Is GDP an effective measure to estimate Economic Development in India?

In this article we will be talking about whether GDP is an effective measure to estimate economic development in India or not. Firstly, we will talk about some of the problems of GDP measure that is common to all i.e. arises out of the concept of GDP itself. Then, we will move on to India specific scenarios and try to access whether that GDP paints a complete picture or not.

Problems common to all

A quick glance at any macroeconomic book will introduce you to the limitations that we will be talking about. But they understanding of which is important nonetheless for understanding the bigger picture. Before moving on to these problems let us define GDP first. GDP is the sum total of all Goods and services produced within the domestic territory of a country within a given period of time. It can be calculated via three approaches sum of all income, sum of all expenditure and lastly sum of value added by different sectors. It excludes goods and services produced for self-consumption because of lack of records for reporting and sales and purchase of second hand goods.

GDP assigns equal weightage to the same magnitude of benefit driven by two different income classes. Let us understand the statement with an example: Let us say the income of a person X increases by Rs.1000. Then the GDP will also increase by Rs. 1000. Introducing a microeconomic concept to aid our analysis alias utility analysis. Suppose person X has, 1) an annual income of Rs. 10 Crores or 2) an annual income of Rs. 10 Lakh. In which case this Rs.1000 will provide higher utility? Have we done anything to address that in GDP?

GDP assign equal weightage to two types of goods namely Goods and Bads. What we essentially mean, a cigarette of worth Rs. 10,000 carries the same weightage as Essential Medicinal Drug worth Rs. 10,000. GDP doesn’t take into account the externalities. For example, suppose a bridge worth Rs. 100 Crores is constructed. Due to which the travel time was increased by 20 mins while it was under construction and decreased by 10 mins after it was completed. GDP will only take into consideration the monetary value of the bridge and not the positive or negative outlook. Given the climatic conditions of metropolis similar argument can be extended to dust particles emission via construction. Something to ponder upon specifically in Indian context.

Arising Because of Indian Scenario

The Employment and Contribution to the economy via different sectors leads to some difficulties in assessing the development via GDP. Let us look at certain facts and figures to understand the same.  

Contribution of Agriculture sector to GDP is mere 16%. But it employees nearly 43.86% of the populace (as per ministry of labour and ministry of stats). The largest contributor is of course services with 54%. Now suppose the whole GDP is 100, if service sector contribution was to increase by let’s say 10%, and that of agriculture was to decrease by let’s say 10%. The new fig will be 14.4 and 59.4 with a total of 103.8. Even when agriculture sector fell the overall GDP was increasing because of the boost provided by services. This would have not posed a problem, but when we bring in employment into the picture. The whole rosy picture gets distorted. A 10% fall in agriculture impacts a larger share of population than a 10% increase in the services. A counter argument can be the income multiplier i.e. increased income from one sector moves to another and the impact is magnified. But that is a complex phenomenon, with propensity to consume of different sectors. Let us for the sake of argument accept this phenomenon. But the same is not reflected in the income equality. India was the second most unequal country in the year 2016 after Russia. In the year 2019, A survey by Oxfam shows that top 1% of Indian Economy own more than 73% of wealth. Which seems reasonable given the service sector is consolidated industry with a larger share coming from a few major players. Let us look at data of GVA by Agri sector to get a glimpse of its condition.

As we can see from the above graphs, period where we were talking about high GDP growth rate. Our Agri sector was facing problems of its own. We have indeed seen some stress upon the Agri sector in recent times the early signs of which can be seen in above figure.
The last argument that we would like to point out is the shadow economy. Before moving on to the complication. Let us define what it exactly means:

Bhattacharyya (1999) describes the hidden economy to be a sign of the unrecorded national income “calculated as the difference between the potential national income for the given currency in circulation and the recorded national income.”

In the famous paper, the rise of the shadow economy: An Indian perspective. A deeper definition of shadow economy is provided. shadow/hidden/black/gray economy can be defined as— the segment of a country's economic activity that is derived from sources that fall outside of the country's rules and regulations regarding commerce. In simple words, it can be stated as the unrecorded or unaccounted national income. It could also be stated as the contribution of the informal sector that goes unaccounted or the outcome of the illegal activities that are prevalent in the country. In a broader sense, we can say black economy captures part of the income from both the illegal and legal activities that could not be used in the formal compilation of the productivity of an economy.

From the above definitions key takeaway is that shadow economy is not just illegal activities but is also the sum of legal activities which cannot be simply recorded because of lack of proper records. Let us look at certain figures to understand why it is a problem:

According to the paper, “Estimating the Size of Black Economy in India, Chandan Sharma, MPRA Paper No. 75211, posted 24 Nov 2016 15:14 UTC”. The size of the shadow economy is greater than 50% in India. As per International Labour Organization (ILO) 81% of Indians are still employed in informal sector. Looking at a figure which represents less than 50% of the economy while ignoring the other part is not a right way of looking at the economy. Also, this figure which uses an estimate called Mixed Income to take into account the informal sector doesn’t paints a fair picture of the Indian Economy.

Conclusion:

GDP is not an accurate measure if we are looking at just GDP. There are various other parameters which must be stressed upon such as Purchasers Managers’ Index, Index of Industrial Production, GVA of different sectors and lastly qualitative factors such as HDI, Corruption Index, Ease of Doing Business and Electrification etc. But a step must be taken to formalize the economy, GST was one such step in the right direction. We must understand when we force something to change it takes time to adjust. Forcing a large section of economy to shift to formalization is a big move and surely had its impact on the economic development. But we must not forget the big picture of formalization while looking at individual scenarios.

References and Data Sources: Ministry of Labour, Ministry of Stats, International labour organization, Estimating the Size of Black Economy in India, Chandan Sharma, MPRA Paper No. 75211, posted 24 Nov 2016 15:14 UTC, The rise of the shadow economy: An Indian perspective by Priyanka Menon, LiveMint & Economic Times Articles, Business Today, Oxfam.