borders of a country. At the same time, it also acts as a reliable scorecard of a country’s total economic health.
Experts usually calculate the GDP on a yearly basis. However, it is also possible to calculate it based on quarterly sums as well. For example in the United States of America, the government produces an annualized GDP report. This is not only for every quarter but for each year as well. The production of the majority of the individual data sets happens in real-time. This means that all the data get adjusted on the basis of price changes and hence takes into consideration inflation.
The Basics of GDP
GDP takes into account all private as well as public consumption, investments, government outlays paid-in construction costs, etc. It also considers additions that privatized inventories make. With it is the foreign balance of trade, including exports being added and imports being subtracted.
The various types of GDP measurements are as follows:
- Nominal GDP: The measurement that takes into account the raw data.
- Real GDP: This measurement takes into consideration other factors like inflation. It hence allows for a comprehensive comparison between the economic output of a specific year to the following. It also includes other comparisons with different time periods in mind.
- GDP Growth Rate: This measures the increment in GDP from one quarter to another.
- GDP per capita: This measures the GDP per person among the population in a nation. This is one of the best ways to make comparisons of GDP between various Nations.
GDP of India
Current GDP of India
India is among the fastest-growing economy reaching a trillion dollars. The current nominal GDP of India is $2.94 trillion. This makes it the fifth-largest economy in the world as of 2019. When we compare the GDP according to our purchasing power parity, the Indian GDP rests at $11.33 trillion, ranking third in the world. The high population of India, however, reduces the per capita nominal GDP of the country to merely $2,170.
We may measure GDP using three basic methods. When we do the calculations correctly, using any of the three methods should yield the same result. The three approaches for calculating GDP are the output or production approach, the expenditure approach and the income approach.
GDP Formula Based on Spending
The spending approach to calculating GDP is what we also know as the expenditure approach. In this method, the expenditure by different groups that have a role to play on the economy is calculated. The formula used for this method is GDP = C + G + I + NX, where C= consumption, G= government spending, l= investment, NX= net export. Since the GDP of a country is a sum total of all these aspects, adding them provides the GDP of a nation. US calculates GDP using this method.
Going to the Depths
The C in this formula represents consumer spending or private consumption expenditures. Consumers are spending money on a regular basis in order to consume services and goods. This includes shopping or eating at a restaurant. We may consider consumer spending as the biggest factor that contributes to the GDP of a country. Economic growth is hence very significantly dependent on consumer confidence. A High confidence level connotes that the consumers want to spend on services and goods. However, lower confidence levels usually denote uncertainty about the buying activities that may take place in the future and an unwillingness to expend money
The G in the formula represents gross investment or government consumption expenditure. There are many expenditures that the government has to undertake in the form of payrolls, infrastructure and equipment. Government spending sometimes occupies a very significant role in the calculation of GDP. The business activities and consumer spending decline steadily at times, for example after a recession. The gross investment by the government at this juncture. becomes a very important factor.
The I in the formula stands for capital expenditures or government consumption expenditure. Business activities within a country require the expenditure of money in order to invest in and broaden their business. For example, businesses invest in buying machinery and on manpower. Investment by businesses is very important to the GDP. This not only provides an opportunity for employment but also enhances the productive capacity of a country.
The NX in the formula represents net export. Net exports calculated by subtracting total import from total export (NX= Export – Import). Basically the services and goods which a country produces within a national border and sells to another country, are the exports. On the other hand, those goods that a country brings from other countries are subtracted from the total exports which give the net export. While a chronic account surplus is great for a nation’s GDP, chronic deficit causes a decline in the GDP. All the expenditures by companies inside a nation’s border are taken into consideration. This also includes foreign companies within the nation.
GDP Based on Production
The production approach of calculating the GDP of a nation is exactly the opposite of the previous approach. The production approach does not take into consideration the input cost that fuels economic activity. On the other hand, there is a production approach. In this, experts make thorough estimates about the economic output and the entire value of such output. The spendings on intermediate goods that they use in the production are deducted. The expenditure approach moves ahead of cost. On the other hand, the production approach takes the standpoint in viewing the completed economic activities within a nation.
