It’s a good idea every once in a while—at the end of the year or perhaps at tax time—to take stock of your financial health. How much did you spend? How much did you save? Did your investments grow? Stepping back to look at the big picture can be useful and informative.
The Government of Egypt does this too, but what numbers does a country use? One of the most meaningful statistics is a country’s Gross Domestic Product or “GDP.” This number is used by national governments, international agencies and economists as a measure of economic health.
So, what is the GDP? Where does it come from? And what does it tell us?
GDP is the total value of all the finished goods and services produced by a country, and as a broad measure of a country’s output, it provides a scorecard for its economy. In Egypt, the Ministry of Planning, Monitoring and Administrative Reform calculates and publishes GDP data both quarterly and annually. Egypt’s annual GDP has been growing steadily; rising from USD 5 billion in 1965 to USD 300 billion.
There is more than one way to calculate GDP. The standard methods are the spending approach, the production approach and the income approach. When correctly calculated, they should all produce the same number.
GDP Based on Spending
The spending approach adds together the expenses of the main groups that participate in the economy. It is summarized by the formula:GDP=C + G + I + NX.
TheCis spending by consumers: it includes the money used to buy goods and services, everything from haircuts to houses.Grepresents government spending: the money spent by the government on salaries, equipment, and infrastructure such as roads, sewers, power lines and airports.Ifor investment: also known as capital expenditures, this is the money that businesses spend buying machinery or building factories and generally invest in their businesses.NXstands for net exports: is the value of all the goods and services that a country exports to other countries, less what it imports. NX can be a positive or a negative value.
GDP Based on Production
The production approach is the reverse of the expenditure approach. Instead of measuring all the spending that drives economic activity, it estimates the total value of the country’s economic output after deducting the costs of intermediate goods such as raw materials and other supplies that are used to produce that output.
GDP Based on Income
The income approach takes the view that one person’s expense is somebody else’s income. So it adds up the money earned by all the activities that go into economic production such as wages paid to labor, rent paid for land or buildings, the interest earned on capital and other investments, as well as corporate profits.
What does the GDP tell us?
Let’s examine the components of the spending approach in calculating the GDP: consumer spending, government spending, investment, and foreign trade.
People spend more when they are feeling confident about their income, and less when they are uncertain about the economic future. Consumer confidence is a strong indicator of economic growth. Because government spending fuels many other economic activities, it is important to a country’s economic development especially when consumer spending and business investment start to fall such as after a recession. Investment by businesses are key because they boost employment and increase a nation’s production capacity. Finally, the trade balance can be considered a measure of how self-sufficient a country is, and thus an indicator of its economic strength.
These are four diverse and strong economic signals, and the GDP sums them up into one number that is easy to compare from year to year and from country to country. That is GDP’s main value—as a way to compare national economies.
Using GDP Data
GDP data is followed and discussed by economists, analysts, investors and policymakers. Businesses use GDP as a guide to their business strategy. Governments use GDP especially its growth rate to decide which monetary policies to implement. Investors watch GDP growth rates to determine which economies to invest in. GDP is also very useful for calculating other statistics. For example, when comparing the greenhouse gas emissions of countries, it can be more useful to look at them on a per-GDP basis instead of just comparing the national totals.
Basic GDP data shows us the size of an economy but tells us little else. Consider that there are almost 300 times more people in Egypt than in Iceland, so comparing the GDPs of these countries without taking their populations into account would not tell you much. For these reasons, economists and statisticians call a country’s raw GDP data the “nominal” GDP, and they make a number of adjustments to GDP to improve its usefulness.
Limitations of GDP
Of course, GDP is just one number, and there are limits to how useful it can be. To begin, it is “backward-looking.” Not only does it describe the past, but usually a lot of time passes between the end of the period it measures and when it is released.
It also does not consider unofficial income and spending. GDP relies on official data, so it fails to measure the value of under the table employment, black market activity, volunteer work and household production, which can be significant in some nations.
It ignores business-to-business activity. GDP calculations cancel out intermediate spending and transactions between businesses. By doing so, GDP might overstate the importance of consumption for the economy.
In today’s global economy, GDP is geographically limited. It does not take into account the profits earned within a country by overseas companies that they send back to foreign investors. As a result, it can overstate a country’s actual economic output.
GDP emphasizes material output without considering overall well-being. GDP growth by itself cannot measure a nation’s development or its citizens’ well-being. For example, a nation may have rapid GDP growth, but with terrible environmental impacts or even increased poverty if the benefits of growth go only to the wealthy people.
The Big Picture
Gross Domestic Product is the value of all finished goods and services made within a country during a specific period. It provides a useful economic snapshot of a country that is used to estimate the size of its economy and its rate of growth. GDP can be calculated in three ways by using expenditures, production or incomes. It can also be adjusted for inflation, population and other factors to provide deeper insights. Though it has limitations. GDP is a key tool to guide policymakers, investors, and businesses in strategic decision making.