Summary: I had absolutely no plans of writing this. But given what has been happening on Twitter and WhatsApp since the morning, I was forced to write this. Please read and share widely.
There is a full-fledged controversy raging on the internet where people have said that the economy of the United States, as represented by its gross domestic product (GDP), contracted by 32%, during April to June 2020. This was worse than India’s contraction of 23.9%.
This comparison is totally wrong. The way the United States reports GDP growth/contraction is different from the way India does. Let’s try and understand this in detail.
In April to June 2020, the US economy contracted by 9.1% in comparison to January to March 2020. This is a quarter on quarter comparison. This figure is then annualised.
How do we annualise it? We do that by assuming that the US economy will continue to contract by 9.1% quarter on quarter, over the next three quarters (basically we compound in a negative direction, since the economy is contracting). Let’s understand this through a simple example.
So, let’s say during the January to March 2020, the size of the US economy or its GDP was $100. In April to June 2020, this contracted by 9.1%. The size of the economy came in at $90.9 ($100 – 9.1% of $100).
In July to September 2020, the economy will contract further by 9.1% to $82.63 ($90.9 – 9.1% of $90.9).
In October to December 2020, the economy will contract further by 9.1% to $75.11 ($82.63 – 9.1% of $82.63).
In January to March 2021, the economy will contract further by 9.1% to $68.27 ($75.11 – 9.1% of $75.11).
Hence, by the end of one year, the economy has contracted from $100 to $68.27 or by 31.73%, which is nearly equal to 32%.
This is how the GDP growth/contraction numbers in the US get reported. Hence, by this logic, on an annualised basis, the US economy contracted by close to 32% in the period April to June 2020, in comparison to January to March 2020. But this figure can’t be compared with the Indian figure.
The Indian system is different. The GDP during a particular quarter is compared to the GDP during the same quarter in the last year. In the Indian case, the GDP contracted by 23.9% during April to June 2020, in comparison to April to June 2019 (and not January to March 2020, as is the case with the US). The Indian comparison is a year on year one and not a comparison with the previous quarter. The US comparison is a quarter on quarter comparison which is then annualised.
If the US were to report the GDP growth/contraction in the same way as India, its GDP during April to June 2020 contracted by 9.1% in comparison to the GDP between April to June 2019. The Indian economy contracted by 23.9% during the same period. That’s the right comparison.
This is the right way of looking at things and not how they are being misrepresented on the social media, even by experienced economists.