GDP Based on Income
An intermediate level of calculating GDP between the expenditure and production approach is the income approach. The reverse side of spending is expenditure. Within National borders, your expenditure is someone else’s income leading to the income approach in calculating GDP. The income approach takes into consideration all factors of production within an economy and the total money earned by them. This includes rent earned by the land, the wage paid to laborers, corporate profit and even return if capital as interest.
The calculation of GDP using the income approach needs some adjustment. This includes those payments that don’t make an appearance in the production factors. Some taxes like property tax and sales tax fall under the indirect business tax head. Depreciation, that is an amount that companies set apart to account for machinery that tears and wear, also taken into the national income. Taking all these factors into consideration, we calculate the national income. It acts as a pointer of implied expenditure as well as indicated production.
GDP vs. GNP vs. GNI
There are a number of tools of measurement when it comes to measuring the economic activity of a nation. It is true that GDP is the most common metric. However, some people also make use of other tools depending on nationality instead of geography.
GDP measures and refers to all the economic activities that take place inside a nation’s border. This is irrespective of whether the production is on part of the foreign entities or those who are native in the country. Gross National Product or GNP of the other hand, functions exactly in the opposite way. It takes into consideration all nature of productions or entities. These, however, should be within the physical border of a country as well as those, outside. However, it does not take into consideration domestic productions made by foreign corporations in the nation.
GNP and GNI
Gross National Income or GNI measures the total of all incomes owned by the citizens of a particular country. It however does not take into account if the fundamental economic activity takes place within domestic borders or abroad. GNI and GNP are similar in ways and are actually related to each other. It is similar to the income approach and the production approach of calculating GDP. If you pay attention you will see that GNP is simply an older approach. It makes use of the production approach.
GNI on the other hand is much more recent and modern and often preferred. This makes use of the income approach. The earnings of a country measured with the help of GNI includes not only its domestic income but also other factors. These include the net foreign factor income, depreciation and indirect business taxes. The net foreign factor is calculated by deducting the payments made to foreign countries from the payments being made to the citizens of the nation.
In order to keep track of the international economy, we now consider GNI as a better tool of measurement compared to GDP. There are chances of seeing a better and more accurate economic health of a country with this new measure. There are many countries, the majority of whose income is withdrawn by foreign individuals and corporations. As a result, the GDP turns out to be way higher than their GNI. For example, in 2014 Luxembourg reported a GDP of $65.7 billion, while the GNI was simply $43.2 billion. The difference in these numbers was because of the huge payments that had to be made by the foreign corporations to the rest of the globe that were stationed in Luxembourg.
Nominal GDP vs. Real GDP
Inflation usually affects GDP because it is rooted in the value of services and goods. When prices rise GDP increases and when prices fall, GDP decreases. This, however, does not comment on nature and modification in the quantity or quality of the services and goods. It is hard to say whether the increase in GDP is because of expansion in production or because of the rise in prices of services and goods within National boundaries
For this reason, economists have found a way through which they can adjust the inflation to produce the real GDP of a country. For this, price levels in a prevailing reference year is considered which is known as the base year. Experts adjust the output in a particular year with reference to the base year. This they do, in order to take into account the inflation. By doing this it is feasible to compare the countries GDP from one year to another. It helps in charting whether any real development in the economic health of the country has been seen.
When computing real GDP, economists use GDP price deflator. This is basically the discrepancy in prices in a specific year compared to the base year. For instance, if prices rise 5% from the base year to the particular year the deflator then comes to 1.05. When you divide the nominal GDP by the deflator, it gives the real GDP. The Nominal GDP is almost always higher than the real GDP as inflation is usually a positive number.
The Real GDP takes into account the various changes in the market value. This helps in narrowing down the discrepancy between the output from one year to another. When the difference between the real GDP and the nominal GDP is very big it signifies rather significant inflation (when the nominal GDP is higher than the real GDP). It may also signify a considerable deflation (when the real GDP is higher than the nominal GDP) in the economic health of the country.
