Why we urgently need a real alternative to GDP as an economic measure

As a proxy for economic success and growth, Gross Domestic Product (GDP) is deeply flawed. But there are other measures out there.

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At this late date, it’s almost too easy to spoof the goings-on at the World Economic Forum’s annual winter meeting at Davos. Indeed, the confab of A-Listers and status-anxious wannabees who fly to the glitzy Swiss ski resort (often on private jets) to furrow their (frequently well-curated) brows over issues such as global warming and economic inequality screams out for parody.

But rather than sending up this crowd yet again, I’m writing here to compliment Klaus Schwab, the wealthy founder of the forum, and his confreres. The shallowness and frivolity of its winter meeting notwithstanding, the World Economic Forum organisation does some good work during the rest of the year. The Inclusive Development Index it recently developed is a case in point. This concept is in many ways an improvement over – or at least a very useful supplement to – standard but problematic measures of well-being such as GDP per capita.

Since the 1930s and 1940s, when national income accounting began to develop in the UK and the US, the concepts that developed as part of it, such as GDP (Gross Domestic Product) and GDP per capita, have become widespread as proxies for an economy’s performance. National income accounting was a notable achievement, to be sure, but these measures are at once incomplete and inadequate as measures of human welfare and well-being.

GDP is a monetary measure of the total value of the finished goods and services produced within a country’s borders over a specific period of time. In the US, for example, the Department of Commerce’s Bureau of Economic Analysis estimates GDP on a quarterly and annual basis. GDP can be estimated via three different approaches: aggregating data regarding income, expenditures, or output. However aggregated, the data can be divided by any given economy’s population to derive GDP per capita.

Although GDP and GDP per capita provide vital economic information, for years now, the concepts have come in for criticism from various quarters, as writers such as David Pilling and to a lesser extent Diane Coyle have pointed out. Interestingly, Nobel Prize-winning economist Simon Kuznets, one of the founders of national income accounting, wrote presciently about the limitations of concepts such as GDP early on, particularly about their use as measures of welfare.

Although Kuznets believed that GDP could to a considerable extent capture labour productivity, he also believed, as he put it his pioneering 1934 work National Income 1929-32, that “economic welfare cannot be adequately measured unless the personal distribution of income is known.” He also presciently pointed out that measures of GDP tell us nothing about “the intensity and unpleasantness of effort going into the earning of income.” Unfortunately, his warnings generally went unheeded.

There are other problems with GDP as well. For one thing, GDP only counts formal market transactions, which means that unpaid housework and work in the informal sector are not included in estimates. Moreover, all market expenditures count equally, whether the purchase of a book, a banana, or a burglar alarm, the building of a school, a massage parlour, or a prison. Changes in the quality of goods produced or services rendered are not captured. New investment is added, but neither capital depreciation nor negative externalities such as air pollution, noise and crime are factored in.

Pilling conveys many of these problems well in his 2018 book The Growth Delusion, and does so with literary flair:

If GDP were a person, it would be indifferent, blind even, to morality. It measures production of whatever kind, good or bad. GDP likes pollution, particularly if you have to spend money clearing it up. It likes crime because it is fond of large police forces and repairing broken windows. GDP likes Hurricane Katrina and is quite ok with wars. It likes to measure the buildup to conflict in guns, planes, and warheads, then it likes to count all the effort in reconstructing shattered cities from the smoldering ruins. GDP is good at counting, but a pretty poor judge of quality. It has terrible table manners. For GDP, a dinner setting of three forks does just as well as a knife, fork, and spoon.

Economic sustainability cannot readily be ascertained from GDP numbers either. Nor can the relative satisfaction or happiness of a given population. Most importantly for our purposes here, however, is the fundamental problem raised from the get-go by Kuznets: the degree of inequality in and inclusiveness of a given economy are not ascertainable from figures on GDP or GDP per capita.

Because of the omissions and deficiencies mentioned above, various alternative measures for evaluating and ranking economies have been developed. In the mid-1970s, with many new nation-states emerging from colonialism, a measure emphasizing “basic needs” – infant mortality, literacy, life expectancy, and the like – became popular. This approach was broadened and standardized by UN experts in 1990 with the creation of the Human Development Index, which has continued to evolve since then.

Other more holistic measures of development have also emerged, beginning in 1972 with Bhutan’s espousal of the quirky measure “Gross National Happiness.” But more rigorous measures of happiness and “well-being” developed by economists such as Joseph Stiglitz and Amartya Sen gained a good deal of publicity beginning about a decade ago, inspired in part by promotion from former French president Nicolas Sarkozy.

As concern over social justice, inequality, and disparities has spiked in recent years, social scientists have tried to find more ways to capture the degree to which various economies include or exclude the people living therein. In its 2010 Human Development Report, for example, the UN introduced an Inequality-adjusted Human Development Index, and at Davos in 2017 the World Economic Forum (WEF) followed suit, commissioning the research group that came up with the Inclusive Development Index.

The WEF’s index includes per capita GDP figures, but supplements them with other growth measures, along with a broad array of metrics that attempt to capture the degree to which a given economy’s performance is inclusive, and sustainable and equitable over time. Thus, figures on unemployment and productivity are included, as are figures for median income, inequality, poverty, healthy life expectancy, net savings rates, and public debt. Carbon intensity is measured as well.

The WEF’s 2018 report included figures for current levels as well as five-year trends for 103 nation-states, subdivided into tables for advanced economies and emerging economies. Among the advanced nation-states, Norway came out on top, and eleven of the top 12 performers were located in northern Europe. Australia ranked highest (ninth) among advanced economies in the Asia/Pacific region. The UK placed 21st among advanced economies and the US 23rd. It should be noted, though, that the wealthy island-nation of Singapore was not included in tables for advanced economies because of the paucity of data pertaining to inclusion-related indicators.

European nation-states score well in the “emerging economies” tables as well, taking four of the first five spots: Lithuania, Hungary, Azerbaijan, Latvia, and Poland. None of the so-called BRICS score especially well in the emerging economies grouping: the Russian Federation (19th); China (26th), Brazil (37th), India (62nd), and South Africa (69th). China, not surprisingly, ranked first among emerging economies in GDP growth rate and the rate of growth of labour productivity, but its overall score was pulled down by low marks on measures of social inclusion.

The WEF’s Inclusive Development Index is not the last word on the subject of growth and development, but it at once provides very useful information and helps us better to interpret blunter stand-alone measures such as GDP and GDP per capita. It would be useful in my view to incorporate measures associated with infant mortality and literacy rates, and perhaps some proxies to capture community vitality and/or social capital – but let’s not let the quest for the perfect be the enemy of the good. The WEF’s new index is indeed good, and I for one am looking forward to the next instalment.

Peter A. Coclanis is Albert R. Newsome Distinguished Professor of History and Director of the Global Research Institute at the University of North Carolina-Chapel Hill.