Limitations of GDP statistics
GDP statistics are widely used for comparing economic performance of developing countries, but they can be criticised for several reasons.
Differences in the distribution of income
Although two countries may have similar GDP
per capita, the distribution of income in each country may be
very different.
Differences in hours worked
As when comparing a country over time, the
number of hours worked to generate a given level of income may be quite
different. For example, workers in the UK tend to work longer hours than
those in France, and this would falsely inflate the GDP figures in the
UK relative to France.
International price differences
International prices will also vary, which is
significant because purchasing power is based on price in relation to
income. To solve this problem, GDP statistics can be re-calculated in
terms of purchasing power.
The purchasing power of a currency refers to the quantity of the
currency needed to purchase a given unit of a good or common basket of
goods and services. Purchasing power is determined by the
relative cost of living and inflation rates in different countries.
Purchasing power parity means equalising the purchasing power of two
currencies by taking into account cost of living
differences.
For example, if we simply convert GDP in Japan
to US dollars using market exchange rates, relative purchasing power is
not taken into account, and the validity of the comparison is weakened.
By adjusting rates to take into account local purchasing power
differences, known as PPP adjusted exchange rates, international
comparisons are more valid.
Difficulty of assessing true values
The true value of public goods such as defence
and transport infrastructure and, and merit
goods, such as healthcare and education, is largely unknown. This means it is difficult to compare two
countries with very different spending on these goods and assets.
Hidden economies
Similarly, the existence of a large hidden
economy may make comparisons based on GDP very misleading. For example,
comparing the official GDP of the UK and Russia may be misleading
because of the size of the hidden economy in Russia. To avoid tax,
transactions may go unrecorded and excluded from
official statistics.
Currency conversion
GDP figures for different countries must be converted to a common currency, such as the US dollar, and this may give misleading figures. Exchange rates against the US dollar may not be accurate for countries whose international trade is relatively small. In such cases converting to US dollars may significantly under-value national output. This is why converting to purchasing power parity is preferable to converting to US dollars.
See: Measures of Economic Welfare