Posted by Dimitar Vlahov
It has become increasingly common over the last decade or so to come across reports of various studies comparing standards of living or satisfaction with life across countries, as in this article or this one. Such rankings come in multiple flavors, depending on the concept to be measured and the methodology employed. Some – such as the Human Development Index, the Quality of Life Index, and the Genuine Progress Indicator – rely solely on the crunching of already existing national statistics and data from academic publications. Others tend to utilize direct surveys or a combination of direct surveys and observed data. Examples of the latter type include the Happy Planet Index, the Legatum Prosperity Index, or Bhutan’s Gross National Happiness idea (a fascinating story which I encourage you to google further).
Despite the multitude of such initiatives and approaches, however, the academic community, governments and other policy makers continue to use and cite GDP as the main indicator of economic prosperity. Needless to say, we’re all constantly exposed to news reports on the latest GDP figures, coupled with all-important projections for the next quarter or year.
But is GDP good enough as a measure of overall societal well-being? If not, what’s wrong? The president of France, Mr. Sarkozy, has displayed a lot of interest in researching and answering these questions. In February 2008 he asked renowned economists Joseph Stiglitz, Amartya Sen and Jean-Paul Fitoussi to assemble “The Commission on the Measurement of Economic Performance and Social Progress” (CMEPSP) with a few goals in mind: to point out the limitations of GDP as an indicator of economic performance and social progress; to suggest additional information that could be used to construct better measures of social progress; and to address the feasibility and potential usage of alternative measurement tools. The Commission responded in the fall of 2009 with a publicly-available 291-page report (attached below).
The report points out major weaknesses of GDP as it is compiled and used currently as a measure of societal well-being. GDP does not measure essential components of well-being such as good health, amount of enjoyment extracted out of a given economy’s goods and services, or the state of that economy’s natural environment. More relevant to the theme of this blog, however, is the Commission’s criticism with respect to the compilation of GDP itself, and especially its public-sector contributions.
Government output, the Commission observes, is large in scale and has increased significantly in the last several decades. However, measurements of its value, as well as national-accounts estimates of some private-sector services, are misleading in the following ways:
- Traditionally, the value of government services has been based on inputs used to produce these services (such as the wages and salaries of the number of doctors employed) rather than on the actual outputs produced (such as the number or value of particular medical treatments). Since said government output is assumed to move in tandem with inputs, productivity changes tend to be ignored or misrepresented. Thus, If there is a positive productivity change in the public sector, standard measures would underestimate economic growth and real income, and vice versa. The potential solutions are complicated by the fact that prices don’t exist for many government goods and services.
- When there are no markets for government output, there are no market prices, and valuing such output requires estimates known as “imputations”. The issue of a lack of market value for goods and service extends to the private sector. For example, a key imputation in GDP is the consumption value for the services that home-owners derive from living in their own dwellings. The main issue with such imputations is that the quality of assumed “imputed” values may not be perceived as income-equivalent by people, which would lead to a discrepancy between changes in perceived income and changes in measured income.
- With the help of “imputations”, national accounts approximate the values of some household services that cannot be measured directly; however, many other services are left behind. To stay with the running example, the value derived from living in one’s own dwelling might be included (and it turns out it is usually the only one!), but the values of other household services such as cooking or child care are not. Thus, the overall picture is incomplete, and the final indicator of people’s well-being potentially majorly skewed.
These and many other GDP-formation issues are discussed at length in the full report, and multiple branches of directions for solutions are suggested.
