GDP is significant because it provides information on the size and performance of an economy. The pace of increase in real GDP is frequently used as a gauge of the economy’s overall health. An increase in real GDP is viewed as a sign that the economy is performing well in general.
Why is GDP not a good indicator of progress?
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.
What makes GDP such a useful metric?
Because it is a representation of economic production and growth, GDP is a crucial metric for economists and investors. Economic growth and production have a significant impact on practically everyone in a particular economy. When the economy is healthy, unemployment is usually lower, and wages tend to rise as businesses hire more workers to meet the economy’s growing demand.
What is GDP and how is it used to measure progress?
- The monetary worth of all finished goods and services produced inside a country during a certain period is known as the gross domestic product (GDP).
- GDP is a measure of a country’s economic health that is used to estimate its size and rate of growth.
- GDP can be computed in three different ways: expenditures, production, and income. To provide further information, it can be adjusted for inflation and population.
- Despite its shortcomings, GDP is an important tool for policymakers, investors, and corporations to use when making strategic decisions.
What is a decent indicator of progress?
This gauge of progress was also acknowledged by UN experts in their study on “Measures of Economic Development of Underdeveloped Countries.” In computing national income statistics, Charles P. Kindleberger proposed the same procedure with adequate precautions.
Economic development aims to improve people’s living standards and, as a result, their consumption levels. Per capita income, rather than national income, can be used to estimate this. If a country’s national income rises but its per capita income does not, the people’s living standards will not improve. As a result, per capita income is a more accurate indicator of economic development than national income.
Increases in per capita income are a solid indicator of economic progress. Because the growth rate of national income is greater than the growth rate of population in advanced countries, per capita income has been steadily increasing. This has improved the people’s economic situation. In developing countries, per capita production capacity is quite low. As a result, as these economies’ capacity to create grows, they progress toward economic development.
Why is GDP a poor indicator of living standards?
GDP is a rough indicator of a society’s standard of living because it does not account for leisure, environmental quality, levels of health and education, activities undertaken outside the market, changes in income disparity, improvements in diversity, increases in technology, or the cost of living.
Is GDP a reliable indicator of economic well-being?
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.
Quiz: Why is GDP not a good indicator of economic well-being?
The use or depletion of our natural resources, such as oil, rainforests, wetlands, fish populations, and so on, has little effect on GDP. There is no indication of how the economy’s GDP is distributed across the various social and economic categories and people.
What is the most accurate indicator of a country’s progress?
“Development can be viewed as a process of increasing people’s true liberties.” Sen, Amartya
The expansion of a country’s economy is measured by economic growth. Today, policymakers and scholars alike commonly quantify it by rising gross domestic product, or GDP. This metric calculates a country’s value added, which is the total value of all products and services produced minus the value of goods and services required to produce them. The GDP per capita is calculated by dividing this metric by a country’s population to determine how productive and developed an economy is.
A brief history of growth and GDP
Economic growth is derived from classical economics, where an increase in national income signifies an increase in a nation’s wealth the traditional metric of success. During the industrial revolution, when market economies blossomed, the concept of economic growth gained prominence. Simon Kuznets, a Nobel winner, wrote extensively about national statistics in the 1930s and promoted the use of GDP as a measure of the US national income. “The national income total is thus an amalgam of relatively accurate and only rough estimations rather than a unique, extremely precise measurement,” Kuznets stated, taking this measure with a grain of salt (Kuznets, 1934).
Governments were looking for analytical methods to raise taxes to fund the newly minted war machine against the backdrop of a brutal world war. GDP became the standard metric for measuring a country’s economy at the 1944 Bretton Woods conference. The concept of development has always been linked to economic expansion, i.e. the accumulation of wealth and the creation of products and services, from the classical through the neo-classical periods.
Finally, with the close of World War II, in 1945, the concept of emerging countries became a focal point of public policy. In his inauguration address in 1949, US President Harry Truman characterized “underdeveloped countries” as a bigger portion of the world, and stressed that growth should be based on “democratic fair-dealing” (Truman announces Point Four program).
