Economics: Limitations of GDP, Alternative Indexes

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The gross domestic product is the market value of all final goods and services produced in a country in a given period of time, usually one year. Let's look at some gross domestic product figures from 1998. These numbers measure the real GDP in each of the countries - "real" meaning that the prices used are those from 1996, and the quantities and output used are from 1998. Using these numbers, the United States had a real GDP of about $8.75 trillion in 1998; Japan's real GDP is about $3.8 trillion; France's about $1.4 trillion; and so forth.
Looking at these numbers, you might ask, "Well, what should I make of these? What do they mean?" One thing you can do with these numbers is look at how they change from year to year, and that's the information that's reflected in the growth rate of real GDP. The growth rates are now shown in the table, and as you look them over, you immediately notice that Mexico has a more rapid growth rate than does the United States. Well, what does that tell you? What it really tells you is that Mexico's growth rate is more rapid because Mexico is starting from a smaller base. A given absolute change in output in Mexico translates into a larger percentage change because Mexico's starting point is a smaller real GDP than the GDP in the United States. The given change in the United States translates into a smaller percentage.
Whenever you hear people in the press talking about economic growth, they're usually talking about the change in real GDP, or the percentage growth rate of real GDP. Again though, what do you make of this? When you hear that a country has a rapid growth rate, does that mean that the standard of living of its citizens is improving? Or that Mexicans are getting better off three or four times as fast as are people who live in the United States? Well, this depends on how you interpret the numbers. Let's divide all of the numbers in this column by the populations of the respective countries. That gives us per capita GDP - per capita real GDP in 1998. First thing you notice is that two countries - Switzerland and Japan - have higher per capita real gross domestic products than does the United States. Well, what does this tell us? Would you rather live in Japan, or Switzerland? Is the typical Swiss or Japanese better off than the typical American? This, once again, depends on what the numbers are telling us.
Gross domestic product numbers began to be compiled in the middle of the last century - that is, around the time of World War II - when countries were concerned in measuring their productive capacity; that is, how many machines - how much output - could be brought to bear quickly on the war effort - what was the productive capacity of our economy. Nowadays, however, these numbers are used to represent the ability of goods and services to provide satisfaction to the citizens of an economy. That is, there's usually an implicit link made in the press, when we're talking about these numbers, between the gross domestic product of a country and its standard of living, or its quality of life. But is that an obvious link? Does the gross domestic product really tell us whether people in a country are better off or not?
Let's consider several qualifications to the gross domestic product that will occur to us on reflection. That is, why might the gross domestic product not tell us what we want to know about quality of life in a country? The first problem with the gross domestic product is that there are things that are important to our standard of living that are left out of its number. The first is leisure. Does it matter if the gross domestic product has increased by 20% if we're all working so hard that we're tired and unhappy? That is, one of the things that we value is our vacation time, our time to sit and read a book; and yet leisure time does not show up in any form in the gross domestic product. In fact, on the contrary, you can argue that when gross domestic product increases, it could be because people are working harder, or working longer hours, and that has to be traded off against their lost leisure. So leisure activities don't show up in the number.
A second qualification is environmental quality. We're all concerned about clean water, breathable air, and beautiful landscapes, and yet none of these have market values that show up in the gross domestic product. Therefore, whenever business activity increases the final value of goods and services traded in markets but at the same time diminishes the quality of air and water, we get an increase in the gross domestic product, but perhaps a reduction in our standard of life.
The third question is about goods that are not traded in markets. What about child care? What about production in the household? What about meals put on the table, and redecoration of houses, and things like that, through effort that occurs at home? Well, all of these things make our life better, and yet they don't show up directly in the gross domestic product, because they're not traded in markets.
Another concern is the quality of products. Think about television sets today compared to television sets 40 years ago. Not only are the television sets of today of higher quality and more fun to watch and providing better and clearer pictures, but their prices are also lower, because technological progress has made it easier to produce these goods than back in the 1950s. Television sets are better and less expensive, but this doesn't show up in the gross domestic product, because the gross domestic product doesn't provide explicitly for changes in the quality of products.
