Yesterday, the Sydney Morning Herald announced it had commissioned the development of an index of national wellbeing that will go beyond GDP as a measure of social progress. For that, they get two thumbs up from me.
Developing new measures of social progress and wellbeing is a crowded field. Ever since the use of GDP was popularised as a way to ‘keep score’ of progress, there have been people trying to develop better ‘social scoring systems’. The United Nations, for example, measures quality of life with the Human Development Index (HDI). Nicholas Gruen, who has been developing what will be called the Herald-Lateral Economics Index of Australia’s Well-being, seems to be expanding on these past endeavours and adding flavor to the index by including a factor to estimate our ‘human capital’, or the stock of knowledge our population has developed.
Gross National Product (GNP) and Gross Domestic Product (GDP) were originally developed by Simon Kuznets, during his depression era commission from the US Department of Commerce to develop a set of ‘national accounts’ to monitor economic activity. In 1937, Kuznets presented his report to the US Congress, containing the original formulation of GDP. The very basic quality of the measure – that it should rise in good times, and fall in bad times – made it immediately politically popular.
However, even Kuznet’s original report warned of its limitations as a measure of progress, wellbeing, and indeed, the total sum of production in the economy. Kuznets wrote:
…national income and gross national product do not measure all the goods and services produced in the nation, since they exclude, by definition, a large volume of services and a substantial volume of commodities produces outside the economic system proper. The great contribution to our stock of utilities made within the family system and by numerous activities of mankind engaged in the ordinary process of life is not included.
To translate, GDP ignores the informal economy and the goods and services we provide for family and friends each day. For example, if I mow my neighbours lawn and she minds my children, but no payments occur, these services go unmeasured. If I start a business of lawn mowing, and pay for formal child care for my children, run by my neighbour, this adds to GDP. But physically we are doing the same tasks and generating the same welfare gains.’
Over the long term I would argue that GDP gains have had an upward bias due to the expansion of the formal economy.
Back to Kuznets:
… estimates of the national product do not necessarily measure adequately the result of economic activity in terms of command over commodities and services. As has been mentioned, the results of economic activity are evaluated at current market prices. These evaluations reflect, among other factors, inequalities in the distribution of income, difference among various types of services with respect to the competitive position of their producers, changes in the effective supply of money, and difference over space or time in the methods of estimating the consumption of durable capital goods.
That is a somewhat longwinded way of saying that the measure is very poor at acknowledging the structure of the economy. If a king kept all his subjects as near slaves, but was coordinated their production efforts well, his kingdom may have a high GDP, and a high GDP per capita (as measured by the market value of the goods produced when traded with other kings). But that wouldn’t be socially desirable.
It was Milton Friedman who promoted the idea that the existence of poor people imposes a negative externality on the wealthy. No one would like to see even stranger starve to death on their street after all. And in fact, rich people impose a negative externality on the poor, through envy and jealousy.
Moreover, recent OECD research shows that a high degree of income inequality stifles GDP growth. Thus, we always need to look at the economy in more detail than can be provided for by GDP.
Kuznets continues:
… even when we consider the part designed as aggregate income payments to individuals, does not represent all the means of purchase that are available to individuals during any given year, The power of individuals to buy in markets depends not only upon the possibility of exploiting other sources, such as assets and credit facilities. This suggests that measures of the national product, in order to be adequate as a gauge of the performance of the economic system even in terms of the market place, must be supplements by a study of wealth and capital structure.
So GDP also ignores, by definition, the role of credit. This is probably a more important consideration at an international political level than GDP itself.
A more recent consideration is concerned with estimating the stock of natural assets in a measure of progress. If we are depleting a fixed stock of non-renewable resources, are we getting richer, or poorer, since future generations do not have that wealth at their disposal.
Renowned economist Sir Partha Dasgupta put it like this:
As long as we rely on GDP and HDI we will continue to paint a misleading picture of economic performance. So successful has this enterprise been that if someone exclaims, ‘Economic growth!’, no one needs to ask, ‘Growth in what?’ — we all know they mean growth in GDP.
If the SMH measure gains popularity, we may see a push towards a government policy evaluation against this metric. French President Sarkosy is now considering redirecting his government to use measures of happiness as a benchmark for progress; much like the quirky Kingdom of Bhutan, whose King Jigme Singye Wangchuck introduced Gross National Happiness as a measure of Bhutan’s progress in the 1970s.
The key shortcoming of any such measure is the requirement to aggregate subjective individual values of non-market conditions. As Arrow’s paradox and related theorems demonstrate, it is impossible to create a measure of social preference from a combined group of different individual preferences. Even if we assume that each individual within a country has the same values and use a subjective survey to make an average measure, then we can’t even compare the result between 2 or more different countries as the measure is subjective to each country. You can assume, but it is still just a plain false assumption that everyone has the same values.
But such broad measures of social progress and quality of life, by incorporating non-market conditions such as crime rates, environmental conditions, inequality, and life expectancy, are hugely valuable inputs to our social and political choices. To whoever pushed to develop this measure – good on you.
UPDATE: Here is the full report on Wellbeing Index methodology
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