Limitations of GDP
Limitations of using 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. Wider measures of economic welfare usually include an adjustment of GDP to take into account the value derived from leisure.
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.
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.
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.