How are current measures of economic success calculated?
ICAEW’s thought leadership project ‘So what is economic success? Going beyond GDP and profit’ starts with two measures that dominate current discussions of economic success: GDP at the national level and profit at the organisational level. Both measures are widely used, yet neither is straightforward to define or calculate. They are both subject to ongoing discussion and refinement.
In this phase of the project, we seek to increase awareness and understanding of the debates and judgements underlying the calculation of GDP and profit. This will enable us to explore strengths and weaknesses of these measures, and whether they remain fit for purpose.
How is GDP calculated?
GDP (Gross Domestic Product) is the focus of many discussions about the economy: the standard definition of ‘economic growth’ is real percentage increases in GDP. Despite this, relatively few people have a good understanding of what GDP is and how it is calculated. For example, comparisons are often drawn between a country’s GDP and the revenue or profit of specific multinational companies, yet such comparisons are inappropriate. An individual company’s contribution to GDP is broadly ‘revenue less cost of sales’, or equivalently ‘wages plus taxes plus profit’, so is usually significantly less than its revenue but much greater than its profit.
GDP is part of an extensive set of national accounts that provides detailed supporting information, including a national balance sheet. National accounts are calculated in accordance with the UN System of National Accounts (SNA) which aims to standardise the methodologies used by countries and facilitate comparison between them. The underlying conceptual framework has its roots in the double-entry accounting system used for individual organisations.
National accounting calculations are subject to ongoing improvement and refinement. Major changes are taking place to EU countries’ calculations, starting in 2014, as they transition to the latest SNA rules. Other changes take place on an ongoing basis as the calculations undergo a programme of continuous improvement. It is important to recognise that there is no one ‘right’ number for an economy’s GDP: despite the SNA rules, the calculations require numerous assumptions, estimates and judgements.
How is profit calculated?
In this project, we typically use ‘profit’ in the loose sense of the financial ‘bottom line’ of an organisation’s income statement. In the case of not-for-profit organisations, this is more commonly referred to as ‘surplus’.
The project will draw upon ICAEW’s other thought leadership work on profit and related topics, particularly the Financial Reporting Faculty’s Information for Better Markets (IFBM) initiative. For example, the 2013 IFBM conference considered questions such as: At what point should you recognise profit? How is this information used to evaluate companies? How should you structure, present and analyse this information? How can stepping outside the standard reporting regime help you to communicate a company’s economic success more effectively? The 2012 PD Leake lecture discussed how the target we choose to measure (eg, profit) can affect our behaviour. And the 2012 IFBM conference provided relevant context by looking at the objectives underlying financial reporting and how financial reporting can meet wider social needs.
Growth: the numbers behind the headlines
This ICAEW talk, delivered in June 2014, explains how GDP is calculated, addresses some common misconceptions and outlines the limitations of GDP.
National accounts - a short guide
This guide, published by the UK Office for National Statistics, gives an introduction to the concepts and underlying principles of national accounting.
Understanding national accounts
This OECD publication provides a more detailed guide to national accounts, including the calculation of GDP and economic growth statistics.
The broader project
Our thought leadership project ‘So what is economic success? Going beyond GDP and profit’ is exploring what we mean by economic success, the role that GDP and profit play in this, and the potential of broader measures of economic success to help us balance our economic priorities, our social goals, and the constraints imposed on us by the natural environment we live in.
We are considering: