| GDP and Wealth: Part 1 |
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| Written by Martin Siesta |
| Monday, 12 January 2009 09:10 |
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There are a number of limitations to this approach. Simon Kuznets, the inventor of the GDP, said in his very first report to the US Congress in 1934, "..the welfare of a nation [can] scarcely be inferred from a measure of national income." What we are seeing in the markets today may be an indication of the limitations of this measurement. GDP is widely used by economists to gauge the health of an economy, as its variations are identified relatively quickly. However, its value as an indicator for the standard of living is considered to be limited. Wikipedia cites many criticisms of how the GDP is used: • Wealth distribution - GDP does not take disparity in incomes between the rich and poor into account. • What is being produced - GDP counts work that produces no net change or that results from repairing harm. For example, rebuilding after a natural disaster or war may produce a considerable amount of economic activity and thus boost GDP. The economic value of health care is another classic example - it may raise GDP if many people are sick and they are receiving expensive treatment, but it is not a desirable situation. • Quality of goods - People may buy cheap, low-durability goods over and over again, or they may buy high-durability goods less often. It is possible that the monetary value of the items sold in the first case is higher than that in the second case, in which case a higher GDP is simply the result of greater inefficiency and waste. (This is not always the case; durable goods are often more difficult to produce than flimsy goods, and consumers have a financial incentive to find the cheapest long-term option. With goods that are undergoing rapid change, such as in fashion or high technology, the short lifespan may increase customer satisfaction by allowing them to have newer products.) • Externalities - GDP ignores externalities such as damage to the environment. GDP even views externalities as positive if work/production is required in response to the externalities. • Sustainability of growth - GDP does not measure the sustainability of growth. A country may achieve a temporarily high GDP by over-exploiting natural resources or by misallocating investments. Oil-rich states can sustain high GDPs without industrializing, but this high level would no longer be sustainable if the oil runs out. Economies experiencing an economic bubble, in housing or stocks for instance, or economies with a low private-saving rate appear to grow faster owing to higher consumption, but in reality, they are mortgaging their futures for present growth. Economic growth at the expense of environmental degradation can end up costing dearly to clean up; GDP does not account for this. On the eve of the 2005 U.N. Summit, The World Bank published a report, Where is the Wealth of Nations?, The report accounted for the actual value of natural resources, including resource depletion and population growth. The results show that net savings per person are negative in the world's most impoverished countries, particularly in sub-Saharan Africa. According to the World Bank publication, current indicators used to guide development decisions - national accounts figures, such as GDP - ignore depletion of resources and damage to the environment. In the Conference Edition of Where is the Wealth of Nations?, the World Bank offers new estimates of total wealth, including produced capital, natural resources and the value of human skills and capabilities. These new estimates show that many of the poorest countries in the world are not on a sustainable path. In its March 13, 2008 issue, The Economist weighed in with "Grossly Distorted Picture," criticizing the widespread focus on GDP-growth. This limited definition has long been the subject of criticism by environmentalists and a few economists. The fact that this esteemed journal of economy and free trade is criticizing GDP-growth signals is significant. The Economist pointed out that a better measure than GDP-growth rates would be to compare GDP per head - a much more tangible sign of progress that takes into account the growth of population. For example, Japan's GDP growth has been about 2.1% over the past five years, while GDP in the USA has grown 2.9%. Comparing the average growth of income per capita between the two countries, a different story emerges: the USA saw a 1.9% increase while Japanese citizens' income grew by 2.1%. This was among the reasons Hazel Henderson, an economist, has urged Japan to shift from GDP growth to quality-of-life indicators (Nikkei Ecology, August 2000). She pointed out that Japan had matured beyond the need for more material growth and could now concentrate on higher-level services and improving quality of life. Japan's average income-per-head also was greater because Japan's population is shrinking while the US population is rising. India has enjoyed rapid GDP-growth, but its population has grown much faster, leaving more people to share that income. The limits of GDP as a scorecard of national progress began appearing at the UN Earth Summit in Rio de Janeiro in 1992, followed by the European Parliament's conference in 1995 on "Taking Nature Into Account." In November 2007, the European Parliament again took up the issue at the urging of the European Commission. EU President José Manuel Barroso of Portugal keynoted the debate before almost 700 parliamentarians and statisticians of sustainability and quality of life. Statisticians themselves also emphasized the need for better measures of national progress, with over 13,000 attending their conference in Istanbul, convened by the OECD (Organization for Economic Co-operation and Development) in June 2007. EU Commissioner of Economic Policy Joaquín Almunia noted that GDP "cannot distinguish between economic activities that have a negative or positive impact on wellbeing. In fact, war and natural disasters may register as an increase in GDP." By March 2008, the US Senate had taken up these critical debates and the plethora of new, broader indicators of health, education and environment. The Senate's Committee on Commerce held its own hearing on "Rethinking GDP as a Measure of National Strength" - a low-key academic exploration on how all of these new measures of overall quality could be used to correct all of the now-recognized errors in GDP. The Economist is correct that the growth of average income per capita is the more realistic indicator. But, they omit another problem with these GDP measures: averaging per capita of growth in incomes masks how that income is distributed. Averaging incomes across the whole population could mean that a country might have a few billionaires while most of its citizens live in poverty. So there is still much work to do and conversations to have. Part 2 of the exploration of the relationship between GDP and Wealth will be available at InsideMoney.org later this week.
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This topic is so important. Thank you for explaining it so clearly. Picking the right benchmark is important so that we do not fall into the error of improper attribution. If GDP is the bogey than growth and efficiency becomes paramount to the exclusion of resiliency and sustainability. |
The gross domestic product (GDP) or gross domestic income (GDI) is one of the measures of national income and output. GDP is defined as the total market value of all final goods and services produced within a country in a given period of time. GDP is often used to define the wealth of a country.
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