GDP has always been an indicator of output rather than welfare. It calculates the worth of goods and services generated for final consumption, both private and public, in the present and future, using current prices. (Future consumption is taken into account because GDP includes investment goods output.) It is feasible to calculate the increase of GDP over time or the disparities between countries across distance by converting to constant pricing.
Despite the fact that GDP is not a measure of human welfare, it can be viewed as a component of it. The quantity of products and services available to the typical person obviously adds to overall welfare, while it is by no means the only factor. So, among health, equality, and human rights, a social welfare function might include GDP as one of its components.
GDP is also a measure of human well-being. GDP per capita is highly associated with other characteristics that are crucial for welfare in cross-country statistics. It has a positive relationship with life expectancy and a negative relationship with infant mortality and inequality. Because parents are naturally saddened by the loss of their children, infant mortality could be viewed as a measure of happiness.
Figures 1-3 exhibit household consumption per capita (which closely tracks GDP per capita) against three indices of human welfare for large sampling of nations. They show that countries with higher incomes had longer life expectancies, reduced infant mortality, and lesser inequality. Of course, correlation does not imply causation, however there is compelling evidence that more GDP per capita leads to better health (Fogel 2004).
Figure 1: The link between a country’s per capita household consumption and its infant mortality rate.
Why is real GDP not a good indicator of economic well-being?
The Gross Domestic Product (GDP) measures both the economy’s entire income and its total expenditure on goods and services. As a result, GDP per person reveals the typical person’s income and expenditure in the economy. Because most people would prefer to have more money and spend it more, GDP per person appears to be a natural measure of the average person’s economic well-being.
However, some people question the accuracy of GDP as a measure of happiness. Senator Robert F. Kennedy, who ran for president in 1968, delivered a powerful condemnation of such economic policies:
does not allow for our children’s health, the quality of their education, or the enjoyment of their play. It excludes the beauty of our poetry, the solidity of our marriages, the wit of our public discourse, and the honesty of our elected officials. It doesn’t take into account our bravery, wisdom, or patriotism. It can tell us everything about America except why we are glad to be Americans, and it can measure everything but that which makes life meaningful.
The truth is that a high GDP does really assist us in leading happy lives. Our children’s health is not measured by GDP, yet countries with higher GDP can afford better healthcare for their children. The quality of their education is not measured by GDP, but countries with higher GDP may afford better educational institutions. The beauty of our poetry is not measured by GDP, but countries with higher GDP can afford to teach more of their inhabitants to read and love poetry. GDP does not take into consideration our intelligence, honesty, courage, knowledge, or patriotism, yet all of these admirable qualities are simpler to cultivate when people are less anxious about being able to purchase basic requirements. In other words, while GDP does not directly measure what makes life valuable, it does measure our ability to access many of the necessary inputs.
However, GDP is not a perfect indicator of happiness. Some factors that contribute to a happy existence are not included in GDP. The first is leisure. Consider what would happen if everyone in the economy suddenly began working every day of the week instead of relaxing on weekends. GDP would rise as more products and services were created. Despite the increase in GDP, we should not assume that everyone would benefit. The loss of leisure time would be countered by the gain from producing and consuming more goods and services.
Because GDP values commodities and services based on market prices, it ignores the value of practically all activity that occurs outside of markets. GDP, in particular, excludes the value of products and services generated in one’s own country. The value of a delicious meal prepared by a chef and sold at her restaurant is included in GDP. When the chef cooks the same meal for her family, however, the value she adds to the raw ingredients is not included in GDP. Child care supplied in daycare centers is also included in GDP, although child care provided by parents at home is not. Volunteer labor also contributes to people’s well-being, but these contributions are not reflected in GDP.
Another factor that GDP ignores is environmental quality. Consider what would happen if the government repealed all environmental rules. Firms might therefore generate goods and services without regard for the pollution they produce, resulting in an increase in GDP. However, happiness would most likely plummet. The gains from increased productivity would be more than outweighed by degradation in air and water quality.
GDP also has no bearing on income distribution. A society with 100 persons earning $50,000 per year has a GDP of $5 million and, predictably, a GDP per person of $50,000. So does a society in which ten people earn $500,000 and the other 90 live in poverty. Few people would consider those two scenarios to be comparable. The GDP per person informs us what occurs to the average person, yet there is a wide range of personal experiences behind the average.
