Changes in Gross Domestic Product (GDP) have been accepted as a country's economic growth for more than five decades. It is an estimate of market throughput, summing up the value of all final goods and services that are produced and traded for money with in a particular frame of time. It is usually measured by summing together a nation's personal consumption expenditures (payments by households for goods and services), government expenditures (public spending on the provision of goods and services, infrastructure, debt payments, etc.), net exports (country's exports value minus the imports value), and net capital formation (the increase in value of a nation's total stock of monetized capital goods).
Figure 1 shows a simple representation of the circular flow of income and expenditures within a market economy: individuals, businesses, and governments use capital to create goods and services. Fundamentally, GDP measures the annual volume of this flow (or throughput) in an economy, just as how an electric meter measures use of electricity in a building.
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Since the time of its use, economists familiar with methodologies of GDP and SNA have highlighted that GDP is only a measure of economic activity, but not economic well-being.
History of GDP
The world was in the midst of major social and economic upheaval from two global wars and the Great Depression when GDP and SNA methodologies were initially developed in the US and UK in the 1930s and 1940s. President Roosevelt's government used the statistics to rationalize policies and budgets meant to bring the country out of the great depression. As involvement of US in World War II (WWII) became inevitable, there was a concern that it would dampen the life of US citizens who had just begun to recuperate from the depression. GDP estimates were used to show that the economy could provide sufficient supplies for WWII while at the same time maintaining adequate manufacture of consumer goods and services.
Economic instability in a number of countries was one of the important reasons in the outbreak of WWII. The instability was caused by unstable currency exchange rates and bigoted, inequitable trade practices that dispirited global trade. In 1944, so as to evade a recurrence of such instability, leaders of the 44 allied nations congregated in Bretton Woods, New Hampshire, to construct a process for global cooperation on trade and currency exchange. The objective of the gather was to "speed economic progress the world over, assist political stability and promote peace". International trade would generate employment in all countries which would provide income that in turn would allow people everywhere to acquire sufficient food, housing, shelter, health care and other services. Growing the economy was seen as the path to economic well-being. This further strengthened GDP's stance as an indicator of economic well being.
The establishment of the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD-now part of the World Bank) were some of the crucial decisions taken in the gathering. The IMF was created as a forum for collaborative management of international monetary exchange and for stabilization of the country's currency exchange rates.
The World Bank was founded to provide investment credits for development and infrastructure restoration in war-affected regions and undeveloped nations such as Latin America. Though in theory, these institutions were supposed to provide an equal voice to all member countries, in practice, the US dominated both institutions for two decades and half because of its political power and economic muscle following WWII.
This resulted in the 'US dollar, economy, and economic policies' becoming the effective standards for comparison of other countries. Thus GDP came to be used by these institutions as the chief measure of economic progress in the consequent 60 years. In 1970s, with the reformation of these institutions, the US lost its strong dominance over the World Bank and the IMF. However, GDP continues to be the common measure of economic growth all over.
Today GDP and economic growth is repeatedly referred to by prominent economists, politicians, the media, and crucial decision-makers, as if it represents overall progress. As a matter of fact, a recent report of the World Bank says that to solve the world's poverty problem, nothing other than long-term high rates of GDP growth can achieve it.
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This is analogous to measuring a building's energy use and saying that more the use of energy, better will be the overall quality of life of the building's inhabitants. Although electricity provides some of life's amenities, a higher electric bill, does never equate to a better life, a fact most of us will accept through our experience.
Problems with Using GDP to Measure Quality of Life and Economic Progress
GDP is based on a curtailed picture of the system within which the human economy functions because it measures only monetary transactions pertaining to the production of goods and services.
A more comprehensive picture of how the human economic system fits within the social and environmental systems upon which it depends is shown in the figure below.
