Explainer: What is GDP and Why is it Important to Investors?

You may have heard the term Gross Domestic Product (GDP) several times, and you may even have a peripheral idea of what it means but chances are you don’t have an in-depth understanding of it. And if you are a complete novice, this piece will enlighten you.

Let’s dive in.

What is GDP?

Gross Domestic Product is the yardstick by which the health of a nation’s economy is measured. In calculating a country’s GDP, some factors are taken into consideration, which include its consumption and investment. It is calculated by adding together these figures: personal consumption; private investment; government spending; and exports (less imports).

A classic definition of GDP, as fxcm put it, is that, a recession occurs when there are two consecutive quarters of negative GDP growth.

Why is it important to investors?

Oftentimes, GDP is what most investors and economists rely on to understand the true economic state of a country, because it represents the total monetary value of all goods and services produced within a country’s border over a specific period. Therefore, investors can use the GDP of a nation to make investment decision. When a country records lower earnings and lower stock prices, it means its economy is bad.

Investors keep close watch on the GDP because a significant percentage change in it, whether a decline or an increase, could make or mar the stock market.

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Is GDP the only of measure of economic prosperity?

As the world’s economy evolve, with technology taking centerstage and service economy rising, some experts believe that GDP is no longer the most effect indicator of a country’s economic wellbeing. They argue that it fails to capture much of the value created in the modern world.

GDP, which primarily captures the monetary value of tangible goods produced in the economy, was developed during the manufacturing age. It is believed to be an inaccurate measure of economic prosperity. 

As David Pilling, the Africa Editor of the Financial Times, wrote in his book, The Growth Delusion: Wealth, Poverty and the Wellbeing of Nations, “GDP is not bad at accounting for production of bricks, steel bars and bicycles. Try GDP out on haircuts, psychoanalysis sessions or music downloads and it becomes distinctly fuzzy.”

However, GDP remains the indicator used to measure economic growth globally. It is used to track all goods and services bought and sold in an economy annually.