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Why We Shouldn't Categorize an Economy Based on GDP Alone

09/12/2014 05:40 EDT | Updated 11/12/2014 05:59 EST

GDP growth rate is a commonly used indicator when discussing and comparing national economies. It is often used to compare countries and as a yardstick to measure their economic performance. A country with a high growth rate would be classified as economically healthier compared to one with a relatively low growth rate. However, arbitrarily categorizing an economy based solely on GDP growth rate may lead to important caveats in the analysis and classification of an economy.

A country with a low economic base would naturally have a high GDP growth rate compared to a developed country. When a country starts growing from a preliminary stage, basic developments like construction of schools or roads would translate into substantial GDP growth rates. Even though the absolute change or improvement to the country's economy may not be that substantial, it would be substantial in terms of GDP growth rate as the country has a low economic base that accompanies an initial stage of development.

Again, a developed country has a high economic base which means that the construction of a few schools or roads would not even register as GDP growth. When the country experiences substantial absolute changes to its economy, it may still clock a low GDP growth rate just because it has a high economic base which is a trait of an advanced economy.

The fastest growing economies in the world are almost always developing countries. These developing countries, typically small, have started at an initial stage of development. As they are building roads and highways, their growth rates are very high. Also, they are emulating and introducing technologies that have already been in existence. These developing countries, mostly in Africa and Asia, grow at 8 or 9 per cent and, sometimes, even experience double digit growth rates. However, GDP growth rates of 3 to 4 per cent for advanced economies like the US, Canada or the UK are considered very impressive growth rates. This is because the advanced economies are mature economies which have sizable GDPs. A significant increase in the GDP of an advanced economy would register as a relatively low GDP growth only because of the initial large size of the economy. Also, developed countries grow mainly through innovation as they are already at the leading edge of technology, finance, etc. and the most modern techniques, whether it is in banking or healthcare, are already being practiced in the advanced economies. As innovation does not happen in leaps and bounds, developed countries do not grow at high growth rates, unlike developing countries.

This means that comparing a relatively high growth rate of a developing country with the relatively low growth rate of a developed country is meaningless. It does not indicate that the former has a more dynamic economy than the later. The comparison of GDP growth rates of developed countries and developing countries is like comparing apples to oranges. The developed countries and developing countries have different economic structures and, more importantly, are at very different stages of development. Therefore, a comparison of the GDP growth rates fail to state anything about the respective countries.

The comparison of the GDP growth rates of US and China is erroneous and misleading. The US is an advanced economy with the largest economy in the world and a high per capita income. On the other hand, China, inspite of its ranking as the second-largest economy in the world, is a developing country that is mostly manufacturing based. It has a low per capita income which is a fraction of the high per capita income of the US. Again, China is faced with numerous problems that are characteristics of developing countries. Moreover, it has the largest population in the world, which leads to overpopulation and exacerbates the unemployment issue that many countries encounter in varying degrees. The United States and China are at completely different stages of development with very different economic structures. Therefore, the comparison of the GDP growth rate of an advanced economy like the US to that of a developing country like China is very misleading.

The absolute size of an economy does not portray the complete picture of a country. When a country has a large gross domestic product, it does not necessarily mean that its residents are rich. The country may have a significantly large population which will lead to low per capita income. Also, the existence of high net worth individuals or the number of billionaires cannot necessarily be an indicator of the economic health of a country. There are many poor, developing countries that display surprisingly high number of billionaires and high net worth individuals. Again, there are rich, developed countries that do not boast many billionaires and high net worth individuals. Therefore, the absolute GDP size, number of billionaires and high net worth individuals do not necessarily demonstrate the economic health and prosperity of a country. When considering the economic health of a country, GDP per capita in terms of purchasing power parity (PPP) is more important. It could actually indicate the purchasing power and standard of living of the average citizen in the country.

The analysis of an economy based on its GDP growth rate may tell an incomplete and misleading story. It would not reveal anything about the structure of the economy or its stage of development. Also, it would not state anything about the prosperity and standard of living of its citizens. One must be very careful when making cross-country comparisons of GDP growth rates. A comparison based solely on GDP growth rates would be misleading when considering the economic health of countries.

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