The dominance of GDP as a measure of economic growth today is due in part to the fact that it is easier to quantify the production of goods and services than it is to measure other welfare outcomes with a multi-dimensional index. Because of this, GDP is not an appropriate indicator of a country’s development on its own. Development is a multi-dimensional notion that encompasses not only an economic but also social, environmental, and emotional aspects.
Towards inclusive and sustainable growth
One of GDP’s shortcomings is that it solely considers average income, which does not reflect how most people live or who benefits from economic growth. Thomas Piketty (2014) proposes a two-pronged hypothesis for how a society’s wealth grows more concentrated and why this is harmful to development:
- The first law states that when the rate of return on capital (profits, dividends, interests, and rents) exceeds the rate of economic growth, inequality rises.
- According to the second law, continuous rises in the capital-to-output ratio concentrate income in the hands of capital owners at the expense of employees (return of capital surpasses the return of labour, i.e. wages).
Piketty examines a large number of data sets, although they are all limited to industrialized countries. He contends that these principles explain capitalism’s fundamental market failings. These shortcomings should be addressed by government intervention in the form of:
Growing inequalities, if allowed unchecked, might not only stifle prosperity, but also create instability and disorder in society, jeopardizing the very foundations of free democracy. As the wealthy amass ever more capital and wealth, economic and, as a result, political power becomes increasingly concentrated in the hands of a few wealthy individuals. As a result, policy-making processes are skewed to favor the interests of these wealthy elites.
As a result, a rising GDP cannot be believed to automatically lead to long-term development. On the other hand, Piketty’s so-called “basic rules of capitalism” have been widely criticized due to miscalculations in savings and depreciation rates (Mankiw, 2015; Milanovic, 2016).
The Human Development Index
The Human Development Index (HDI), devised by the United Nations Development Programme, is one enlarged indicator that aims to quantify the multi-dimensional element of development (UNDP). The index was created by Mahbud ul Haq and Amartya Sen, and it is better suited to tracking the progress of both rich and poor countries.
The first HDI report was published in 1990. It takes into account the traditional method of assessing economic growth, as well as education and health, which are important factors in establishing a society’s level of development. This is derived by using the geometric mean of GDP per capita, life expectancy at birth, and the average of mean and predicted schooling years.
The Human Capital Index
The Human Capital Index was established by the World Bank on October 11th, 2018. (HCI). This newly established index rates 157 nations on a set of four health and education variables based on a calculation of the economic output lost as a result of poor social outcomes. The key advantage is that, like the Social Progress Index (SPI) and unlike GDP, it focuses on results rather than inputs. For example, educational quality is more correctly weighted against years of schooling when measured by actual adjusted learning. The main objection leveled about the HCI is that it risks overvaluing the pecuniary benefits of education and health care, so commoditizing people rather than their societal contributions and intrinsic status as basic human rights. Nonetheless, it is expected that the HCI will be used primarily by developing countries to quantify the outcomes of social sector investments, thereby increasing spending on human development (health, education, social security, and so on), which the World Bank claims has been overlooked in favor of infrastructure and institutional development.
The Social Progress Index
The SPI is a superior means of gauging societal growth, in my opinion. The SPI was created by the Social Progress Imperative, a non-profit organization. It’s one of the Commission on the Measurement of Economic Performance and Social Progress’s or simply Stiglitz-Sen-Fitoussi, after the commission’s leaders outcomes. The Commission’s major goal was to look at how countries’ wealth and social development may be quantified in ways other than the one-dimensional GDP measure. It is still a relatively new indicator, with data only going back four years, but it covers a large number of countries, totaling more than 130.
The SPI is a modification of the HDI in that it increases the number of composite indicators from four to fifty-four in a wide range of categories, such as basic human requirements, foundations of well-being, and possibilities for advancement. As a result, this index can synthesize the most important aspects that influence development. Access to water and sanitation, educational and health results, public criminality, housing, information access, and communication are only a few examples. Naturally, the SPI’s biggest flaw is its relative complexity and lack of applicability when used to advise policymaking.