Figure 2: View of Economy as Part of a Larger System
Figure shows that the economy draws benefits from natural, social, and human capital and that the quantity and quality of such capital, in turn, is affected by net investment from the economy. By only measuring the inner circle-marketed economic activity, GDP ignores changes in the natural, social, and human components of community capital on which the community depends for continued survival and well-being. Thus, GDP not only fails to measure important facets of quality of life but even encourages activities that are detrimental to community well-being in the long term in many ways.
For an example, GDP encourages deforestation because clear-cutting a forest for lumber in GDP terms is more valuable than the ecosystem services that forest might provide if left untouched. Similarly services such as biodiversity habitat, reducing flooding from severe storms, filtration to improve water quality in rivers and lakes, and the sequestration of carbon dioxide and manufacture of oxygen- are not part of the market economy and as a result are not counted in GDP. Thus, we can say that the existing national accounting method treats the planet as a liquidated business.
GDP's Threshold effect
With increase in GDP, the overall quality of life more often than not increases only up to a certain level. Beyond this level, increases in GDP are offset by the costs associated with rising income inequality, loss of leisure time, and natural capital reduction. A research study confirms that, beyond a certain threshold, further increases in material affluence lessen community bondage, healthy relationships, knowledge, wisdom, a sense of purpose, connection with nature, and other aspects of human happiness. In fact, recent global trend suggests that as material affluence increases, serious components of psychic income often decline amidst increasing rates of alcoholism, suicide, depression, poor health, crime, divorce, and other social pathologies.
Besides this, GDP obscures a growing inequality between the haves and have-nots. A highly disproportionate distribution of income can be damaging to economic welfare by increasing crime, reducing worker productivity levels, and reducing investment. Moreover, when growth occurs only in the wealthiest income brackets it matters less in improving economic welfare of all because the social benefits of increases in eye-catching spending by the well-off are less beneficial than increases in spending by those least well-off.
Other Ways to Measure Progress
There is a growing realization that GDP is a measure of economic quantity, not economic quality or welfare, let alone social or environmental well-being.
A number of ways of measuring national-level progress have been proposed, developed, and used to address this. Broadly these new measures of growth can be classified as:
Indexes that make 'corrections' to existing GDP and SNA accounts in light of the issues discussed above
Indexes that directly measure aspects of well-being
Composite indexes that integrate approaches
Whether GDP should be improved on, replaced by these approaches, or supplemented is a question that ponders people within the indicator's community.
Indexes that 'Correct' GDP
There are several indicators of economic well-being that use GDP and the national accounts as the underpinning and then add or subtract quantities in an attempt to address some of the issues discussed above. As these measures are based on the same economic data as GDP, they have the following drawbacks:
Lack of consent on how to value items that are not stated in monetary terms regularly (e.g., volunteer labor or illegal activities)
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To decide which expenses are favorable and therefore should be added to the total and which are unfavorable and therefore should be subtracted from the table (i.e., junk food and home security systems) is subjective
Lack of consent on ways of quantifying the costs of exhausting natural capital
However, the widening gap between GDP and actual economic well-being is absolutely evident from applications of these indicators.
Index of Sustainable Economic Welfare/ Genuine Progress Indicator
It is a measure that uses GDP as its basis. While GDP is a measure of current income, GPI measures the sustainability of that income, basically measuring whether growth is a result of living-off the interest of community capital or spending it down. Like GDP, it uses the same personal consumption data but makes deductions to account for income inequality and costs of crime, environmental degradation, and loss of leisure and additions to account for the services from consumer durables and public infrastructure and the benefits of volunteering and housework.
Green GDP accounts for estimation of environmental degradation and depletion of natural resources into the national income accounts. As an experiment in national accounting, the Green GDP endeavor in China failed miserably in 2007, when it became clear that the adjustment for environmental damage had reduced the growth rate to almost zero in some of its provinces.
GS aims to measure sustainable use of resources although it does not take into account consumption related 'equity issues'. GS computation deducts amounts for environmental degradation and resource exhaustion and adds in amounts for investments in human capital. One noteworthy finding from GS is that increased wealth in a country is as a result of increase in intangible wealth-human capital and the formal and informal institutions that humans create.