Finally, we might conclude that GDP is a good measure of economic well-being for the majority of purposes but not all. It’s critical to remember what GDP covers and what it excludes.
Is real GDP a true indicator of economic prosperity?
Living standards have risen all throughout the world as a result of economic expansion. Modern economies, on the other hand, have lost sight of the reality that the conventional metric of economic growth, gross domestic product (GDP), just measures the size of a country’s economy and does not reflect the welfare of that country. However, politicians and economists frequently use GDP, or GDP per capita in some situations, as an all-encompassing metric for measuring a country’s progress, combining economic success with societal well-being. As a result, measures that promote economic growth are perceived as positive for society.
We now understand that the reality is more complicated, and that focusing just on GDP and economic gain as a measure of development misses the negative consequences of economic expansion, such as climate change and income inequality. It’s past time to recognise GDP’s limitations and broaden our definition of development to include a society’s quality of life.
This is something that a number of countries are starting to do. In India, for example, where we both advise the government, an Ease of Living Index is being developed to gauge quality of life, economic ability, and sustainability.
Our policy interventions will become more aligned with the qualities of life that citizens actually value, and society will be better served, if our development measures go beyond an antagonistic concentration on increased productivity. But, before we try to improve the concept of GDP, it’s important to understand where it came from.
The origins of GDP
The contemporary idea of GDP, like many of the other omnipresent things that surround us, was born out of battle. While Simon Kuznets is frequently credited with inventing GDP (after attempting to quantify the US national income in 1932 in order to comprehend the full magnitude of the Great Depression), the present concept of GDP was defined by John Maynard Keynes during WWII.
Keynes, who was working in the UK Treasury at the time, released an essay in 1940, one year into the war with Germany, protesting about the insufficiency of economic statistics in calculating what the British economy might produce with the available resources. He stated that the lack of statistics made estimating Britain’s capacity for mobilization and combat problematic.
According to him, the sum of private consumption, investment, and government spending should be used to calculate national income. He rejected Kuznets’ version, in which the government’s income was represented but not its spending. Keynes observed that if the government’s wartime purchase was not factored into national income calculations, GDP would decline despite actual economic expansion. Even after the war, his approach of measuring GDP, which included government spending in a country’s income and was driven by wartime necessities, quickly gained favor around the world. It is still going on today.
How GDP falls short
However, a metric designed to judge a country’s manufacturing capability in times of conflict has clear limitations in times of peace. For starters, GDP is an aggregate measure of the value of goods and services generated in a certain country over a given time period. There is no consideration for the positive or negative consequences produced during the production and development process.
For example, GDP counts the number of cars we make but ignores the pollutants they emit; it adds the value of sugar-sweetened beverages we sell but ignores the health issues they cause; and it includes the cost of creating new cities but ignores the worth of the crucial forests they replace. “Itmeasures everything in short, except that which makes life worthwhile,” said Robert Kennedy in his famous election speech in 1968.
The destruction of the environment is a substantial externality that the GDP measure has failed to reflect. The manufacturing of more things increases an economy’s GDP, regardless of the environmental damage it causes. So, even though Delhi’s winters are becoming packed with smog and Bengaluru’s lakes are more prone to burns, a country like India is regarded to be on the growth path based on GDP. To get a truer reflection of development, modern economies need a better measure of welfare that takes these externalities into account. Expanding the scope of evaluation to include externalities would aid in establishing a policy focus on their mitigation.
GDP also fails to account for the distribution of income across society, which is becoming increasingly important in today’s world as inequality levels rise in both the developed and developing worlds. It is unable to distinguish between an unequal and an egalitarian society if their economic sizes are identical. Policymakers will need to account for these challenges when measuring progress as rising inequality leads to increased societal discontent and division.
Another feature of modern economies that makes GDP obsolete is its disproportionate emphasis on output. From Amazon grocery buying to Uber cab bookings, today’s cultures are increasingly driven by the burgeoning service economy. The concept of GDP is increasingly falling out of favor as the quality of experience overtakes unrelenting production. We live in a society where social media provides vast amounts of free knowledge and entertainment, the value of which cannot be quantified in simple terms. In order to provide a more true picture of the modern economy, our measure of economic growth and development must likewise adjust to these changes.
