GDP and its Alternatives

GDP “measures everything in short, except that which makes life worthwhile” -Robert F. Kennedy

 Gross Domestic Product (GDP)

GDP is a measure of costs.

In 1934, Simon Kuznets designed the modern GDP. The UN System of National Accounts standardized it in 1953.

GDP measures the dollar value of the output of all goods and services produced within a country per year.

GDP is useful in that it measures production well.

2 main ways of calculating GDP are:

  1. Expenditure approach: add up all the spending on final goods and services.

GDP = Consumption + Business investment + Government Spending - Net Exports (I-E)

2. Income approach: add up all the income from selling final goods and services.

GDP = Rent + Wages + Interest + Profits

Nominal VS Real GDP

Nominal is GDP measured in current prices. It does not account for inflation from year to year.

Real is GDP expressed in constant, or unchanging, dollars, and adjusts for inflation. Real GDP is the preferred measure of economic growth by economists.

Things not included in GDP:

  • Intermediate goods: goods inside the final goods, e.g., the price of a finished computer, not the chips or random access memory (RAM) in it.

  • Non-production transactions: Financial transactions (e.g. stocks and bonds, real estate), and used goods (e.g. used cars, computers, clothes). However, it does account for fees from FIRE sector and interest from credit intermediation (FISIM).

  • Non-market and “illegal” activities: Things made at home, e.g. black markets, unpaid work, drugs.

  • Inequalities.

  • Environmental degradation.

  • Resource depletion.

GDP is not a good measure of well-being because:

  • In 1934, Kuznets himself stated that “the welfare of a nation can scarcely be inferred from a measurement of national income.”

  • It only measures what is bought and sold in markets and leaves anyone without purchasing power (income) behind.

  • It does not take into account unpaid work or leisure time.

  • It does not account well for standard of living, e.g., environmental cleanliness, health, and education.

  • GDP per capita (GDP/population) is very misleading especially when compared among income groups and to labor hours spent between nations, e.g., U.S. and Germany.

  • Obsession with GDP growth tends to lead to uneconomic growth in a fossil fueled economy.

Are there Alternatives to GDP?

Human Development Index (HDI)

  • The HDI aims to objectively emphasize that people and their capabilities should be the ultimate criteria for assessing the development of a country, not economic growth alone.

  • The HDI is a composite index that ranks countries according to their Life Expectancy index(long and healthy life), Education Index (mean years of schooling and expected years of schooling), and GNI Index or per capita income (decent standard of living) indicators are.

  • It does not reflect on inequalities, poverty, human security, empowerment, environmental degradation, resource depletion, etc.

  • The Inequality-adjusted HDI (IHDI) was introduced in 2010, and measures the inequality in the distribution of health, education, and income. The USA drops from 17 in HDI to 28 in IHDI.

Planetary Pressures-Adjusted HDI (PHDI) (Similar to the Sustainable Development Index)

  • The experimental Planetary pressures-adjusted HDI (PHDI) includes CO2 emissions per person and material footprint per capita.

  • The PHDI is motivated by a concern of intergenerational inequality.

Index of Sustainable Economic Welfare (ISEW)

  • ISEW starts with personal consumption (just like GDP) and adjust GDP for ecological and social costs.

  • “The ISEW is far from perfect. All statistical measures are inevitably misleading in many respects. But the difference in policies ordered to the improvement of the ISEW and those ordered to the increase of GNP [or GDP] would be considerable, and they would help to buy time for the deeper changes that are needed.” (Daly and Cobb, 1994).

  • “The difficulty still remains that although people may recognize that true welfare is increased by reducing throughput, many individuals and businesses will find that this also reduces their immediate profits. Their short-run advantage lies with increasing the throughput.” (Daly and Cobb, 1994).

Genuine Progress Indicator (GPI)

  • Similarly to ISEW, GPI is designed to reveal the economic, social, and environmental trade-offs associated with conventional economic growth as traditionally measured in GDP.

  • It provides a general assessment of the quality of economic activity through a series of 24 (or 26) adjustments (within 3 components) to personal consumption expenditures which composes a significant fraction of GDP.

  • Some of it social adjustments are considered “subjective” and it does not measure well the business cycle.

Happiness Index

  • The Happiness Index is supposed to help governments use their budgets to improve the welfare of people as opposed to the nation’s GDP.

  • The Gross National Happiness Index includes 4 pillars: good governance, sustainable socio-economic development, cultural preservation, and environmental conservation.

  • UNSD Solutions Network publishes the World Happiness Report where they asks people to rank their happiness from 0-10, and correlate it with 6 quality of life factors including: GDP per capita, social support, healthy life expectancy, freedom to make life choices, generosity, and corruption.

  • The Happiness Index is considered to be too subjective.