Indexes that do not use GDP
There are indexes that do not measure economic activity. Instead they compute changes in environmental, social, or human capital, well-being, environment or social activities.
ItÂ measures human demand on the planet'sÂ ecosystems. It compares human demand with planet'sÂ ecologicalÂ capacity to regenerate. It represents the amount of biologically productive land and sea area that is required to restore the resources the populationÂ consumes and to soak up and render harmless the corresponding waste. Using this assessment, assuming that every one followed a given lifestyle, it is possible to estimate how much of theÂ EarthÂ would be required to support humanity. For 2006, humanity's total ecological footprint was estimated at 1.4 planet Earths. This implies that humanity is using ecological resources 1.4 times faster than the time it would required for the Earth to regenerate those resources. It is calculated every year, with a three year lag due to the time taken for collection and publication of the underlying statistics.
The last two decades have seen an active body of work that measures human well-being based on self-reporting by individuals and groups. The attempt is to measure "satisfaction" with quality of life, and the extent to which human needs are being met. Due to the fact that these measures are based on responses from groups and individuals based on their thinking and judgment, there are critics who say that these measures do not have the factual backing and are less valid than objective measures like GDP. On the other hand, objective measures such as life expectancy, rates of disease, and GDP are only proxies for well-being that have been identified through the subjective judgment of decision-makers; hence the distinction between objective and subjective indicators is somewhat illusory. One more concern is cultural differences which make it complex to evaluate results across different ethnic, sex, age, belief, and other cultural precincts.
As Figure 3 Percent Very/Quite Happy vs. GDP shows, comparisons of reported well-being and per capita GDP have shown that happiness does not increase considerably with increase in income beyond a certain level.
Figure 4: GNP Versus Well-Being illustrates the trend in which economic gains beyond the threshold no longer correlate with increases in well-being
Gross National Happiness
It is not an actual index but a principle suggested by the Bhutanese king in 1980s as a fitting measure than GDP for guiding the kingdom's progress in a manner in line with the country's culture and spiritual values rather than focusing on just increasing economic activity. Since 2004, the Bhutanese government has sponsored four international conventions on GNH. It has established a GNH Commission but a framework for measuring GNH has not been explained yet.
Composite Indexes Including GDP
These are indexes that combine GDP or its variants with some of the non-GDP environmental or social indexes or with other measures of well-being.
Human Development Index (HDI)
The UN Development Program has used HDI in its annual Human Development Report since 1990. The purpose of this Index is to show how well the administration of economic growth and human development is enhancing human well-being in the countries all over the world. The index concentrates on "longevity, knowledge and decent living standards" as substitutes for people's ability to live long and well-to-do lives.
Longevity is measured using life expectancy at birth. This also serves as a proxy for other facets of well-being such as adequate nutrition and good health.
Knowledge is measured using literacy rate and school enrollment, which serve as proxies to reflect the level of knowledge possessed by the adult population and at the same time investment made in the youth.
Access to a respectable standard of living is measured using GDP adjusted to reflect PPP (Purchasing Power Parity) and the threshold effect using a logarithm of real GDP per capita.
Living Planet Report (LPI)
LPI is a measure of the world's forests, freshwater and marine ecosystems, particularly on the "amount and severity of biodiversity loss". It follows biodiversity trends by tracking the populations of over 1,000 species of fish, amphibians, reptiles, birds, and mammals. The 2006 LPR showed that human use of the earth's biocapacity is greater than the regenerative capacity by 25%.
Figure 5 compares selected countries' bio-capacities with their ecological footprints on a per capita basis using the LPR estimates. Countries like Brazil, Canada etc have a positive reserve because of comparatively smaller populations, vast areas, and per capita use below the regeneration rate. However, most countries in the world are operating on the negative side.
Figure 5: Living Planet Index
Ecological Reserve/Deficit for Selected Countries
Happy Planet Index (HPI)
The HPI's purpose is to compute a nation's ecological effectiveness and efficiency in delivering human well-being. The index is an integration of three measures: life expectancy at birth, life satisfaction, and ecological footprint.
