With governments globally, including our own, “laser focused” on economic growth, it’s bizarre that the universally accepted way of measuring it is fundamentally flawed. Gross domestic product (GDP) dictates political thinking, determines whether a country is included in the G7 and, more than any other economic data point, grabs headlines.
Yet I’m not alone in regarding its role as the leading barometer of economic health as flaky, at best.
The dire headlines accompanying America’s 0.3 per cent GDP first-quarter contraction just over a week ago were a reminder that you shouldn’t believe everything you read. This isn’t about the validity of some of the bombastic coverage, but the interpretation of the data itself.
While the GDP figure — the first shrinkage since 2022 — wasn’t good news, it was far from the watershed moment some commentators suggested. That’s not to say the US economy is in rude health, or even that the impacts of tariffs are necessarily overstated. It’s because GDP might be one of the most misunderstood, misrepresented and misleading indicators in economics.
• US economy shrinks for first time since 2022
GDP is often treated as the final word on whether a country is booming or busting. It shouldn’t be. By design, it measures the total goods and services produced in an economy. Consequently, it completely ignores important factors such as income or, in the event of higher consumer spending, whether this would be completely offset by more imports to cater for it — rendering it a blunt and backwards-looking instrument.
At best, therefore, GDP provides a general sense of the economic direction of travel — in the same way that looking at the number of corners won by a football team might indicate something about how well they’re playing, but stops well short of giving you a clear picture of whether they’re actually winning or losing. At worst, it delivers wild false positives or negatives, like using book sales to measure Prince Harry’s popularity.
For example, the current annual cost of sending someone to prison in the UK is about £55,000. This is significantly more than the median earnings for a full-time employee — £37,000. This means that someone of working age, a university graduate, say, is, in GDP terms, better off going to prison than getting a job.
By the same token, natural disasters often increase GDP — not because they are economically beneficial (try telling that to a family in a flood zone), but because the subsequent rebuilding efforts count as increased output.
The first quarter in the US is a classic example of a GDP red herring. The contraction was driven by a surge in imports, subtracting a record 4.83 percentage points from GDP, primarily due to businesses rushing to stock up on goods ahead of newly imposed tariffs. Strip out the volatile components and real final sales to private domestic purchasers — a better proxy for underlying demand — actually increased by 3 per cent. Hardly a signal of imminent recession. In fact, consumer spending, the real bedrock of the US economy, continued to rise, albeit at a slower pace.
Aside from the drawbacks inherent in how GDP is calculated, for investors — whose job revolves around gauging where asset prices are likely to head in future — a backwards-looking metric has limited value. By the time a GDP figure is released, the quarter is already in the rear-view mirror; it’s like judging a race by watching the runners warm down. Moreover, GDP gets revised — often significantly — in the following months.
Despite all of this, politicians and journalists consistently over-index on the importance of GDP. Consequently, it can have a disproportionate impact on markets and consumer confidence. In essence, having the economic equivalent of “one ring to rule them all” is a convenient device for governments and policymakers looking to justify their actions or demonstrate progress. One number. One narrative. That it isn’t robust is secondary.
Government boasts about the UK-India trade deal last week adding an annual £4.8 billion to GDP should be taken with a large serving of salt.
• Is India trade agreement good for UK business? The winners and losers
Alongside other data points, GDP provides a degree of insight, but it’s partial. The only real way to accurately assess growth prospects is to examine a mosaic of data — jobs, retail sales, industrial production, manufacturing surveys, credit spreads, even satellite imaging or high-frequency indicators such as job postings or card spending.
So much of the US economic outlook rests on actions that the Trump administration takes when the 90-day tariff pause ends. Investors are right to be cautious, but the recent negative GDP doesn’t tell us a great deal, particularly when one considers the recent resilient jobs and consumer spending data.
Markets don’t care about tidy narratives. In a highly uncertain economic and market climate, fixating too heavily on a single data point risks being blindsided by the bigger picture.
Seema Shah is chief global strategist at Principal Asset Management