GDP is not the good measure of standards of living

At the time it was conceived, GDP was a useful signpost on the path to a better world: a path where increased economic activity provided jobs, income, and basic amenities to reduce worldwide social conflict and prevent a third world war.

That economic activity has created a world very different from the one faced by the world leaders who convened at Bretton Woods in 1944. We are now living in a world overflowing with people and manmade capital, where the emphasis on growing GDP and economic activity is leading the world back toward the brink of collapse.

The world financial system is in crisis, partly as a result of over emphasis on material growth at all costs and a neglect of real and balanced development. Now, the world is in need of new goals and new ways to measure progress towards those goals. There is a need for a global dialogue and consensus on these issues.

Measuring GDP requires adding up the value of what is produced, net of inputs, across a wide variety of business lines, weighting each according to its importance in the economy. Both the output and the materials (if any) used up in making it have to be adjusted for inflation to arrive at a figure that allows for comparison with what has gone before.

Using GDP as a measure of welfare has well-known problems, which are among the first things macroeconomics principles courses cover.

But the point of the discussions at Davos is that in the digital age, those problems are even deeper. Standard GDP statistics miss many of technology’s benefits, so we need to rethink how we measure the typical person’s well-being.

Who are the reasons why GDP data may give a distorted picture of living standards in a country?

The reasons could be more than those ranked below, but the most important on all this discussion is about how to reflect better the developments and inequalities that have raised nowadays in every country.

Here are some of most important reasons:

1. Regional variations in income and spending: National data can hide regional variations in output, employment and income per head of the population
2. Inequalities in income and wealth: Average (mean) incomes might rise but inequality could grow
3. Leisure and working hours and working conditions: An increase in real GDP might have been achieved at the expense of leisure time if workers are working longer hours or if working conditions have deteriorated
4. Imbalances between consumption and investment: High levels of investment as a share of GDP might be superb for creating extra capacity to produce but at the expense of consumer goods and services for the current generation
5. Changes in life expectancy: Improvements in life expectancy don’t always show through in GDP accounts. Putting a monetary value on the benefits of increased longevity is difficult
6. The value of non-marketed output: Much useful and valuable work is not sold in markets at market prices. The value of the output of people working for charities, self-help groups and of housework might reasonably be added to national income statistics
7. Innovation and the development of new products: New goods and services become available because of invention and innovation that simply would not have been available to the richest person on earth less than fifty years ago. About half of what we spend our money on now was not invented in 1870. Examples include air travel, cars, computers, antibiotics, hip replacements, insulin and many other life-enhancing and life-saving drugs
8. Environmental considerations: Rising output might have been accompanied by an increase in air and noise pollution and other externality effects that have a negative effect on our social welfare
9. Defensive expenditures: Much spending is to protect against an economic or social bad e.g. crime, or spending to clean up the effects of pollution and waste

As a result, GDP statistics won’t capture the benefits we gain from free apps, just as it has difficulties accounting for changes in the quality of goods over time.

How can this be fixed?

Catherine Rampell provides a nice summary of the alternative measures that have been proposed, including

• China’s “Green GDP,” which attempts to adjust for environmental factors;
• the OECD’s “GDP alternatives,” which adjust for leisure;
• the “Index of Sustainable Economic Welfare,” which accounts for both pollution costs and the distribution of income; and
• the “Genuine Progress Indicator,” which “adjusts for factors such as income distribution, adds factors such as the value of household and volunteer work, and subtracts factors such as the costs of crime and pollution.”

Finally, there are more direct measures of well-being such as the Happy Planet Index, Gross National Happiness and National Well-Being Accounts.

How to measure the full impact of technology on our lives?

The problem is that GDP assigns a zero value to goods with a zero price, but those goods aren’t valued at zero and as they become more prominent, we’ll need to find a way of including the benefits they provide in our measures of the standard of living.

But there’s still something to be gained from this work.

When you hear that your standard of living has gone up, ask yourself:

• What has happened to leisure time are you working more or less for the same income?
• How much of technology’s benefits might have been missed?
• How was the additional GDP distributed across the population did it mostly go to the 1 percent?

In the end, everybody don’t care about GDP, but we care about the happiness we receive from the goods and services we consume.