Furthermore, GDP is usually measured in nominal value at market exchange rates or at purchasing power parity (PPP) rates. PPPs are currency conversion rates that take into account the differencies in price levels between countries. The more appropriate tool to compare GDP between countries is comparing at PPP rates, because nominal value of GDP at market exchange rates is shaped also by interest rates and capital flows. For example, the nominal GDP and GDP PPP statistics are completely different according to CIA WF data. India’s nominal GDP is 12th in the world ($1,099 bn), whilst its GDP PPP is 6th in the world ($2,966 bn). This is because the price level in India is very low and consumers can buy much more in India than in USA for the same amount of money. In present times, GDPs are always compared at PPP rates, as it reflects the “more real” value of GDP.
It is also important to consider with emphasis on what we want to compare between countries. If we want to compare the size of two economies, the GDP method will be the most appropriate. But if we want to compare countries with emphasis on each consumer in the country, we will focus on GDP per capita, which is GDP divided by the number of country’s population. It is also a common method in measuring the standard of living in each country. For instance, it cannot be said that there is higher living standart in India (GDP PPP = $2,966 bn) than in Poland (GDP PPP = $623 bn), as India has much bigger population. After calculating GDP PPP per capita, it appears that each Pole earns $16,200 a year, while each Indian earns only $2,600.
WHAT GDP DOES NOT MEASURE?
GDP does not measure the composition of output and therefore cannot be a good indicator of standard of living. For example, according to CIA WF the GDP PPP per capita is 13% higher in Oman ($19,000) than in Lithuania ($16,800), so there should be higher standart of living in Oman. However, GDP PPP per capita does not take into account that Oman spends 11.4% of GDP on military, while Lithuanian military expenditure is equal to 1.2% of GDP. Because of that, there is higher standard of living in Lithuania, because it spends more money for its infrastructure, education and health system.
It is impossible to measure positive and negative externalities by GDP. A country such as China has GDP more than twice bigger than Germany, but it produces six times more greenhouse gases than Germany. Nevertheless, it it cannot be measured which country has more developed economy, as pollution cannot be measured in monetary terms. Some people can prize clean environment much higer that others.
Moreover, inequalities of wealth are not included in GDP. Some people can prefer to live in a country where is a low inequality of income distribution. For example, there are two countries with similar GDP PPP per capita: Denmark ($37,200) and Australia ($37,300). Denmark has gini coefficient 24, while Australia has 35.2 (the Gini coefficient is a measure of inequality of income distribution). When choosing a country to live in, more people will choose Denmark, because it has a lower inequality of wealth.
The hidden economy is all output produced within a country in an illegal or not declared way. These are all self-employed workers who do not pay taxes, all grandmothers taking care of children (nonmarketable services), farmers who grow food for their own use, etc. The hidden market is excluded from GDP, because it is difficult to measure. In 2008, the United Nations Statistics published the first ever report about the non-observed economy in 43 countries in the world. According to it, “the groups of activities that are often non-observed are those that are underground, illegal, informal or undertaken by households for their final use”. The hidden economy in Moldova is equal to 31.6% of its GDP, which would have substantially changed the GDP of Moldova if it had been included.
What is more, GDP does not take into account the unemployment rate and the economic efficiencies of countries. For example, Thailand with GDP PPP $522 bn has an unemployment rate 1.4%. Saudi Arabia with similar GDP PPP ($546 bn) has 13% unemployment rate.
GDP does not measure the security from crime. For example, two countries with similar GDP PPP – Lithuania and Oman – have completely different homicide rates. Lithuania is a country with the highest murder rate in the world (9.38 per 100 thousands inhabitants per year), while Oman is the 5th country in the world with the lowest murder rate (0.59 per 100 thousands inhabitants per year).
In July 2006, the New Economics Foundation introduced the Happy Planet Index (HPI), which was invented to challenge GDP as it does not measure the happiness. According to it, USA with the highest GDP PPP in the world is 150th country out of 178 in terms of happiness.
It has to be stated that GDP does not reflect the quality of goods. When a quality of a good is improved and the price of it falls, then GDP also falls despite the fact that the quality of a good improved.
GDP does also not take into account educational level, productivity of the public sector, life expectancy, level of democracy, economic freedom and many other variables.
CONCLUSION
GDP figures are quite perfect when comparing the outputs and size of economies of different countries. However, GDP figures are not really useful when comparing with respect to standard of living or different feature. There are many indexes such as Human Development Index, Democracy Index, Happy Planet Index or Environmental Performance Index, which can be also used to compare countries.