How we’re redefining development in India
In order to have a more holistic view of development and assure informed policymaking that isn’t solely focused on economic growth, we need additional metrics to supplement GDP. Bhutan’s attempt to assess Gross National Happiness, which takes into account elements including equitable socioeconomic development and excellent governance, and the UNDP’s Human Development Index (HDI), which includes health and knowledge in addition to economic prosperity, are two examples.
India is also started to focus on the ease of living of its population as a step in this approach. Following India’s recent push toward ease of doing business, ease of living is the next step in the country’s growth strategy. The Ease of Living Index was created by the Ministry of Housing and Urban Affairs to assess inhabitants’ quality of life in Indian cities, as well as their economic ability and sustainability. It’s also expected to become a measurement tool that can be used across districts. We feel that this more comprehensive metric will provide more accurate insights into the Indian economy’s current state of development.
The ultimate goal is to create a more just and equitable society that is prosperous and provides citizens with a meaningful quality of life. How we construct our policies will catch up with a shift in what we measure and perceive as a barometer of development. Economic development will just be another tool to drive an economy with well-being at its core in the path that society chooses. In such an economy, GDP percentage points, which are rarely linked to the lives of ordinary folks, will lose their prominence. Instead, the focus would shift to more desirable and genuine wellbeing determinants.
Is GDP a measure of social well-being?
GDP is a measure of the benefits of economic expansion in terms of cost-benefit analysis. However, in order to adequately assess social welfare, the losers of economic expansion must also be considered before a logical choice on the desirability of economic growth can be made.
How is economic well-being assessed?
Question from the audience. What exactly is economic well-being? Could you perhaps explain how this affects the economy?
Economic welfare is defined as the amount of prosperity and the quality of living standards in a given economy. Economic well-being can be quantified using a range of parameters, including GDP and other measures that indicate population well-being (such as literacy, number of doctors, levels of pollution e.t.c)
Economic well-being is a broad notion that is difficult to define. It essentially relates to how well people are performing. Economic well-being is commonly expressed as a ratio of real income to real GDP. An increase in real output and real incomes indicates that individuals are better off, and hence that economic wellbeing has improved.
Economic well-being, on the other hand, will be concerned with more than just income levels. People’s living standards, for example, are influenced by issues such as health-care access and environmental concerns such as traffic and pollution. These aspects of quality of life are crucial in determining economic well-being.
Factors influencing economic welfare
- Housing Housing that is unaffordable despite a high salary reduces economic well-being. Housing that is both good and affordable is critical to economic well-being.
- Life expectancy and quality of life – access to healthcare, as well as healthy behaviors, such as obesity and smoking rates are all factors to consider.
- Economic expansion can lead to greater pollution, which is harmful to people’s health and living conditions.
- Leisure time high pay as a result of working extremely long hours reduces economic well-being. Leisure has monetary worth.
Economics is concerned with utility concepts. A consumer’s satisfaction/happiness is represented by utility. If you spend 10 for a CD, for example, you are likely getting at least 10’s worth of usefulness from the item.
This is a discipline of economics concerned with establishing the best resource distribution in society. It is interested in both allocative and social efficiency.
Measure of economic welfare (MEW)
This was created in 1972 as a substitute for GDP. William Nordhaus and James Tobin came up with the idea. (WD Nordhaus and J Tobin) (1972) Is Growth No Longer Necessary?
It modifies the definition of total national output to only include products that contribute to economic well-being.
- The underground economy’s economic output (not measured by official GDP statistics)
Index of Human Development Index HDI
This is a metric that looks at the many options available to people. It is a composite measure that takes into account three key criteria that influence living standards: income, life expectancy, and education. The three elements are as follows:
A rating of 1 is assigned to the highest level of human development. A value close to 0 is assigned to low levels of human development.
Well-being index
The ONS developed this measure of economic well-being and life satisfaction. It takes into account our health, relationships, education, and talents, as well as what we do, where we live, our finances, and the environment. It contains both positive and negative data, as well as surveys and questionnaires; it also employs a novel technique and is experimenting with economic data.
What are the drawbacks of using GDP to assess economic well-being?
It does, however, have some significant drawbacks, including: Non-market transactions are excluded. The failure to account for or depict the extent of income disparity in society. Failure to indicate whether or not the country’s growth pace is sustainable.
As a good measure of economic welfare, how does HDI compare to real GDP?
