GDP still relevant in assessing well-being

May 08, 2014

ASK: NUS ECONOMISTS

By Suresh De Mel For The Straits Times

How do you assess the well-being of a country?

THERE are many measures and rankings of well-being in circulation. For example, Singapore ranks among the top six economies of the world in terms of income per capita. And according to the 2013 Human Development Report and the 2013 World Happiness Report, both published by the United Nations, Singapore is placed 18th and 30th respectively.

What do these different measures mean? Let us begin with the economic dimension. Within the field of economics, gross domestic product (GDP) has become the standard metric of economic well-being. GDP measures the total value of goods and services produced within a country during a specified period. It also indicates the total income earned within a country's borders.

To compare across countries, GDP is usually expressed in purchasing power parity dollars (to take into account price differences across countries) and in per capita terms (to reflect an average standard of living in a country). The sister measure, gross national product (GNP), is the total value of goods and services produced in a specified period by the nationals of a country. Unlike GDP, which defines production based on geographical location, GNP accounts for production based on ownership of the production inputs.

The twin measures of GDP and GNP arose out of the work of economists Simon Kuznets and Richard Stone, who developed the system of national accounting in the 1930s. These were formally adopted by the International Monetary Fund and the World Bank in the 1940s. Although the initial emphasis was on GNP, the focus shifted to GDP in the 1980s.

GDP and GNP, as measures of success and well-being, have several limitations. They leave out non-market transactions (for example, unpaid household work or child care), do not distinguish between market transactions that increase versus decrease well-being (for instance, building schools versus prisons) and ignore sustainability issues (for example, cutting down forests). The measures do not adequately capture other important aspects of well-being either, such as education, health, the rule of law and freedom.

The most widely accepted alternative measure, to date, is the Human Development Index (HDI) developed by economists Mahbub Ul Haq and Amartya Sen for the UN Development Programme in 1990. The HDI was developed as a composite indicator of human development incorporating education outcomes, health outcomes and income.

Broadly speaking, there is a positive relationship between income levels and HDI scores. However, the relationship is not always clear-cut. There are some countries with low HDI scores despite relatively high income levels (such as Kuwait and Oman), and also countries with similar HDI scores but quite different income levels (like Indonesia and South Africa).

"Green GDP" has been proposed as a measure which would take into account the depletion of natural resources and the cost of environmental degradation. These environmental costs are monetised and deducted from traditional GDP. Economist Joseph Stiglitz has been a key proponent of this concept. China's first green GDP accounting exercise revealed that the economic loss caused by environmental pollution alone (ignoring costs of natural resource depletion and ecological damage) amounted to 511.8 billion yuan or 3 per cent of GDP in 2004.

The search for alternatives continues. The Commission on the Measurement of Economic Performance and Social Progress, led by three economists - Professor Sen, Professor Stiglitz and Professor Jean-Paul Fitoussi - identified eight dimensions of well-being as indicators of social progress, of which material living standards was only one.

Similarly, the Organisation for Economic Cooperation and Development developed the Better Life Index in 2011. It incorporated three dimensions of material living conditions and eight dimensions of quality of life. And the UN Sustainable Development Solutions Network released the first World Happiness Report in 2012, based on subjective measures of well-being from nationally conducted surveys.

So does all this make GDP irrelevant? Not quite. Income is still a vital and necessary aspect of well-being. And what is measurable is more manageable. But it is certainly not all-sufficient.

So the current call to action would be to: first, improve upon the methodologies of alternative measures; and second, consider a variety of measures which capture different aspects of well-being, rather than focusing on a single metric.



The writer is a Visiting Associate Professor in the Department of Economics, National University of Singapore.