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Decimal Digest
21 Nov 2011

Changes to GDP measurement system in the new paradigm

Many of us would readily agree that since July 2007, the world economy is in a structural deleveraging mode, and is expected to remain so for the foreseeable future. In this operating mode, the global financial markets have taken to heart their original mandate of discriminating between the good borrowers of capital and the profligate borrowers of capital. Many financial institutions and also sovereigns have been severally punished, for being profligate borrowers with too little regard for the end use of capital.

We want to suggest here that the roller-coaster of the extreme leveraging since early 1980s and now possible deleveraging could have been avoided if one had modified the way GDP is measured.

Traditionally, GDP = C + I + G + (X-M)i.

We suggest three adjustments to this traditional measure to accurately assess the real increase in output, and not merely a transfer from one financial year to another financial year via borrowings.

We propose GDP = C + I + G + (X-M) –CB –GB, where

CB = zero if the starting {Consumer Debt / GDP} <= 60%

Else = increase in Consumer Borrowing when the starting {Consumer Debt / GDP} > 60%,

GB = zero if the starting {Government Debt / GDP} <= 60%

Else = increase in Government Borrowing when the starting {Government Debt / GDP} > 60%,

The above formulation of GDP would consider Consumption expenditure or Government expenditure only if it is sustainably financed. The moment these expenditures are financed in an un-sustainable manner, the above formulation presumes that it is a mere transfer from one year to another year, and hence excludes that portion from the calculation of GDP.

We believe conceptually this measurement to be a stronger, and anti-cyclical measurement of economic activity. Also, it is possible to develop a similar framework by including only those Investments which are productive, by having some linkage to Incremental Capital Output Ratio.

iFor the readers unfamiliar with this formulation, please refer to Wikipedia for detailed definition of GDP.


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