Gross Domestic Product (GDP) Expalined

In the world of economics, there are many ways to determine how a country’s economy and population are doing. We can call this economic health. One of the most popular ones is Gross Domestic Product (GDP). GDP measures the monetary value of all finished goods and services produced in a country. All the intermediary steps aren’t accounted for. There exist different ways of calculating GDP as well as alternative measures of economic health. Developed countries are at the top of the total GDP list, but developing countries dominate in terms of GDP growth. Below, we will take a more in-depth look at all these measures.

What Is Gross Domestic Product?

Gross Domestic Product

GDP is usually calculated on a quarterly and annual basis. Think of Gross Domestic Product as a quarterly report from a public company.

This allows us to compare the output at the same time during previous years and the change from quarter to quarter.

Some quarters are more productive than others. Summertime is usually slower as there are many holidays. Meanwhile, the fall and winter months usually produce more output since people are at home and many holidays promote spending.

It becomes easier to compare how the country did in comparison to the same time last year. We can also divide the GDP into 4 main components.

Components of GDP

Below are the 4 main components of Gross Domestic Product. They show what we as a society spend money on. The numbers in parenthesis show the breakdown of the US economy in 2019. Not all countries are net exporters. Many import much more than they export. Different countries have different breakdowns, but the main components remain similar.

Personal Consumption (70%): Durable goods (cars, furniture, appliances etc.), non-durable goods (clothing, fuel, food etc.), services (banking, health, education, assistance etc.). 

Business Investment (18%): Purchases businesses do towards the production of new goods. There are two sub-categories. The first is fixed investments. It is mainly equipment and new real estate constructions. The second is change in private inventory. This includes inventory private companies add.

Government Spending (17%): Government spending on infrastructure, transportation, public health and education etc. 

Net Exports (5): Exports minus imports of natural resources, agricultural products and other products in the economy. When imports surpass exports, there is a trade deficit.

Calculation of GDP: To calculate the GDP, we take the sum of all the elements above. We multiply the components by the price of each. We obtain the nominal GDP when we use the prices of each year or quarter. In this case, we can see the effects of inflation. However, to obtain a more comparable measure, we use a base year’s prices to obtain the real GDP. It becomes easier to compare the volume of goods and services produced year over year. 

Gross Domestic Product Per Capita

Gross Domestic Product

To measure on a more personal basis, we use GDP per capita. We divide the total Gross Domestic Product by the population.

It becomes easier to compare living standards across all countries. When per capita GDP grows, the living standards and production increase.

It can also mean that a country is self-sufficient and doesn’t require too much outside help to develop its industries.

If we compare the top 10 countries in GDP and GDP per capita, 

Top 10 GDP countries for 2021

  1. US ($20.49T)
  2. China ($13.4T)
  3. Japan ($4.97T)
  4. Germany ($4T)
  5. UK ($2.83T)
  6. France ($2.78T)
  7. India ($2.72T)
  8. Italy ($2.07T)
  9. Brazil ($1.87T)
  10. Canada ($1.71T)

Top 10 Gross Domestic Product per capita countries for 2021 and change since 2020

  1. Luxembourg ($125k, 15% increase)
  2. Ireland ($90k, 14% increase)
  3. Switzerland ($90k, 10% increase)
  4. Norway ($76k, 12% increase)
  5. US $66k, (5% increase)
  6. Denmark (63k, 9% increase)
  7. Singapore ($62k, 6% increase)
  8. Iceland ($58k, 2% increase)
  9. Netherlands ($58k, 13% increase)
  10. Sweden ($57k, 15% increase)

The only country that appears in both top 10s is the US. We can see European countries well represented in both graphs. Not only are they growing their economy, but their citizens seem to enjoy a better life year after year.

The US and China do have the highest GDP in the world, but there seems to be a lot of disparity between the upper and lower classes in both countries. 

GDP Growth Rate

Let’s do the same exercise for the leading growth rates in both the Gross Domestic Product and GDP per capita categories. We can see which countries are growing faster and whose citizens are enjoying a better life year after year.

Top 10 growth GDP countries for 2021

  1. Ireland (13%)
  2. Chile (11%)
  3. India (9,5%)
  4. Turkey (9%)
  5. China (8%)
  6. Colombia (7.6%)
  7. Argentina (7.5%)
  8. Israel (7%)
  9. Romania (7%)
  10. UK (6.76%)

Top 10 growth GDP per capita countries for 2021 and change since 2020

  1. Macao (13%)
  2. Ireland (11%)
  3. Aruba (9,5%)
  4. Estonia (9%)
  5. Hungary (8%)
  6. Israel (7.6%)
  7. UK (7.5%)
  8. Greece (7%)
  9. Hong Kong (7%)
  10. Slovenia (6.76%)

When we compare both graphs, we can see three countries stand out: Ireland, Israel and the UK. All three countries are growing their GDP and their citizens are enjoying a better life when we compare the last 2 years.