Nominal GDP is however also important when comparing the outputs made in different quarters in the same year in a country. However, experts compare GDP between two or more years, and then they consider the real GDP. Because inflation is adjusted in real GDP the comparison between years solely focuses on the volume of economic production.
Real GDP is a largely better metric which we can use for measuring the long term economic performance for the health of a country. Let’s take the example of a hypothetical country, with a nominal GDP of $100 billion in 2009 and a nominal GDP of $150 billion in the year 2019. While it seems like the economic performance of the year has shown significant growth without considering a 100% price rise in the country. When we take this into full consideration, the real GDP in the year 2009 falls to $75 billion which reveals an overall deterioration in the economic performance of the country.
Comparisons based on the nominal GDP of a country can be risky and even illusory. This is because it does not take into account the impact of inflation on the economy.
GDP and PPP
Economists make several adjustments on GDP so it can be used in a variety of assessments. GDP on its own shows us the extent of the economy however it does not help us understand the standard of living of the people living in the country. This happens because the population and the cost of living is not equal or consistent in countries all over the world. For example, you will not be able to make out much by correlating the nominal GDP of Ireland to that of China because of the vast difference in population alone. China has a population 300 times larger than Ireland making a comparison like this futile.
In light of this problem, many statisticians have been using GDP per capita in order to solve this problem. The calculation of GDP per capita is done by dividing the total GDP of the country by its population. The figure that hence appears is often used as an important tool to evaluate the standard of living of people living in a country. The measure however is still not completely perfect. This can be understood by the following.
Consider China has reported a GDP per capita of $1,500 while that of Ireland is $15,000. This however does not mean that every person in Ireland is doing 10% better than every person in China. GDP per capita hence does not act as a measure of how costly it is to live in a particular country.
The Power of PPP
What comes in handy at this juncture is purchasing power parity or PPP. With the help of PPP, we can compare how many services and goods can be purchased by an exchange rate adjusted unit of money in various countries. Hence the price of an entity or a collection of items can be compared after the exchange rate between both the countries has been adjusted in order to make a comprehensive comparison.
We, therefore, adjust the real per capita GDP with respect to purchasing power parity. This gives us an extremely refined statistics which helps us measure the true income of the population. This is very important in understanding the standard of living and well being in a country. For example, a person in China can make $50,000 per year while another person in Ireland can make $100,000. When viewed in nominal terms the person and Ireland are better off than the person in China. However, if the basic necessities of life including food, clothing and shelter cost three times more in Ireland than in China, then the person in China is better off on the basis of the real income.
Using GDP Data
Most countries publish GDP records every quarter and on an annual basis. For example in the USA, the Bureau of Economic Analysis (BEA) releases an early quarterly report four weeks after the end of the quarter. They then finally release it three months after the end of the quarter. The GDP reports usually published by the economists of a country are rich in details and information that help the businesses, investors and economists to use these data and documentation in various facets and gain insight about the economic health of the country.
The impact that the GDP report has on the market is normally limited. This happens because it is a backward-looking operation and a good amount of time generally lapses between the release of the report and the quarter. Still, GDP reports can have a magnanimous impact on the market If the real numbers vary considerably from the expected numbers. For example, the S&P 500 had faced a huge decline in the two months on Nov. 7, 2013. In the third quarter, the US GDP increased at a 2.8% rate while the economists had only expected an increase at the rate of 2%. This data led to a host of speculations that the bigger economy could enable the U.S. Federal Reserve to scale down on the enormous stimulus program that was effective at that time.
Businesses can also take the help of GDP data in order to plan investment and expansion because GDP is an explicit indication of the health and development of the economy. Multiple government agencies like the Federal Reserve in the US often use not only the GDP but also other documentations stated in the GDP report in determining the various monetary policies and strategies that demand implementation. When they see a slowing down in the rate of growth of the country, they might decide to enforce an expansionary fiscal policy that will strengthen the economy of the country. If this is the rate of growth of the country is already very strong they might use certain monetary policy that may postpone things down so that it does not lead to impending inflation.
