Last week as president Kibaki bid farewell to parliament as one of its longest serving members, Social media was trending with debate as to what would best define his legacy. As expected, most Kenyans agreed that, amidst other achievements, infrastructure is his biggest score. And most economists would agree, in some way, that this would play a pivotal role in delivering his promise to make Kenya a ‘working nation’ albeit long after his term ends. Obviously, a more preferred feat that has a direct relation to positive economic growth – an increase in productive capacity in an economy- which is usually determined by computation of the Gross Domestic Product (GDP) between different periods.
Occasionally, it is not unusual to come across the term GDP in business magazines or TV shows , mostly after the Central Bank of Kenya releases economic growth figures for a given quarter and analysts across different sectors try to interpret what it means to the economy. Termed the most important economic indicator, to understand it better, think of it as a measure of the market value of different goods and services produced in a country in different periods, usually quarters for most countries.
For instance, this year the Central Bank projects the GDP to be at 5.2% compared to last year’s which was at 4.4%. Several interpretations of this would be that this year the economy expanded 0.8% more than last year or simply there were 5.2% more goods and services produced in the economy this year compared to last year which saw an expansion of only 4.4%.
Methods of computation
Economists normally use three sophisticated methods to accurately measure the total output of an economy namely ; The Expenditure approach, The Income approach and Production approach. In theory, the figures arrived at should normally be the same or have slight difference. The formulas as used in each approach are as shown.
Expenditure approach
Income Approach
NB: The GDP obtained using the production approach can be represented either at factor cost or at producer price. At factor cost the Net value added is summed up for various economic activities while at producer price the GDP at factor cost is adjusted for indirect taxes and subsidies on products.
Importance as an economic indicator
Economic growth is normally an important indicator for the government as it aids the Monetary Policy Committee make decisions on Interest rates and as a reference for planning economic policy. On the other hand, knowledge of a country’s economic growth usually has several advantages especially to investors looking for investment opportunities in an unfamiliar economies. Since it’s normally measured for various sectors in the economy, it can provide valuable leads as to which sectors are on a steady growth thus providing insight on opportunities with potentially valuable returns, or a basis for asset allocation. Companies also tend to return good profits in economies with impressive growth which has a direct bearing on their stock prices. But in most African countries stable economic growth remains a lasting challenge.
In Kenya, for example, a close study of the last two decades reveals a disturbing trend mostly marked by episodes of impressive growth preceded by not so impressive growth that mostly occur during election years given our history of descending into violence at such times. This is majorly because most of the sectors that prop our economy like Agriculture and service sectors, specifically tourism, are sensitive to political instability. A good example is the 2007/08 period that saw growth drop by 6% with investors holding back most planned investments in the country.
Perhaps a better grasp of how the economy functions can curb this by making citizens aware of how bad politics turn to sting them. Understanding the GDP should be a good starting point.