The top 10s in the last 2 sections can give investors a hint on where to invest. Economies that are growing quickly and that have a stock market can be good investments. They enjoy strong growth, meaning their public companies must also be benefitting. 

Ireland is a misleading figure in the charts above. Many multi-national companies have their European headquarters there for a simple reason: tax breaks. Their economic activity is recorded in the country’s Gross Domestic Product but doesn’t really benefit its citizens.

GDP and Investing

GDP

How can we use GDP data more precisely for investing? If we dig deeper, we can look at the inventory and corporate profits domestically and abroad.

Abroad, we have to target rapid-growing economies. Many ETFs are centered around emerging markets such as BRICS (Brazil, Russia, India, China and South Africa), the Next Eleven N-11 (Bangladesh, Egypt, Indonesia, Iran, Mexico, Nigeria, Pakistan, the Philippines, Turkey, South Korea, and Vietnam) and MINT (Mexico, Indonesia, Nigeria and Turkey). 

Many of the countries mentioned above are worth a look. Some of them might rise as leaders in certain industries, which would boost their economies.

To go even further, those with a stable stock market are a plus. Global tensions are affecting current emerging market leaders (BRICS). It’s the time for new countries (N-11 & MINT) to rise and establish their dominance.

GDP Limitations

Measuring a country’s Gross Domestic Product gives us a good idea of its performance. However, it doesn’t paint the complete picture. Many social welfare impacts aren’t depicted in the GDP calculation. 

Inequalities: As we saw earlier, GDP does not represent the population as a whole. We need to see the GDP per capita to have an idea of the median income of a country. When we think of certain taxes such as a carbon or sales tax, which social class is the most affected? The lower classes are much more affected as a percentage of their income. If we look at the Ireland example above, we can put these inequalities in perspective. 

Transactions Unaccounted for: All the transactions leading to the final product aren’t accounted for in the GDP calculation. All the volunteer and free work are also omitted. Lastly, black markets, underground markets, cash transactions and illegal activities such as bribes are also excluded. These transactions can be a big part of certain economies where the only way to obtain a product or a service is illegally. This applies to developed and developing countries. 

Negative Impact Products: Not all products are beneficial to society. In the US, health and education aren’t free or affordable. Meanwhile, in many countries with rising GDP per capita growth, they are. Furthermore, we also produce goods that reduce our social welfare as a planet. Think of weapons and pollution. 

To have a complete image of the economic well-being of a country, it could be useful to include all these externalities. Therefore, there exist alternative indicators of economical and social wellness.

Other Measures of Economic Health

GDP

Gross Domestic Product is easy and quantitative. We can put a numeral value to a country and compare it to others. Not every indicator is as straightforward. 

Human Development Index (HDI): The HDI takes people and their skills to assess the economic health of a country.

There are 3 dimensions (health, education and standard of living). Each is assessed with measures. Health is measured with life expectancy at birth. Education, with schooling for adults over the age of 25 and expected years of schooling.

Finally, the standard of living is measured by income per capita. According to the HDI scale, here are the top 10 ranked by human development. Each dimension is measured on a scale of 0 to 1. The overall score is also between 0 and 1. 

  1. Norway (0.957)
  2. Ireland (0.955)
  3. Switzerland (0.955)
  4. Hong Kong (0.949)
  5. Iceland (0.949)
  6. Germany (0.947)
  7. Sweden (0.945)
  8. Australia (0.944)
  9. Netherlands (0.944)
  10. Denmark (0.94)

Gross National Happiness Index (GNHI): The GNHI was developed by the small country of Bhutan. There are 4 pillars (governance, socio-economic development, cultural preservation, and environmental conservation), classified into 9 areas (psychological wellbeing, health, education, time use, cultural diversity and resilience, good governance, community vitality, ecological diversity and resilience and living standards).

There are 33 indicators measuring them. Needless to say that the majority of the same countries appear as for the HDI. it is a more complete analysis, but despite the indicators, it isn’t always easy to associate a numerical value to each area. 

Social Progress Index (SPI): The last index is also socially oriented. It measures 3 dimensions (basic human needs, foundations of wellbeing and opportunity). Once again, there are many indicators such as nutrition, education, health, rights etc. 

Now You Know What Gross Domestic Product Is

To conclude, Gross Domestic Product is a very popular measure to calculate the economic health of a country. However, it is incomplete. A country may be atop of the chart, but certain essential needs aren’t available for all, such as education, freedoms and health.

Access to free education and health lack in the US while freedom isn’t particularly popular in China. Surprisingly, they lead the way for GDP. European countries lead in terms of social freedoms and basic needs. Many are also ranked much higher in terms of GDP per capita. However, many of the leading multinational companies are situated in the US and China.

When it comes to money, investors follow the money.  If European and emerging countries continue their strong growth, we may see a shift in the stock markets. Once upon a time, the London Stock Exchange was the biggest stock market in the world. Who knows what the future will bring?

If you want to learn more about how you can profit from the stock market, head on over to our free library of educational courses. We have something for everyone, including trading options for those with small accounts. 

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