By G Davies 2015, Published in Company Directors Magazine

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If your doctor judges your health solely on the basis of the mass of food you eat, or if a board judges company health solely on its turnover, you would be concerned. Yet, in an analogous fashion, we judge the health of a nation and its economy predominantly by using Gross Domestic Product (GDP)as the predominant metric. This is not to say that GDP should not be measured, but it’s a question of how relevant is the correlation between GDP, wealth and standard of living. How valid is GDP as a KPI?

Christchurch was severely damaged by earthquakes, which required much effort and cost to re-build yet this tragedy increased GDP. Volunteer workers from many of the thousands of organisations do great things for our society, but the GDP does not measure not monetary transactions. It also places no inherent value on our natural resources which are handed to us on a plate ‘pro bono’. Land purchases may reflect some of this value, but in general, accounting practice only valuates ‘improvements’.    Disastrous projects (eg. Union Carbide, Deep Water Horizon and Montara off the Australian coast)  that result in serious illness, capital write-offs and toxic run-off, require  additional expense in the form of doctors, emergency workers, demolition, rebuilding and clean-up. All this extra work increases GDP. Similarly, consumer products (eg. phones, appliances, fashion) with a short life and designed-in obsolescence increase GDP because of the continual need to repurchase said items after ‘throwing them away’, yet does this add real value? Criminal activity, disasters, disposable products all add to much to GDP compared to the SES, CFS, neighbourhood watch, protection agencies and natural processes.

GDP does not predict the future, though it is fair to say that prices go up based on demand and scarcity, so that trends may indicate growing scarcity, and the high prices would cause behaviour to adjust accordingly. However, economic forecasts do not easily consider delayed consequences and thus can mask reality. This in turn leads to cycles (in the same way as steering a houseboat down the Murray without anticipating the time lag) and ultimately can lead to crashes.

 GDP did not measure the ‘free stock’ provided to coal powered generation in the UK in 1952, nor did it measure the negative effects of pollution until a week-long smog resulted in the deaths of thousands. The pollution and other negative side effects were costs borne by all, (negative externalities) yet individual companies benefited. This resulted in the introduction of laws and compliance requirements to better ensure the polluter pays, but do we have to learn the hard way again?

So why is there this unquestioned reliance on GDP?  The G20 Summit at great (at great expense and thus increased GDP) concluded with a commitment to economic growth (ie an increase in GDP) of 3%. Is this groupthink in action?  Historically, when there was scarcity, GDP had some correlation with standard of living, possibly in the same way our ancestor’s health probably correlated with amount of food eaten, or companies with large turnover were economically strong. So perhaps this was the basis of GDP getting such credence, but given the list of companies with large turnover that no longer exist and the obesity epidemic, is it not time to question GDP as the only reported measure of the economy?

Robert F. Kennedy in 1968 referred to GNP as ‘we seem to have surrendered values to material things … GNP measures everything except that which makes life worthwhile’. In the context of this article, Gross National Product (GNP) and Gross Value Add (GVA), GNI and GSP are considered to be of the same ilk as GDP.

In short GDP does not measure value or even accumulated material wealth; it only measures economic activity – good and bad, and in fact, the developer of GDP Simon Kuznets warned against its use as a measure of wellbeing or standard of living.  Now if we consider that Labour Productivity is effectively GDP per person, we then bring into question the Productivity measure as well, and many other KPIs that are all based on GDP.

So what alternative measures or KPIs are there for an economy? There is no easy answer, but it may be better to have no KPI than a misleading KPI. What about Net Assets, Net Tangible Assets, or Gross Equity? A measure worthy of consideration is the total net tangible assets less the total value of land, which aims to value ‘human improvements’. Further to this, what about subtracting the cost to rehabilitate damaged environments and displaced communities along the lines of the Genuine Progress Indicator (GPI)?

There are numerous indices proposed that look at net wealth, wellbeing and standard of living.  According to some of these measures, the ‘Western World’ has not really progressed in the last 20 years, which appears consistent with anecdotal evidence and public surveys.

So if there is a problem with the measures of GDP and Productivity, what should directors do about it? Firstly, consider the fundamentals on which the modern economy is based. Then review your KPI fundamentals, understand how your organisation is affected by the greater environment in which it operates and strategise how this may change in the future. Then do a risk assessment on various scenarios and where high risks may eventuate. Consider what the business opportunities are in the future, as we approach the limits to growth on a finite planet. Consider what happens to profitability and assets if/when growth (change in GDP) stops and how will this affect market capitalisation.

Given our finite resources, a measure of efficiency worth consideration may be wellbeing divided by footprint. Using a measure similar to this, viz the Happy Planet Index, Costa Rica comes out on top! They even did pretty well in the FIFA world cup.

Black Swan events are often cited, whereas in reality they were foreseeable and occur as a result of ostrich behaviour and/or groupthink. I am generally known for being an optimist, but I believe that we are heading for large financial crashes, which will be considered ‘black swans’, until we realise that  ‘Just as a profitable business depends on people and systems, so to an economy depends on people and eco-systems and not GDP’.  Is it time to don the ‘black hat’ and reconsider GDP as the fundamental metric and driver of an economy?