Gross Domestic Product (GDP), which is the total value of all final goods and services produced in a country over a given period of time, is the most common technique of quantifying an economy. GDP can be calculated per capita, which reflects total output per person, or as a proportion of national output over time. Critics of the GDP measurement, on the other hand, contend that it is an antiquated way of study. Economists devised the concept between World Wars in order to quantify the economic damage caused by the Great Depression and compare production capacities between countries. GDP, on the other hand, simply assesses a country’s productive potential, not its entire well-being. As Robert F. Kennedy famously put it, “Air pollution, cigarette advertising, ambulances, jails, napalm, nuclear warheads, and armored cars for police to fight riots in our cities are just a few examples… However, it ignores our children’s health, the quality of their education, and the joy of their play… in short, it assesses everything except what makes life valuable. And it knows everything there is to know about America except why we are pleased to be Americans.”
William Nordhaus, the Sterling Professor of Economics at Yale University, gave another example of the inefficiencies of GDP calculation. In the 1990s, he wanted to see how well GDP reflected changes in living standards, so he devised a method to do so “Over the last 200 years, the “cost of light” has risen dramatically. He tallied up the change in the price of resources needed to produce light over time, from candles to light bulbs, while calculating GDP using one-dimensional analysis. Between 1800 and 1992, the cost of light increased by 3 to 5 times on this basis. However, that system of calculation ignores the fact that each new light-production technology was far more efficient than the preceding one. He then converted his calculations to pennies per lumen-hour and realized that the price of light had dropped by more than a hundred times.
Economists recognized the inefficiencies of GDP over time and sought to build a system of analysis that would provide a more realistic picture of an economy’s health. Economists at the United Nations Development Programme aimed to establish a statistic that would shift the focus of development economics away from national income accounting and toward measures that benefit individuals. These economists believed that people and their talents, not just economic progress, should be the ultimate criterion for judging a country’s development. As a result, they devised the human development index, a summary metric that takes into account three major aspects of human development: health, education, and living standards. Life expectancy at birth, which is factored into the life expectancy index, determines one’s health. The education index is calculated by combining the mean years of schooling with the projected years of schooling. And the GNI index, which measures gross national income per capita, determines living standards. The Human Development Index is derived from the sum of these three indicators.
The HDI places a larger emphasis on human development than the GDP. It considers a country’s quality of life as well as its production capacity. A country’s education and health are regarded as equally essential as its economic power. GDP is viewed as a means, not an end, to human growth. GNI per capita, which is effectively the purchasing power of the average person, is one of the factors used to calculate the Human Development Index. The Human Development Index, rather than GDP, provides a more comprehensive picture of a country. Countries with similar GDPs, for example, can have dramatically varied HDIs. When two countries’ GDPs are similar but their HDIs are not, it can assist policymakers identify the basic issues that need to be addressed in their country, such as education or health. Finally, it portrays changes in living standards throughout time more precisely. For example, if every employee in a country’s tobacco and weapons industries suddenly became academics or joined the health business to treat people, find cures, produce vaccines, and so on, GDP might not improve significantly. The Human Development Index, on the other hand, would shift dramatically to reflect the country’s progress.
As previously stated, GDP was created as a statistic to allow economists to quantify the extent to which the Great Depression harmed economic production and to allow countries to compare their relative power. In times of peace, GDP was never intended to account for technical advancement or the quality of life. Although economists agree that the GDP calculation is far from ideal, there are few better options. In addition to GDP, the Human Development Index takes into account health and education.
Why is real GDP a more accurate indicator of economic growth?
Real GDP removes the distortions produced by inflation, deflation, and currency rate variations, giving analysts a better picture of how a country’s total national output is rising or declining from year to year.
Is GDP a reliable indicator of economic well-being in class 12?
Since GDP accounts for both the economy’s total revenue and expenditure on goods and services, one would wonder whether GDP is a good indicator of economic well-being. GDP, on the other hand, cannot be regarded as a perfect indicator of economic well-being.
How is GDP a flawed indicator of well-being?
Which is better for a country’s well-being: spending $10 million on a jail or spending $10 million on a smartphone line? How about chopping down rain forests to make $10 million worth of lumber? Or a hurricane that necessitates a $10 million repair bill?
All of the above are equal in today’s most frequent shorthand for national welfare, gross domestic product. GDP just measures output and makes no promises about its quality, let alone subjective ideas like societal progress or human happiness. It accomplishes what it was designed to do provide a value for marketable goods and services produced in a certain country during a specified time period and it does it fairly successfully.