What does GDP really tell us about economic growth?

For the first time this year, the Office for National Statistics will release data on our economic well-being, giving us a better idea of how the recovery has impacted ordinary Britons.

Traditionally, the ONS has focused on the state of the public finances, like debt and borrowing levels, and measured our economic growth in terms of Gross Domestic Ouput (GDP).

These numbers have long dominated the debate over the health of the economy and are the bellwethers by which politicians are often held to account.

But with the ONS now deciding to give "greater prominence" to broader indicators of our economic well-being, could this finally mark the end of the most closely watched statistic in economics - GDP?

What is GDP?

An estimate of the total value of goods and services produced in a country, GDP aims to best capture the true monetary value of our economy.

It is defined by the ONS as "the sum total of the final output an economy produces."

In Britain, GDP is calculated through a mixture of methods, which include adding up all the money spent, earnt and value-added each year.

GDP has long been considered the best aggregate measure of economic activity we have, both in the UK and across the world. It's also the measure most of us refer to when we talk about an economy growing or contracting.

But with at least one Nobel Prize winning economist lambasting "GDP fetishism", is it about time we stopped fixating on GDP?

The pitfalls of GDP

Taken on its own, GDP is an incomplete measure of the many facets of our modern economy - a fact that has led the likes of the ONS to give greater attention to different variables of growth and progress.

The most common refrain aimed at GDP is that it tells us little about our overall or individual economic welfare.

For example, headline GDP numbers are often quoted as indicating whether a country is growing and by how much. But should our total output increase at the same rate as our population, there is likely to be no resultant rise in our material well-being.

This is exactly what seems to have happened in the UK. A rising population means that on a per capita basis - which accounts for population - we see that our output has actually failed to recover since the onset of the Great Recession in 2008 (chart above).

Although the economy may now be bigger in size than it was in 2008, Britain's larger population means output is still around 6pc below its pre-crisis peak.

Revisions

Another perennial issue around output statistics is that they are subject to near constant revision.

Earlier this year, changes in the way the ONS calculates economic output revealed that the British economy exited recession nine months earlier than we first thought.

Although significant for economic historians and very good news for the Chancellor, it is questionable whether the revisions had any discernible impact on how individuals felt in the aftermath of the crisis.

It is facts such as these which have now prompted the ONS to take look at a broader set of indicators that can help up understand what the recovery has really meant for most people.

So what can we use instead?

The ONS has yet to reveal which set of metrics they will be putting out alongside GDP figures to measure our economic well-being, but they are likely to include a number of existing measures that are already part of our national accounts.

Income

The yellow line below represents the total national disposable income held by Brits and adjusted for inflation.

The chart shows that for the most part, disposable income levels have tracked GDP per capita quite closely. But unlike the black line above, which has been relatively flat since 2009, the population's net disposable income has been falling steadily since 2013.

It's also possible to take a closer look at how individual incomes have fared by examining disposable cash at the household level.

The yellow line below is a measure of Real Household Disposable Income (RHDI) which takes into account the level of tax we pay and benefits we receive.

According to the ONS, this is a measure which "seems directly relevant to assessment of households' economic well-being."

The trend shows that households suffered a delayed impact from the recession in 2008 - as incomes held up reasonably well in the immediate aftermath of the crisis. They have however gone into steady decline since 2010, failing to pick up even as the recovery has generated momentum.

The red line above is a measure of the average, or median, household income. This provides some indication of how income and resources are distributed across the population. For example, although overall income levels may be unchanged, this could still mask a shift in distribution with the richest households taking a bigger slice than those at the poorer end of the scale.

The median income line tracks disposable income quite closely, suggesing that there have been no major distributional changes in income since the recession.

Wealth

Along with income, wealth is also a useful gauge of our material well-being. The ONS already calculates household wealth based on the value of our physical and financial assets.

The green bar above shows how rising wealth was driven by a property price boom from 1997-2007. Since the onset of the recession however, net property wealth fell, approaching its pre-crisis peak in 2012. By contrast, the net value of our financial assets has grown considerably since the crash, surpassing £3 trillion in 2012.

The death of GDP?

The ONS stress that their new set of well-being variables will supplement rather than substitute GDP. Despite highlighting the pitfalls of output data, the stats will instead help provide a "more comprehensive and rounded view of the economy", say the ONS.

This is welcome news for economy watchers in the run up to the election, where argument and counter-argument about the true cost of living is already dominating political debate.

But giving more attention to alternative economic variables is not likely to mark the death of GDP just yet. The sheer ubiquity of the measure, helped by the fact it remains one of the best ways to compare different economies, means that for all its rivals, it will be a while before GDP loses its status as the most important number in economics.