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LONDON — GDP is the one number that financial markets wait for more than any other. It is the single most important measure of national success. Currency, stock, and bond markets depend on it, as do presidents and prime ministers.
GDP is the cornerstone of how we measure economies. But increasingly, it is meaningless.
Why? Because GDP doesn't take into account population changes, which are the single-most important determinant of economic growth. In fact, what we should be looking at is GDP per capita — whether actual people, rather than nations, are getting richer or not.
Once you do that, much of what we think we know about the global economy turns out not to be quite right. For example, Japan has been performing decently for the last couple of decades. But Britain has been doing far less well than we thought, and still has not recovered to its pre-financial crisis levels of wealth.
For a long time, developed countries had roughly similar demographics, so it didn't matter that much. GDP told you which ones were doing better or worse. But now, demographics are diverging dramatically. Japan, Germany and Italy have populations that are either shrinking or about to do so. Britain, France and the U.S. have growing populations. As that become more pronounced, GDP will become more and more meaningless — and GDP per capita will become the measure to use.
GDP has just marked its 80th anniversary as the main measure of economic success — it was created at the request of the U.S. President Franklin D. Roosevelt, who decided in the 1930s he needed to know a bit more about what was happening to the U.S. economy to figure out what was going wrong. GDP attempts to add up all the activity within a country to put a precise number on output. The figure has seen many detractors over the decades — GDP doesn't measure housework for example. Even so, it has been a pretty good measure of how a country's population is doing. If it was going up, people were getting richer. If it was down, they were worse off.
But GDP struggles to cope with rapid changes in population levels. The reason is simple: A nation's GDP is the output per person multiplied by the number of people. If the amount of stuff each worker produces changes, GDP changes too. But the figure also changes with the number of people. If the population rises rapidly, so will GDP — even if people are actually getting poorer. And if the population falls significantly, so will GDP — even though people may be better off.
If you look instead at GDP per capita — and the World Bank supplies the relevant numbers — much of what we think we know about the global economy is wrong.
Japan is the most significant example, mainly because it has the most dramatic demographic trends. After peaking seven years ago at 128 million people, the population is now shrinking, and will soon be getting smaller by one million people a year.
"If, instead of the usually-quoted GDP growth numbers, we look at figures for GDP growth per capita, Japan's performance over the twenty years from 1991 was not the weakest in the G7," says Stephen Lewis of Monument Securities in a note published last week. "According to figures compiled and published by the World Bank, that dubious honor fell to Italy. Whereas the average annual GDP growth in Italy in the 1991-2010 period was 0.6%, in Japan it was 0.9%."
True. Japan has been seen as an economic basket case for two decades now. But if you look at GDP per capita, the country has been doing reasonably well, especially considering it is a mature economy with an aging population. Italy, however, has been doing even worse than most of us realized.
Or take the U.K.. Its recent growth numbers have been surprisingly strong, and this year it has one of the fastest-expanding economies in the G-7. In July, the U.K. finally returned to the level of output seen in 2008 before the crash. But Britain also has a fast-expanding population, mainly because of high levels of immigration. It is home to 2.7 million more people than it was six years ago. So its GDP per capita is still significantly down on 2008, and is currently hardly growing at all. It is not doing nearly as well as the headline figures suggest.
Nowadays countries with roughly similar economies are on widely divergent paths. Japan is the most extreme example, with its rapidly falling population. Soon Germany, Italy, and Spain will be in the same boat. Germany has been doing well recently, but its population has already peaked and by the end of this decade will be in steep decline (Germany's population will be down to 50 million by 2050, fewer than the U.K.). Expect Germany's GDP to suffer. China will join them in due course, as will Russia. Just like Japan, GDP by itself will make economic performance look worse than it is.
Other countries should fare better. The U.K., as we have seen, should be doing better, given its demographic growth. So should France. And perhaps the U.S. Headline GDP flatters them.
Why should investors pay attention? Because the markets are looking at a big important number that does not reflect the true state of the global economy. Better to ignore the GDP figures everyone else looks at and focus on GDP per capita instead. That is far more likely to tell you where you should put your money.