Decline of the West May Be More Pronounced Than GDP Figures Suggest
GDP emerged in the 1930s as a tool for policymakers trying to quantify the national economy during the Great Depression. Credited with formalizing GDP was the Russian-born American mathematician and economist Simon Kuznets. But he was explicit about its limitations, stating that “the welfare of a nation can scarcely be inferred from a measurement of national income”.
Around the time of World War II, when economies were mostly industrial and debt levels low, GDP was a decent proxy for capacity underscoring Keynesianism macroeconomics. This has been useful up to a point and world governments have used the measure to discern expansion or contraction, injecting stimulus when needed and withdrawing it when inflation loomed.
However, in the 1970s the Keynesian consensus broke down, largely due to the problem of stagflation. This is a combination of high inflation and high unemployment that Keynesian theory couldn’t explain because its models assumed inflation and unemployment moved in opposite directions.
The neoliberalism of the 1980s followed with Thatcher and Reagan promoting deregulation, privatization, and financial liberalization all sold as growth-enhancing reforms for which GDP became the proof of their success. If GDP rose, which of course it inevitably did, the reforms were working regardless of the economic distortions these policies created.
GDP had morphed from a diagnostic instrument into a legitimising symbol of policies that have effectively de-industrialised the West. As long as the numbers looked good, nobody was too concerned about factories shutting down as the cost of living kept on rising.
By this point, GDP was tracking less productive output and a lot more monetary transactions pumped up by leverage. Yet policymakers, investors, and the media continued to treat it as the authoritative measure of real prosperity. Its symbolic prestige actually increased even as its empirical validity declined.
One of the superficial shortcomings of GDP is its failure to adjust for differences in price levels between countries. GDP measured in Purchasing Power Parity (PPP) terms is consequently a much more accurate measure. This difference between nominal GDP and GDP (PPP) explains why Russia is able to produce more artillery shells than the whole of NATO combined.
But switching to PPP doesn’t solve the underlying problem, because it leaves untouched the structural distortions within GDP itself, which still treats financialization and excessive debt expansion as genuine growth. These are the factors have that created a widening gap between real productive output and monetary transactions.
Because GDP treats all spending equally, regardless of whether it comes out of income or borrowing, it cannot distinguish between genuine expansion of productive capacity and debt-fuelled financial speculation. Lawsuits between manufacturers won’t increase the supply of goods in the broader economy, but the legal fees still show up as GDP.
Yet for some reason we still cling to the idea that financial intermediators are neutral, efficient allocators of capital, rather than actors who seek to maximise financial returns regardless of the economic outcomes they produce. Since the 2008 financial crisis it has become much harder to believe that investment banking is always about efficiently getting capital to the right places in the real economy.
The assumption persists, but no longer holds water.
Everyone intuitively understands that flipping a piece of real estate, or repeatedly securitizing the same pool of mortgages, can produce economic activity in the financial sector that adds to GDP without creating real value. These transactions expand balance sheets, but not productive capacity, and we call it growth.
But if our standard measure of economic prosperity is so vulnerable to distortion, the obvious question is why more effort isn’t devoted to stripping out the debt-driven noise? Dr. Tim Morgan, Cambridge University alumnus and former Global Head of Research at Tullett Prebon, has tried.
The good doctor among dismal scientists developed a proprietary metric that he calls C-GDP, which is an estimate of underlying economic output after removing the inflationary effect of debt and credit. Between 2004 and 2024, Morgan calculated global GDP growth at 96% using the conventional measure, but this falls to just 33% on a C-GDP basis.
His radical recalibration of growth figures lays bare the fact that much of the recorded growth of recent decades came via credit expansion, asset inflation, and consumption rather than new physical output. Morgan calculates that each dollar of reported growth has been accompanied by an increase of at least $9 of net new financial commitments.
While Morgan did not compile a country breakdown of his C-GDP model, it would not surprise anyone if the GDP-inflating effect of debt and financialization is most prominent among the G7.
Finance, insurance, real estate, rental, and leasing combined make up just over 20% of US GDP. Household and federal debt levels are at record highs and the ratio of financial assets to GDP has exploded since the 1980s. Europe is not fundamentally very different and even Germany’s manufacturing sector is finally cracking under pressure from Asia.
While some may argue that China is also heavily indebted, when you rank all the BRICS and G7 countries according to their debt-to-GDP ratios, a clear pattern emerges. The five most indebted countries are all in the G7 with China in 6th place and the UK in 7th. Germany is 12th and the only G7 nation with a lower debt-to-GDP ratio than South Africa.
The bottom of the table is all BRICS.
Iran, Ethiopia, Egypt all have ratios between 30% and 40% while Russia is the least indebted country with a debt to GDP ratio of less than 20%.
Furthermore, we must still consider how the link between credit and real output differs between the two blocs. Much of the credit in China, for instance, has gone into tangible physical assets. Infrastructure, housing, factories, and power systems have transformed the country, though in some cases these investments were wasteful and resulted in overcapacity.
This means a significant portion of borrowing in emerging markets produces physical capital, not just paper claims. China’s system is undoubtably internally leveraged but still anchored in real trade surpluses. Meanwhile, debt expansion in Western countries running trade deficits often supports asset price speculation and consumption rather than production.
This is the hidden weakness in Western economies. Not just has industrial production been largely outsourced but a significant share of what passes for economic output is actually just financial chicanery and consumption. Does anybody really believe that future output will be sufficient to make good the huge pile of debt G7 economies continue to accumulate?
While artificial intelligence has been put forward as a panacea, the high costs involved has simply impaired the balance sheet of America’s largest tech companies, who have swopped cash for debt at an almost unprecedented speed without any sign of commensurate returns.
This expenditure on AI infrastructure accounts for approximately all of US GDP growth in recent years while the technology itself has had no discernible impact. Productivity measures might show more output per worker over because output stays the same and unemployment is rising.
Fertility rates are declining, the environment is under strain, and the cost of living keeps going up. Yet, we pretend none of it matters because GDP figures and equity markets keep booming. However, the welfare of a nation cannot be measured by Gross Domestic Product.
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