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Purchasing power and standard of living
GDP (Gross Domestic Produce) per capita is not a measurement of a standard of living in an economy. However, it often used as such, an indicator with the rationale being that all citizens would benefit from their country's increased economic production. Please remember that, this is a gross method and does injustice on a big section of society similarly; GDP per capita is not a measurement of personal income even though it is often used to do that! Primarily GDP is considered for export calculation and so the prices and such other values considered while calculating this index are all supposed to be export values. GDP may increase while incomes for the majority of a country's citizens may even decrease or change disproportional. For example, in the US from 1990 to 2006 the earnings (adjusted for inflation) of individual workers, in private industry and services, increased by less than 0.5% per year while GDP (adjusted for inflation) increased about 3.6% per year over the same period. For this and many other reasons GDP is not considered by serious economist for measuring the economic health of the country.
GNP (Gross National Productivity) method was necessary to include production of MNCs who though of US origin have production facilities abroad. This method of calculation creates chaos at international consideration because a MNC’s production is likely considered in two countries and that can create double counting mistake. For example a US firm having a production unit in Korea will be producing X million Dollars of production and that shall be included as GNP of US at the same time that production shall be included in the GDP of Korea also. This double inclusion can create chaos. There are controversies about inclusion of such production in the GDP of the producing country, in this case Korea. While theoretically it should be included in GDP of Korea but not included in GNP of Korea!
The major advantages to using GDP per capita as an indicator of standard of living are that it is measured frequently, widely and consistently; frequently most countries provide information on GDP on a quarterly basis (which allows a user to spot trends more quickly), widely in that some measure of GDP is available for practically every country in the world (allowing crude comparisons between the standard of living in different countries). This grossly forgets that all people of that country are not having the exact same income level and so actually the real GDP for individual should vary considerable but present practice does not recognize that!
The major disadvantage of using GDP as an indicator of standard of living is that it is not, strictly speaking, a measure of standard of living. GDP is intended to be a measure of particular types of economic activity within a country. Nothing about the definition of GDP suggests that it is necessarily a measure of standard of living. For instance, in an extreme example, a country which exported 100 per cent of its production and imported nothing would still have a high GDP, but a very poor standard of living. An index showing gross personal income or GPI is introduced that may help show the standard of living of that society. Most of the time this index is used by the shrewd planners to over-show the level to rather misguide the credulous observers. It amounts to nothing but hoaxing!
The argument in favour of using GDP is not that it is a good indicator of standard of living, but rather that (all other things being equal) standard of living tends to increase when GDP per capita increases. This makes GDP a proxy for standard of living, rather than a direct measure of it. GDP per capita (GPI) can also be seen as a proxy of labour productivity. As the productivity of the workers increases, employers must compete for them by paying higher wages. Conversely, if productivity is low, then wages must be low or the businesses will not be able to make a profit. To this argument one must add another factor called minimum wages to cover subsistence that means, whatever be the production, employee is entitled for minimum wages as they work for the unit. It helps cover the expenses of the worker’s survival.
Ever since, modern economic science was developed during the industrial revolution; to address needs of ever expanding empire of European nations GDP is used as an easy and simple method of calculation of nation’s economic activity. As we see today this method of assessing a nation’s economic well being is out dated and need be replaced by a better method.
GDP as it is calculated doe not give any indication of purchasing power of the people. As we know PP is based on local income level and has nothing to do with export values. We have previously considered difference between purchasing power and purchase-ability. Go in archives of this blog to get that article (July, September 2009).
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