GDP per Capita

These are some notes I have kept on GDP per capita. Feel free to copy anything from this post for your own use. I plan to keep updating this post over time, so if you feel that I have missed something please contact me and I will remedy it.

Economists have long viewed GDP per capita to be the best measure for the economic outlook of a country. Unlike all other macroeconomic measures, GDP per capita is untainted by human biases in its calculation. It’s result comes directly from all transactions in the clear-market economy, without arbitrary weights added to any industry or the statistical issues caused by surveys.

GDP (Gross Domestic Product) is the sum of all domestic market transactions, weighted by price. $GDP = \sum_{i \in I}{N_i \times P_i}$ where $N_i$ is the number of final good $i$ sold and $P_i$ is the price of final good $i$ sold. $I$ is the index set for all goods within domestic borders.

GDP is also equal to the sum of all incomes within domestic borders. If I spend $1 on an apple, the store owner will receive $1 in income from me. By extrapolation, all money spent is someone else’s income, so GDP can be calculated by adding everyone’s incomes.

Another GDP calculation method is

GDP = Consumption + Investment + Government + Exports - Imports

This is the same thing as adding all price-weighted domestic transactions. Consumption, Government and Exports, are the domestic transactions of consumers, government entities, and foreigners buying from domestic producers. Imports are subtracted as they are not produced domestically; they are products bought abroad and shipped to domestic borders. Investment is products purchased by firms such as factory equipment or computer software. Investment does not include financial assets such as stocks and bonds, as they are “money saved.” If a business uses the money from a stock purchase on new factory equipment, that money will be reported under Investment.

To find GDP per capita, take the GDP and divide it by the domestic population. While GDP is the sum of all transactions times market price, dividing by population shows the number of transactions per person. This is also equivalent to the average income per person. GDP will naturally be larger for larger countries. Using GDP per capita we can get an estimate for the quality of life for the individuals living in those countries. So while China has one of the largest GDPs, their GDP per capita is pretty low, usually occurring around the #80 mark.

For any GDP per capita comparisons over time, inflation must be accounted for to get an accurate result. Therefore we must use real GDP per capita. Real GDP sets a base year and adjusts for inflation for all comparison years relative to the base year. For example, if you wanted to compare GDP between 1990 and 2020, you would find the inflation rate between the two periods and divide the 2020 GDP by that inflation to get real 2020 GDP with base 1990.

$\frac{Nominal~2020~GDP}{Inflation~rate~between~2020~and~1990} = Real~2020~GDP_{1990}$

By comparing the $Real~2020~GDP_{1990}$ and the $1990~GDP$, we will get the difference between the value of actual market transactions and not from increasing price levels.

The main benefit of GDP per capita is that it’s weighted by the price system. We need weights because some products are more valuable than others. An Apple iPhone has lower sales numbers than actual apple fruit, but the iPhone is a higher value product so we need to add a weight so it’s value added to the economy is not understated.

The market price is the meeting point between the marginal seller’s minimum selling price and the marginal buyer’s maximum buying price¹. This is the price which maximizes welfare for all buyers and sellers in the market. Therefore the price is the perfect weight to determine the marginal value-added to GDP.

A competing standard, HDI (Human Development Index), modifies GDP by adding arbitrary weights to healthcare and education industries. With GDP, supply and demand determine the value of products sold, and no good gets extra value because some “experts” were not happy with the final market values. With HDI, the experts have decided to speak for the crowd as to what their values should be.

GDP per Capita Issues

There are some downsides to GDP per capita. One is that $1 of private spending has the same weight as $1 of government spending. While consumers and producers produce value in voluntary market transactions, it is hard to argue that all government spending is the same due to the involuntary aspect of taxes. Government spending is still seen to bring some value to an economy so it is still included in GDP figures, and economists do not want to add arbitrary weights to GDP so it is left as it is. However this is a clear issue with the GDP measure, and it’s one that no competing measure has attempted to address.

Another is that GDP only tracks goods which are reported to statistical agencies. Black market goods are not reported in GDP, or any measure. For developing countries, black markets can take up a large majority of transactions in the economy, making their GDP calculations completely inaccurate.

Finally, remember that a higher GDP per capita doesn’t guarantee higher happiness levels. If we have two countries, A and B which have exactly the same GDP, but in country A everyone beats their kids, then country A’s residents will be unhappier even though their material wealth is the same as country B’s. Nonmarket interactions such as child-beating will affect people’s happiness even if it doesn’t show up in any macroeconomic measure.

Generally you see people moving from developing countries to developed ones, and not the other way around. So it’s clear that people are getting something out of the higher wealth levels of countries with higher GDP per capita. From this you can claim there is a correlation between GDP per capita and happiness or job satisfaction or whatever, but because these terms are hard to measure statistically, it is difficult to back this claim.

Inflation Adjustment and Purchasing Power Parity

GDP per capita must be adjusted for inflation when measuring GDP per capita over time. The default inflation value used is the “GDP deflator,” which is provided by statical agencies such as The Bureau of Labor Statistics.² GDP deflator is the average inflation for all goods measured by GDP.