Real GDP is the most accurate indicator of the economic health and growth of the nation. Investors, economists, analysts and policymakers widely accept and discuss the same. The release of the latest data always changes and shakes things up in the market even if it is not widespread and rather limited in nature.
GDP and Investing
Investors observe the GDP data very closely because it serves as a basis for them to make decisions. The sections in the GDP data with regard to inventory and corporate profit are excellent resources for information for equity investors. The sections show the total growth during the time period which is of great importance to an equity investor. Corporate profits data that reflect before-tax profits, a comprehensive breakdown for all main economic sectors in the country as well as operating cash flows. Comparing the GDP growth rates with regard to other countries can provide investors with a great opportunity for asset allocation, helping them decide whether they should make an investment in rapidly growing economies abroad and in which such countries.
One metric that the investors can use in order to make sense of valuation in the equity market is surely the ratio of total market capitalization to GDP. This metric usually comes in percentage. In order to understand, the most comparable to this metric, with respect to stock valuation is the market cap to total sales of a company or the total revenue of a company. We know this as the price-to-sales ratio, popularly in the share market.
You must be aware that stocks in varied trade sectors vary divergently on the price-to-sales ratios. In the same way, the market-cap-to-GDP ratios for different countries’ trade also vary extremely vehemently. For instance, according to sources from the World Bank the market-cap-to-GDP ratio of US was almost 165% for the year 2017, while that of China was about 71% while Hong Kong fared at 1274%.
Standing alone, this ratio is not as useful. We can use this ratio by comparing the present data with the historical norms of the particular country. For instance, in the US the market-cap-to-GDP ratio was at around 130% at the end of the year 2006, which has dropped severely in the year 2008 to 75%. These represented zones hence reflect significant overvaluation and undervaluation respectively of US equities.
The biggest disadvantage of using this data is the lack of timeliness. Investors only get a percentage once in a quarter and any revision to the data can cause significant changes to the percentage altering the fate of the decision.
History of GDP in India
India GDP Growth Rate
Keeping in mind the economic liberalization of India, the world has seen economic changes throughout the 1900s and 2000s. According to reports published by the Ministry of Statistics and Programme Implementation, the GDP of India stood at 5,542,706 in the year 1990 and at 842,210 in 1975. With the development of sectors like telecommunication, information technology, airlines, hospitality, consumer durables, infrastructure, retail, power, pharmaceutical, hardware and electronics the GDP of India in the year 2000 reached 20,791,898.
The GDP of India in the year 2007 was about 8% of that of US. The National Democratic Front under the supervision of the Bharatiya Janata Party had its involvement in the economic activities of India from 1998-2004. The telecom sector in India was booming during this time as the Indian government passed on the universal telecom license in the telecom industry. This allowed CDMA license holders to provide GSM services. The NDA government also allowed for Golden Quadrilateral road network that would connect the four largest metropolitan cities in India that includes Kolkata, Delhi, Mumbai, and Chennai.
After the revision of the Indian constitution, education became an essential right for every citizen in the country. The Government infused huge amounts of money into the Sarva Shiksha Abhiyan scheme. However, providing education for all has still been unsuccessful in India. Almost 34 million graduates were reported to be unemployed all over the nation.
Economic activities in India however has taken an energetic route which however the poor state of the country dismisses. This includes the fragmented roads, dwindling electricity and lack of sanitation, and the general lag of the justice system. This again finds balance in the excitement and gusto of the entrepreneurs and the public around the country.
With the economic growth in view, we can expect that the state of the country is to get better. The various shortcomings and the curveballs at the face of infrastructural development are to be tackled as well. Although this is a fast-changing economy it is disorderly and disruptive. However, economists are more hopeful and optimistic about this state than the socialist atmosphere of the country was there during the time of the Indira Gandhi government.
The statistic itself is a testament to the growth of the country. While the GDP in the year 2000 stored at 20,791,898 it had increased vehemently why the year 2005 to 34,195,278.