Economic growth as freedom
Sen’s (2000) concept of economic growth as a successful way of extending personal and societal freedoms the impact it has on people’s lives lies at the heart of the SPI. Consider the following scenario:
- participation in commerce and manufacturing as well as access to economic opportunities.
As a result, development entails the abolition of restrictions on liberty that limit people’s choices and opportunities to express agency in their own lives.
2. A multi-dimensional approach to development
The SPI has a significant additional value in that it incorporates a variety of subjective indicators that are sometimes overlooked in economic debates. Political rights, freedom of expression, assembly, and religion, corruption, tolerance for minorities and immigration, and discrimination and violence against them are among them.
There isn’t a single factor of the index that degrades a country. Instead, a combination of variables provides more information on a country’s level of development. It is unsurprising that developed countries are at the top of the table; nonetheless, some of the world’s wealthiest countries still trail behind in certain developmental indicators. The United States, France, Italy, Russia, Brazil, and China all received low marks.
3. Development vs. economic growth
There are three key reasons why countries do poorly in comparison to their economic size:
The SPI does not capture the third reason, but it does capture the first two. Poverty and inequality are becoming widely contested in academic literature, not only because of their detrimental effects on human development, but also because they stifle GDP growth.
Economic growth: for whom?
Is the average worker’s situation improving? Economic growth, as measured by GDP, is a useful supplementary indication of development, but it is not sufficient on its own. Modern capitalism’s task is to strike a balance between its function as an efficient and successful method of production and its proclivity to concentrate income, money, and thus power. Indeed, social growth will lead to economic progress, and the SPI is a welcome addition to development measures in this regard.
GDP measurement may be strengthened if it included not only physical capital, but also natural and human capital. Economic development in its pure accounting format (GDP expansion) will always result in less inclusivity and a generalized sense of societal discontent, which is harmful in democratic countries when it is divorced from social progress.
As a result, when used to gauge development, the present measure of economic growth, GDP, has significant drawbacks. The SPI can be considered as a more appropriate indication given the multi-dimensional character of development.
References
L. Burman, J. Rohaly, and R. Shiller (2006). The Rising Tide Tax System: Indexing for Changes in Inequality (at Least Partially). http://www.econ.yale.edu//shiller/behmacro/2006-11/burman-rohaly-shiller.pdf is available.
N. G. Mankiw, N. G. Mankiw, N. G. Mankiw (2015). “Yes, r exceeds g. pp. 43-47 in American Economic Review, Vol. 105, No. 5.
E. Matthew (2008). Masters Dissertation, Singapore Management University, Stock Markets and Income Inequality: A Cross-Country Study.
B. Milanovic (2016). LIS Working Papers No. 663, LIS Cross-National Data Center in Luxembourg, Increasing Capital Income Share and its Effect on Personal Income Inequality.
L. Mishel, L. Mishel, L. Mishel, L. Mishel “Economic Policy Institute, “The Wedges Between Productivity and Median Compensation Growth,” Issue Brief #330.
T. Piketty, T. Piketty, T. Piketty, T (2014). Harvard University Press, Cambridge, USA, has published Capital in the Twenty-First Century, translated by Arthur Goldhammer.
T. Piketty and G. Zucman (2015). In the Long Run, Wealth and Inheritance, Handbook of Income Distribution, Vol. 2. Anthony B. Atkinson and Franois Bourguignon edited the book. Elsevier, Amsterdam, Chap. 15, pp. 13031368.
Is GDP a good indicator of living standards?
The sole purpose of macroeconomic policy, or government policy in general, should not be a high level of GDP. Even if GDP may not accurately reflect a country’s overall standard of living, it does accurately reflect output and indicates when a country is materially better or worse off in terms of jobs and earnings. In most countries, a considerable increase in GDP per capita is accompanied by other improvements in daily living in a variety of areas, such as education, health, and environmental protection.
A word as wide as “quality of life” can’t be captured in a single figure. Nonetheless, GDP per capita is a respectable, if imprecise, indicator of living standards.
Why is GDP more significant than GNP?
GDP is significant because it indicates whether the economy is expanding or contracting. Since 1991, the United States has utilized GDP as its primary economic metric, replacing GNP as the most widely used measure internationally.