Finally, there's this whole question of goods and services that are traded but never show up in official statistics at all, because people are doing them through barter or other informal transactions, but they are trying to avoid paying taxes. The underground economy may be as much as 10% of our gross domestic product - that is, people engaged in informal activity on which taxes are not paid and records are not kept.
So, all considered, there's a lot of activity that's increasing our standard of life that never shows up in official statistics. Therefore, the gross domestic product may understate our true quality of life. On the other hand, it may overstate our true quality of life, because there's a lot of expenditure that gives us no satisfaction. Consider one example - a lock and key. I bought this at the store to lock my locker at the gym so that no one would steal my clothes. Well, did this make me better off? Well, given that there's crime, I'm now protected, so I worry less. But do I want to live in a world where I have to spend a lot of money on locks and keys and security systems and car alarms? Also, because of the stress of modern life, we may spend more money on medication. Also, because of the difficulty of maintaining relationships in a stressful business world, there may be more divorce lawyers. All of these expenditures wind up increasing gross domestic product, but they don't necessarily make us happier. Therefore, our quality of life may be lower even as our total spending increases.
Another concern with per capita real GDP as a measure of quality of life is that it doesn't include other things that make for a good society, such as the distribution of income. If one person has a whole lot of money and everybody else has nothing, you might get a high average - that is, a high per capita GDP - and yet the income distribution is all messed up. One person has everything; and, therefore, there are a lot of people who may be living in misery and poverty. Not only are we concerned about the people who are miserable and poor, but we are also concerned about what kind of society that makes for. Do you want to live in a society where a very small number of people are very rich, while most people are discontent because they can't meet their basic needs? Some measure of the income distribution might be important to a real measure of quality of life, but we don't get any of that from our gross domestic product statistics.
Another concern is infant mortality - how many children are living out of childhood? What about adult literacy? What about life expectancy? All of these measures are important. What about the status of women in this society? What about educational opportunities? All of the things that we think make for a good society, none of them show up in this one-dimensional number that we call gross domestic product. Therefore, there are a lot of efforts now on the part of other groups to conduct measures of quality of life that are taking as their point of departure the gross domestic product, but trying to adjust it for the things that it leaves out, and other things that it should include, or things that should be omitted. One of these is the United Nations Quality of Life Index, which looks at educational opportunities, infant mortality, adult literacy. And what it does, it reorders the countries - the United States slips down in the list, and other countries that might surprise you rise up higher.
Another interesting effort is on the part of a group in San Francisco called Redefining Progress. Redefining Progress has conducted what it calls a Genuine Progress Index. The Genuine Progress Index includes non-market production; that is, it tries to estimate the amount of value that's created from child care and production in the household. It also treats the depletion of natural resources as a reduction in our capital. It tries to take explicit account of the amount of pollution that's created, and it knocks out of the GDP expenditures that are simply trying to clean up messes that we created in the process of production. Other things that it does is to take account of the income distribution and adjust the GDP downwards when the income distribution becomes more skewed. And it considers the drawback of living on foreign assets - are we becoming more dependent on foreigners lending us money.
The Genuine Progress Indicator has actually been declining since the mid-1970s. That is, if you take out the money that we're spending on locks and keys and security systems and divorce lawyers, and if you adjust for the amount of pollution that we're creating, according to redefining progress, our real standard of living has been falling since the mid-1970s.
Well, there you have it - a concern about how to measure quality of life and standard of living. And it turns out that the gross domestic product, which was created to measure your capacity for conducting war, not surprisingly, doesn't always do a great job of telling you whether your people are better off.
Macroeconomic Measurements
Aggregate Output and Income
Limitations of GDP and Alternative Indexes Page [3 of 3]