An interesting outcome of comparing the HPI and HDI indexes is that two countries can have similar results for HDI but have different results of HPI. For an example, Honduras's HPI is higher than Moldova by 30 points even though they share similar HDI ratings, ecological footprint and life expectancy, the reason being Life Satisfaction in Honduras is more than double that of in Moldova.
The indicators explained so far are all nothing but combination of a number of variables into a single composite index, inclusive of GDP. Many new measures of growth simply explain the indicators separately but fail to attempt the aggregation. These indicator suites do that job of aggregation which answers the question, "What do all these mean to the user?".
National Income Satellite Accounts
The problem with developing Green GDP methodologies is that the SNA on which GDP is based use exclusively monetary transactions to establish values for items. As a result, natural resources and ecosystem services, which are not traded in markets, are left out. Rather than estimating "shadow" values for these items and including them directly in the SNA, another method that has been used is the creation of satellite accounts, some of which are reported in physical units. Four categories of satellite accounts to augment the SNA:
â€¢ Flow accounts that provide information at the industry level about the use of energy and materials as inputs and the generation of pollutants and solid waste;
â€¢ Expenditure accounts that show the amount of money spent by industry, government, and households to protect the environment or manage natural resources;
â€¢ Natural resource asset accounts that measure quantities of natural resources such as land, fish, forest, water, and minerals; and
â€¢ Accounts of the non-market flow and environmentally adjusted aggregates to show how non-market items are valued and adjusted for natural resource depletion and degradation.
The Handbook of National Accounting satellite accounts do not include social and human capital components. But other efforts to produce satellite accounts are looking at components such as health, education, volunteer activity, and household production.
Calvert-Henderson Quality of Life Indicators
These indicators, the result of an extensive six-year study, span across 12 issue areas: health, human rights, income, infrastructure, education, economy, energy, environment, national security, public safety, recreation, and shelter. The indicators were developed as a suite rather than as a composite, leaving understanding to the user.
Millennium Development Goals and Indicators
In 2000, leaders of 189 countries signed the UN Millennium Declaration, which recognized eight international goals for augmenting the quality of human life globally. The goals included eradicating extreme hunger and poverty, achieving universal primary education, promoting gender equality and empowering women, reducing child mortality, improving maternal health, combating HIV/AIDS, malaria and other diseases, ensuring environmental sustainability, and developing a global partnership for development. Forty-eight indicators were defined to determine advancement towards these goals.
Barriers to Measuring Real Progress
The barriers to development, implementation and usage of better measures of growth can be broadly categorized as data issues and social issues. The data barriers can be dealt technically. They are common to all indicators including the GDP. The social barriers might be difficult to overcome eventually.
Indicator reliability implies when there is any change in an indicator whether that change clearly reflects actual change in the system it measures. Variation in data quality within and between the indicators is obvious more often than not. Therefore, it would be better to assess and communicate data quality for all the indicators and their component parts instead of drawing a subjective line of satisfactory data quality to incorporate
Timeliness refers to the frequency with which the underlying data is available for measuring any of the indicators. GDP is currently reported annually for all countries of the world. Wherever alternative measures of growth depend on GDP as the underlying data, the timeliness is the same. However, for measures that are not based on GDP but on other data sources such as periodic non-market valuation surveys, the existing infrastructure is inefficient to collect and report the data as frequently.
Data Scope and Scale
Data scope refers to the breadth of the items that are measured. Data scale refers to the level of detail of the data collected and reported. GDP data is reported at the national level for all countries of the world. For measures of growth that use GDP, the data reliability and timeliness remains the same as it is for GDP. However, for the environmental and social data, there is a lack of institutional infrastructure in all the countries of the world.
Because efforts to collect and manage data for alternative measures have kicked off only in the last 20 to 30 years and added to that is the availability of very low funding, the informational infrastructure and expertise for this data is barely sufficient.
