Gross Domestic Product
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What is Gross Domestic Product?
The Gross Domestic Product (GDP) represents the total value of goods and services produced within a country's borders during a specific period, measured in terms of their market worth. It serves as a comprehensive gauge of a country's economic output, reflecting its overall economic performance. In Switzerland, GDP is also calculated at the regional level, including individual cantons and major regions like Zurich (ZH), the Central Plateau (Bern, Fribourg, Solothurn, Neuchâtel, Jura), Northwestern Switzerland (Basel, Basel-Landschaft, Aargau), the Lake Geneva region (Vaud, Valais, Geneva), Eastern Switzerland (Glarus, Schaffhausen, Appenzell Ausserrhoden, Appenzell Innerrhoden, St. Gallen, Graubünden, Thurgau), Central Switzerland (Lucerne, Uri, Schwyz, Obwalden, Nidwalden, Zug), and Ticino (TI).
GDP per Capita
The GDP per capita serves as a metric for assessing the GDP per individual within a nation's population. It denotes the magnitude of production or income allocated to each person in an economy and can serve as a reflection of average productivity or the typical standard of living. On a fundamental level, the GDP per capita reveals the extent of economic value generated for each citizen. While providing insights into a country's overall economic performance, it also enables comparisons of prosperity between different nations.
GDP per capita is often analyzed in conjunction with conventional GDP metrics. Economists utilize this measure to enhance their comprehension of their country's productivity and make comparative assessments with other nations.
Per capita GDP considers both a nation's GDP and its population, highlighting the importance of recognizing the distinct contributions of each factor and their impact on per capita GDP growth. For example, if a country's per capita GDP rises while its population remains stable, it could be attributed to technological advancements that enhance productivity without a corresponding increase in population size. Additionally, some countries with a high per capita GDP may have a small population, indicating the development of a self-sufficient economy based on ample specialized resources.
The Composition of the Gross Domestic Product (GDP)
A country's GDP is calculated by combining the amount of private and public consumption, government expenditures, investments, changes in private inventories, paid construction costs, and the balance of trade (exports minus imports).
In order to calculate the GDP, the Swiss Federal Statistical Office uses two methods:
Production Approach = Output - Intermediate Consumption + Taxes on Products - Subsidies on Products
Expenditure Approach = Final Consumption Expenditures + Gross Capital Formatiion + Exports - Imports
One of the most important components of a country's GDP is its balance of trade. In general, the GDP of a country increases when the value of domestic goods and services sold to foreign countries exceeds the value of foreign goods and services bought by domestic consumers. A trade surplus is the result of this situation. In contrast, a trade deficit occurs when domestic consumers spend a greater amount on foreign products than domestic producers can sell to foreign consumers. When this occurs, a country's GDP tends to decline.
Types of Gross Domestic Product
An economic indicator such as the GDP can be computed either in nominal terms or in real terms. Inflation is taken into account in real terms. Compared to nominal GDP, real GDP represents a nation's long-term economic performance more accurately.
Nominal GDP
By taking into account current prices in its calculation, nominal GDP illustrates the economic output of a nation. This method does not account for inflation or the extent of price increases, which can cause growth figures to be overstated. In nominal GDP, all goods and services are valued according to the prices at which they are actually sold. In order to compare production across different quarters within the same year, nominal GDP is useful. The real GDP is, however, used when comparing GDP over two or more years. Taking into account inflation allows for a focus on production volume over time.
Real GDP
Inflation-adjusted real GDP reflects the amount of goods and services produced by a nation in each year, while maintaining constant prices. As a result, inflation or deflation can be separated from the trend in production over time. Inflation affects GDP since it is based on the value of goods and services in monetary terms. An increase in prices generally increases a nation's gross domestic product, however, this does not necessarily indicate an increase in quality or quantity. As such, it can be difficult to determine whether an increase in nominal GDP is the result of real production growth or simply an increase in prices when considering only the nominal GDP of an economy.
The real GDP of a nation is determined by using inflation-adjusted data. In order to compensate for the impact of inflation, economists adjust production in a particular year in accordance with price levels in a reference year. The reference year is also called the base year. This enables comparisons of a country's GDP between different years.
Real GDP is calculated as a function of the price difference between the current year and the base year. An inflation factor of 1.05 would be calculated if prices have increased by 5% since the base year (= 5% + 1). This inflation factor is divided by the nominal GDP to obtain the real GDP. It is common for nominal GDP to exceed real GDP since inflation tends to be positive. By considering changes in market value, real GDP minimizes the discrepancies between year-to-year comparisons in production figures. A large difference between a nation's real GDP and its nominal GDP may indicate substantial inflation or deflation.
Consider the example of a country with a nominal GDP of $50 billion in 2010. By 2020, the nominal GDP is expected to reach $75 billion. At the same time, prices have risen by 100%. When focusing solely on the nominal GDP, it may appear as if the economy is performing well. In contrast, the real GDP for this period would be only $37.5 billion, indicating a decline in economic output during this period. The calculation is as follows:
75 billion / (100% + 1) = 37.5
How Investors Can Use GDP
As a key reference point for informed decision-making, experienced investment professionals closely monitor GDP. Data on corporate profits and inventory are included in the GDP report and provide investors with valuable insights regarding the overall growth of the economy during the reporting period. Additionally, the breakdown of corporate profits provides a comprehensive view of pre-tax earnings, operational cash flows, and sector-specific performance indicators. By analyzing GDP growth rates across different countries, investors can effectively allocate their assets and make informed investment decisions regarding opportunities in rapidly expanding foreign economies.
One intriguing metric that investors can employ to assess the valuation of a stock market is the ratio of total market capitalization to GDP, expressed as a percentage. In the realm of stock valuation, a comparable measure is the market capitalization-to-total revenue ratio, commonly referred to as the price-to-sales ratio.
Similar to how stocks in diverse sectors exhibit varying price-to-sales ratios, different nations demonstrate significant differences in market capitalization-to-GDP ratios. For instance, based on World Bank data from 2017 (the most recent available year), the United States boasted a market capitalization-to-GDP ratio of nearly 165%, whereas China registered a ratio just above 71%, and Hong Kong recorded an astonishing ratio of 1274%.
However, the true value of this ratio lies in its comparison to historical figures within a specific country. For example, at the end of 2006, the United States had a market capitalization-to-GDP ratio of 130%, which plummeted to 75% by the end of 2008. In hindsight, these ranges represented substantial instances of overvaluation and undervaluation for U.S. stocks, respectively. Good wealth managers can seize such exceptional circumstances to capitalize on investment opportunities while the broader investor population retreats from the market.
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