Criticisms of GDP
The world has expected GDPs one of the most appropriate measures of the economic health of a country. However, there are certain drawbacks to this metric as well. Some of the criticisms against GTP are as follows:
- Geographical restriction in case of an internationally open economy: GDP fails to take into consideration the profits that an overseas company earns in a particular nation. These usually get dispatched back to the foreign investors. This may overestimate a country’s true economic output. an example of this is as follows: in the case of Ireland which had a GDP of $210.3 billion and a GNP of $164.6 billion in the year 2007. This disparity of $45.7 billion which accounts for 21.7 % of the GDP is largely due to the Profit experienced by foreign corporations situated in Ireland.
- It does not account for a number of unofficial sources of income: GDP does not take into consideration any informal economic activity.
- Furtherly, it is based severely on official information available from different sectors of the economy. Hence, it does not quantify several aspects that have an impact on the economy. This includes the black market economy, unofficial employment, household production, volunteering work. These Unofficial sources can be very important to some Nations which are exempted from being calculated into the GDP.
- Business to business activity n: Gross Domestic Product only takes into consideration the final goods and the recent capital investment. It however does not take into consideration intermediate transactions and spending between businesses. This GDP, overvalues the need for consumption in relation to output in the economy. This does not allow GDP to be a sensitive measure of economic fluctuations. Other metrics that take into consideration business to business activities are much more sensitive to such documentation.
- It takes into account material output and ignores overall well being: As we have already mentioned before, GDP cannot take into account or measure an entire Nation’s development or the well-being of its citizens. For example, a nation that is experiencing huge growth in GDP, but it may be impacting the society negatively in terms of the huge disparity in income and environmental hazards.
Sources of GDP
One of the most credible databases to GDP is the World Bank. It also provides data on the Internet and is extremely trustworthy. It has a huge list of countries that they track the GDP of and rank in an extremely comprehensive manner.
Another reliable source is The International Money Fund (IMF). It also furnishes GDP data across various Nations based on its numerous databases. These databases include International Financial Statistics and the World Economic Outlook.
Another source providing a highly accurate GDP report is the Organization for Economic Cooperation and Development (OECD). Besides recent data, it also provides historical norms and data for specific countries. What’s more? It also publishers predictions based on previous data about the expected GDP growth of particular countries. However one of the main disadvantages of utilizing the OECD database is that it does not have a list of all the countries. Data are available only for those countries who are OECD members and a limited number of nonmember countries.
For a particular country, there are inland economists and boards that calculate the GDP. For Example, in the US, the Federal Reserve collects data from a plethora of sources including the World Bank, and the country’s own statistical agencies. One of the main drawbacks of using the database of Federal Reserve is that it does not update the GDP data from time to time. It also does not have GDP data for a number of countries that may be useful to you. The Bureau of Economic Analysis (BEA), which is a special department of the U.S. Department of Commerce issues and analytical research on the GDP data after every release of GDP documentation. This helps investors in order to gain insight and analysis of trends and figures and also read highlights about the information that are important for them.
The Bottom Line
William Nordhaus and Paul Samuelson in their seminal textbook, Economics have provided the most brilliantly crafted reason as to why GDP and national record of economic growth is important. They have agreed that GDP is the only way you will be able to understand the total image of the economy of a country. They have compared it to a satellite in the vast space that can scrutinize the elements of nature across a continent over varying timeframes.
With the help of GDP Central banks and policymakers can understand if the economy is expanding or contracting. This in turn helps them to understand whether the economy needs restrainment or a boost. Again with the help of GDP, it is easy to understand whether we can expect inflation or a recession anywhere in the near future. However, like any other metric GDP does have some drawbacks as well. In recent years governments all over the world have tried to make nuanced alterations to GDP in order to make it more sensitive and accurate. How GDP is measured has also evolved from time to time. This has happened in order to keep in stride with new measurements of industrial activities and the production and consumption of contemporary aspects of intangible assets.
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