Different goods face different levels of inflation. So any inflation value provided by an agency is going to be an average level of inflation for specific set of goods. GDP deflator is an average for all goods within domestic borders, including goods bought by government entities and firms. When it comes to assessing what the average consumer buys, a survey-based measure such as CPI (Consumer Price Index) may provide a better rate of inflation. CPI is a US-based survey index which creates a “bundle of goods” that the average consumer is said to buy. Inflation calculations using CPI can better reflect the price increases an average person will feel.

However, this introduces a lot of the arbitrariness that GDP deflator avoids. In addition to survey arbitrariness, CPI has a whole host of statistical problems due to consumers switching goods between survey periods, or goods heavily changing in quality between survey periods. I have explained these issues in another blog post here.

For consumers, CPI is a more accurate inflation average than GDP deflator. However, different consumers across the US buy different goods and will still face different inflation values. To alleviate some of this, there are many different CPI surveys done for different regions in the US, such as the CPI-U survey taken in urban areas. In fact, you can track prices of all goods tracked by all CPI surveys, allowing you to create a custom bundle for your own statistical projects.

To do cross-country real GDP per capita comparisons, there is another survey-based macroeconomic measure called PPP (Purchasing Power Parity). PPP’s primary purpose is to equalize purchasing power of different currencies in different regions. For example, labor tends to be cheaper in Bangladesh than in the US, so $1 can buy you more services in Bangladesh than in the US³. PPP adjusts for these differences by controlling for how many things you can buy with $1 for both countries.

Because of the world-wide scope of the PPP surveys, they tend to be even more imprecise than the US-based CPI surveys. For example, Ethiopians eat teff while Indonesians eat rice. Because of this difference, PPP will fail to properly compare the most important grain in both countries, as the price of rice is not relevant to Ethiopians and the price of teff is not relevant to Indonesians.

The worst measure: Human Development Index

A popular but highly flawed macroeconomic measure is HDI (Human Development Index). HDI uses Gross National Income per capita, PPP adjusted (GNI is very similar to GDP, it just tracks a country’s citizens for a country’s income instead of all economic activity within a country’s borders. GNI values are generally similar to GDP). On top of GNI, HDI adds weights for life expectancy at birth and average years of education.

The problem with this is that GNI/GDP per capita already correlates very highly with life expectancy and education rates, so HDI is correcting for nothing. It is only adding additional arbitrariness to what was a very objective measure.

What makes GNI/GDP per capita so powerful is that it tells you productivity according to the preferences of consumers living in the country being analyzed. Consumers of a country may not put a high value on education, instead opting to spend those years of their life doing whatever else. Say in country A, people go to apprenticeships and begin working earlier, while in country B, everyone gets a PhD. Are people in country A really worse off than those in country B? If people in country A dislike formal education, then they will find HDI disagreeing with them on their career choices, regardless of their actual career outcome.

Oddities with the Top GDP per Capita Countries List

If you go on Wikipedia and look at the list of countries by GDP per capita, inflation adjusted using PPP, you’ll notice many unexpected countries to take up ranks within the top 30. You would expect countries like the US to be in the top ten but instead it’s mostly a bunch of tiny countries. This shows some interesting patterns with the GDP per capita measure.

1. Very small countries like Luxembourg (population 0.6 million) and Monaco (32,000) are city-states. Most of the population that works in these cities actually lives in the surrounding countries. Therefore the city will produce high GDP per capita because the people producing are not counted in the GDP per capita population.
2. More diverse economies such as Germany or France have rural farms and industrial regions which tend to have lower productivity than urban regions. These rural regions will bring down GDP per capita for their respective countries. However city-states such as Luxembourg or Monaco don’t have these rural regions within their borders; their rural supply lines lie outside the country borders. Excluding these rural regions increases their GDP per capita even further.
3. Tax havens such as Switzerland or Bermuda will also have inflated GDPs. Companies will set up their headquarters there, and move huge amounts of income through those countries, but these “headquarters” will have few employees. This increases GDP per capita.
4. Some countries have large oil industries. Oil is geographically concentrated but has heavy demand worldwide, so oil countries will naturally have a large economic boom. Smaller countries with oil reserves will see more of a GDP per capita boom from them. The US has good oil production but it’s still a small part of GDP here due to our large population of 329.5 million. Canada has a medium sized population (38.0 million), which means their GDP gets more of an oil-boost than the US does. Countries with small populations and near 100% GDP from oil tend to have very high GDP per capita boosts. These include UAE (9.9 million), Qatar (2.9 million), and Brunei (0.5 million). The smallness of these countries give them some boost from point 1 as well. Norway has a population of 5.3 million, but half of their GDP is from oil, which easily pushes them up the GDP per capita list.

Big picture, the US has an unusually high GDP for its population size and diverse economy. The US has the third largest population in the world, and it’s GDP per capita is amongst city-states which have a tiny fraction of the US’s population. Given the characteristics of the US relative to its peers, it’s safe to say that the US is, by far, the most economically successful country in the world.

Sources

This article is mostly sourced from scattered notes on my computer from my economics studies. Here are some additional links.

Gross domestic product Wikipedia Article

List of countries by GDP (PPP) per capita Wikipedia Article

Human Development Index Wikipedia Article

Updated 2022-06-21, added footnote 3 and cleaned up some stuff