The methodology-related barriers involve standardization issues and the values implied by what is actually measured.
Methodology standardization refers to the decisions underlying the creation of an indicator-which item to select, how to measure the items, and which items are required to be combine and when.
Values Embedded in Methodologies
Indicators echo societal choices, values, and goals. We compute what we think is crucial and the indicators that we select implicitly describe our goals. As society changes, what is most important also changes and indicators should change to reflect that.
Social and Institutional Barriers to Better Measures of Progress
"Growth Is Good" psychology
The notion that increasing GDP is the panacea for all the economic problems is the foremost barrier in developing alternative measures of growth. Most reports in the general press associate GDP growth with improvements in human well-being. Business leaders, economists, media, and governments claim that there is no better way to measure economic progress than GDP; there is no better way to eradicate poverty other than growing GDP; and there is no way to maintain current levels of employment without growing GDP. As a result, there is a widespread belieft among common man and elsewhere that improving GDP will improve the overall quality of human life.
Disinterest on the political front
Political leadership on the concern is also lacking due to two major reasons. One is the lack of interest and awareness of the public and the other is of the apparent danger to the political leadership as new indicators would bear naked the fact that past and current policies are source of all the problems.
Vested interest in maintaining the status quo
There are also organizations and institutions with a vested interest in maintaining the status quo-this includes industries and businesses whose financial success depends on continually increasing economic activity as well as those institutions that are responsible for collecting, managing, and reporting on the current indicators.
Moving Forward: Adopting Better Measures of Global Progress
Consent to come out of GDP
It is high time to have consensus on those goals that identify that the current economic system is just a tool for improving well-being and not something to keep increasing just for its own sake. An important ingredient of this step is to recognize that GDP is inherently incapable of measuring progress towards new goals and at the same time to create an open and transparent process for a global engagement for achieving the new goals and how progress towards achieving them will be measured. All the important stakeholders must be engaged and their individual roles must be explicitly defined. How their roles will be estimated so that policies, programs, and plans can be accordingly adjusted to guarantee progress should also be clearly mentioned.
Need to redefine the problem
Adopting new measures of global progress requires a significant change in the global consciousness as to what actually constitutes progress. The attention of the general public is focused on the issues of climate change, rising oil prices, growing inequality, economic uncertainty, financial collapse, and global social unrest. Once we agree that GDP is not the right measure, we need to talk about how the new and improved measures will help move us in the right direction.
Stop quarrelling about the minutiae and endeavor for consent on the big picture
Changing to superior measures of progress faces a big obstacle in the form of continuous argument among the indicator experts on which measure is best or correct to measure economic well-being. The aim is not an academic exercise to find the perfect indicator but an ongoing process to agree on workable solutions. We desperately need to build consensus on new measures.
Use the right indicators for the right task
Given the complexity of the problems confronting humanity, a single indicator will most likely not be sufficient; a comprehensive set of integrated indicators may be most effective at providing a signal as to whether national level policies and programs are moving us in the right direction.
GDP which was once conceived as a positive indicator on the path to a better world: a path where enhanced economic activity would provide employments, income, and necessary amenities to decrease global social conflict and avert WW III, that same economic activity today has created a world awfully different from the one faced by the world leaders who gathered at Bretton Woods in 1944. We are now living in a world overflowing with people and manmade capital, where the importance on growing GDP and economic activity is heading the world back toward the rim of disaster.
As a result of overemphasis put on increasing the material wealth at all costs and due to neglect of real and balanced development, the world financial structure is in catastrophe. The world is badly in need of fresh goals and ways to measure progress towards those goals. There is a call for establishing a global channel of communication and consent on these issues. The time has come now to get on a new round of consensus-building practices that will re-visualize what was institutionalized over the last 65 years. The need is clear for:
New goals with a broader view of interconnectedness among long-term, sustainable economic, social, and ecological well-being
Improved ways to measure progress towards these goals
An invigorated campaign for the recognition of this evolved economic system with new institutions