Wednesday, September 9, 2009

GDP alone not an adequate measure of well-being

Sep 9, 2009

By Joseph E. Stiglitz

Striving to revive the world economy while simultaneously responding to the global climate crisis has raised a knotty question: Are statistics giving us the right 'signals' about what to do? In our performance-oriented world, measurement issues have taken on increased importance: what we measure affects what we do.

If we have poor measures, what we strive to do - say, increase gross domestic product (GDP) - may actually contribute to a worsening of living standards. We may also be confronted with false choices, seeing trade-offs between output and environmental protection that don't exist. By contrast, a better measure of economic performance might show that steps taken to improve the environment are good for the economy.

Eighteen months ago, French President Nicolas Sarkozy established an international Commission on the Measurement of Economic Performance and Social Progress, owing to his dissatisfaction with the current state of statistical information. On Sept 14, the commission will issue its long-awaited report.

The big question concerns whether GDP provides a good measure of living standards. In many cases, GDP statistics seem to suggest that the economy is doing far better than most citizens' own perceptions. Moreover, the focus on GDP creates conflicts: political leaders are told to maximise it, but citizens also demand that attention be paid to enhancing security, reducing air, water and noise pollution, and so forth - all of which might lower GDP growth.

The fact that GDP may be a poor measure of well-being has, of course, long been recognised. But changes in society and the economy may have heightened the problems, at the same time that advances in economics and statistical techniques may have provided opportunities to improve our metrics.

For example, while GDP is supposed to measure the value of output of goods and services, in one key sector - government - we typically have no way of doing it, so we often measure the output simply by the inputs. If government spends more - even if inefficiently - output goes up.

Likewise, quality improvements - say, better cars rather than just more cars - account for much of the increase in GDP nowadays. But assessing quality improvements is difficult. Health care exemplifies this problem: much of medicine is publicly provided, and much of the advances are in quality.

Another marked change in most societies is an increase in inequality. This means that there is increasing disparity between average (mean) income and the median income (that of the 'typical' person, whose income lies in the middle of the distribution of all incomes). If a few bankers get much richer, average income can go up, even as most individuals' incomes are declining. So GDP per capita statistics may not reflect what is happening to most citizens.

We use market prices to value goods and services. But now, even those with the most faith in markets question reliance on market prices, as they argue against mark-to-market valuations. The pre-crisis profits of banks - one-third of all corporate profits - appear to have been a mirage.

This realisation casts a new light not only on our measures of performance, but also on the inferences we make. Before the crisis, when US growth (using standard GDP measures) seemed so much stronger than that of Europe, many Europeans argued that Europe should adopt US-style capitalism. Of course, anyone who wanted to could have seen American households' growing indebtedness, which would have gone a long way toward correcting the false impression of success given by the GDP statistic.

Recent methodological advances have enabled us to assess better what contributes to citizens' sense of well-being, and to gather the data needed to make such assessments on a regular basis. These studies, for instance, verify and quantify what should be obvious: the loss of a job has a greater impact than can be accounted for just by the loss of income. They also demonstrate the importance of social connectedness.

Any good measure of how well we are doing must also take account of sustainability. Just as a firm needs to measure the depreciation of its capital, so, too, national accounts need to reflect the depletion of natural resources and the degradation of the environment.

Statistical frameworks are intended to summarise what is going on in our complex society in a few easily interpretable numbers. It should have been obvious that one couldn't reduce everything to a single number - GDP. The report by the Commission on the Measurement of Economic Performance and Social Progress will, one hopes, lead to a better understanding of the uses, and abuses, of that statistic.

The report should also provide guidance for creating a broader set of indicators that more accurately capture both well-being and sustainability; and it should provide impetus for improving the ability of GDP and related statistics to assess the performance of the economy and society. Such reforms will help us direct our efforts - and resources - in better ways.

The writer, a Nobel laureate in economics, is a professor at Columbia University.



This, and the next article starts to question the role of economics in the future.

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