Out of the many economic concepts that get thrown around in the news, there are arguably few that are quite as important as GDP is.
Gross domestic product (GDP) is by far the most widely used economic indicator, and is used by policy makers, financial markets analysts and business executives to make decisions that will have a far-reaching impact on both businesses and individuals.
Despite the fact that it is one of the most widely used economic indicators, there is a surprising amount of uncertainty among average citizens of what is GDP, what it measures and why it matters.
If have found yourself scratching your head any time it gets mentioned in the news, keep reading this short article for a brief overview of what GDP actually entails and how it impacts businesses around the world.
What is GDP?
In terms of what GDP is and what it measures, at its most basic, GDP is an attempt to measure the economic activity of companies, governments and individuals in the economy of a specific country or region.
GDP measures the total monetary value of the goods and services that have been produced within an economy within a specified time period. Changes in the economic output over time are measured and used as a way of gauging the health of an economy. Increases in GDP are typically taken as a positive sign that the economy is growing, while decreases are usually viewed in a negative light.
GDP can be measured in several different ways, although usually it is done in one of three ways: the income approach, the output approach or the expenditure approach.
GDP can also be expressed differently depending on what exactly you want it to capture. This includes: real GDP, nominal GDP, GDP per capita, GDP growth rate or GDP purchasing power parity.
GDP is not a perfect measure of the economy. Many economists have criticized it for overlooking other types of labor that takes place in an economy, such as unpaid work, and for failing to show how income is distributed across the population.
Just because GDP is increasing, it does not necessarily mean that the living standards of individuals within that economy are actually improving! GDP also doesn’t tell us anything about the impact an economy has on the environment, which is an increasingly important concern.
With this basic understanding of GDP in mind, let’s focus on some of the different ways that GDP can impact businesses.
One of the most immediate ways that GDP can impact the business environment in a country is through interest rates. Central banking and financial institutions will look at GDP figures to decide whether they need to increase or decrease interest rates.
This decision will inevitably impact businesses as rising interest rates will make it more expensive for businesses to access funding and loans from commercial banks. It might also impact what their mortgage or business loan repayments look like. This can have a significant impact on profitability.
Predicting business growth
Another way that GDP figures can impact businesses and the business environment, is when it comes to predicting or projecting growth for the year ahead.
GDP is an indicator of how well the economy is doing. Depending on what this looks like, it will signal whether a business can expect to grow in the months ahead.
GDP figures will often reflect consumer sentiment, which will have an immediate impact on the finances of businesses and whether they can expect to grow.
If GDP is booming, this is a vote of confidence in the year ahead, which might encourage businesses to pursue a growth-oriented strategy.
In much the same way, investors looking to funnel capital into businesses will also be influenced by GDP figures.
Investing in a business is inherently risky. Investors are more likely to take this risk when the economy is performing well. In this way, positive GDP figures will encourage investment decisions.
Another way that GDP data can impact businesses, is in how these figures shape currency exchange prices.
GDP data releases are a closely followed event and when news breaks, there will usually be a reaction in the currency markets.
This can impact a business if they need to acquire foreign currency to do business — particularly when they want to increase their reserves of a certain currency — or if it will be more expensive for consumers to buy their goods with a particular currency.
Multinational companies will also use GDP data to help develop and pursue growth strategies into new markets. If GDP data is continuing to be weak in a certain part of the world, this might put them off investing into that region.
On the other hand, if GDP has been growing at a steady rate, this can be taken as a sign that consumer demand exists in the target market to support a planned expansion.