By Diane Coyle, Managing Director of Enlightenment Economics. Originally published at VoxEU.
The debate about how best to measure economic activity dates back to well before the ‘invention’ of GDP by Richard Stone and others during the Second World War (Stone 1947). The earliest attempt was William Petty’s 1665 estimate of income and expenditure in England and Wales, followed by a variety of other approaches in the 18th and 19th centuries. By the 1930s, partly in response to the demand from policymakers for a better handle on what was happening in the economy, the current approach to national income was taking shape (Coyle 2014).
One of the key questions debated in the 1930s concerned the aim of a single headline indicator of the economy as a whole. Should it measure social welfare, or should it instead just measure the level of activity? Simon Kuznets, often misleadingly described as the father of GDP, argued in favour of the former, but the needs of wartime production settled the debate in favour of an activity measure: GDP.
Economists have always been aware that GDP does not measure welfare, but in practice its growth has come to be widely used as the general litmus test for the health of the economy, both in the economic literature and in the media and public policy debate. So it is not surprising that the tension between measuring welfare and measuring economic growth has re-emerged several times over the decades since World War II. James Tobin and William Nordhaus argued in 1972 that maximising the growth of GNP (more commonly used then) was not a proper objective for economic policy (Nordhaus and Tobin 1972). They proposed a Measure of Economic Welfare in its place.
Subsequently others have suggested a number of alternative measures. One of the best-known is the Index of Sustainable Economic Welfare, proposed by Herman Daly and John Cobb in 1989, and its successor the Genuine Progress Indicator (Daly and Cobb 1989). This subtracts a range of ‘costs’ from GDP, including resource depletion, pollution, and the costs of crime, commuting, and unemployment. By definition, growth in the GPI (or similar indices) is lower than GDP growth.
However, one flaw of the single alternative indicators is that they all omit positive contributions to welfare that are not captured in the GDP statistics either. Despite the use of hedonic price indices to capture some of the quality improvements in a range of goods such as computers or housing, GDP understates – probably to a large degree – the increases in consumer welfare due to quality improvements, new goods, and increased choice. Even apparently trivial innovations such as a novel flavour of breakfast cereal seem to have led to large gains in consumer welfare (Hausman 1996).
A further flaw is that the alternatives to GDP obscure the conceptual distinction between activity and welfare, and all involve an implicit weighting of the different dimensions of welfare. For some purposes – macroeconomic policy for one – an activity indicator is essential. What’s more, the prominent alternative indices do not all rest equally firmly (if at all) on an explicit theory of social welfare; for example, the components of the GPI and the components of the widely-used Human Development Index differ greatly because of the choice of component indicators. Finally, a single welfare indicator obscures unavoidable trade-offs between components. The most obvious trade-off is that between income and what is often called ‘work-life balance’, or in other words the amount of leisure.
For these reasons, dashboards of indicators have much to recommend them as ways of monitoring social welfare, although these are relatively new. One example is the OECD’s Better Life Index. Another is the annual publication Measures of Australia’s Progress. The trade-offs are explicit in a dashboard, and individuals can place their own preferred weights to different sub-indicators in assessing progress.
The other issue obscured by proposed alternatives to GDP is the question of sustainability. Although this is clearly a contributor to social welfare, combining sustainability indicators into a single index along with indicators of current activity and welfare obscures another important set of trade-offs made between present and future consumption. GDP itself has this flaw, making no distinction in the aggregate measure between current consumption and investment. But it is impossible to assess sustainability without making a number of assumptions about the future: what is growth in the interim likely to be? What might be the possible technological innovations? How might people’s behaviour change in response to changing prices, technology and incomes?
Given the uncertainty about these questions, a partial indication of sustainability is given by the current change in net national product, which has the advantage of being derivable from currently available statistics. However, it omits some crucial aspects of sustainability, notably natural assets. We are a long way from having a readily available set of statistics on the changes in national wealth in its widest sense, and it is hard to see how public debate about sustainability can advance without more work in this area.
As a measure of economic activity, which is all it was ever intended to be, GDP is imperfect, but no more so than any single indicator of the whole economy. However, public policy debate about the economy is often focused on GDP growth to the exclusion of questions of social welfare and sustainability. This is unlikely to change until there are equally convenient and regular statistics, so the calls for alternatives to GDP are understandable. Many of the proposed alternatives to date have significant flaws, although dashboards look more promising. Statisticians have a lot of work to do.
Diane Coyle runs the consultancy Enlightenment Economics and has been appointed a Professor of Economics at the University of Manchester.
Stone, R (1947), Definition and Measurement of the National Income and Related Totals.
Coyle, D (2014), GDP: A Brief but Affectionate History, Princeton University Press.
Is Growth Obsolete? by William D Nordhaus & James Tobin in Economic Research: Retrospect and Prospect Vol 5: Economic Growth, Editors William D. Nordhaus and James Tobin, NBER.
Daly, H & J Cobb (1989), For the Common Good, Beacon Press, Boston.
Hausman, J A (1996), “Valuation of New Goods under Perfect and Imperfect Competition“, in Timothy F. Bresnahan and Robert J Gordon (eds.) The Economics of New Goods, University of Chicago Press.
Assuming these costs (resource depletion, pollution, and the costs of crime, commuting, and unemployment) have been subtracted, how does that fact that ‘apparently trivial innovations such as a novel flavour of breakfast cereal seem to have led to large gains in consumer welfare’ lead to GDP understating?
To me, you likely have GDP overstating, if that novel flavor came from not really healthy , artificial ingredients.
You ought to subtract it.
As for this circular claim, ‘(f)or some purposes – macroeconomic policy for one – an activity indicator is essential.’ it’s too late tonight. Maybe tomorrow.
You also could have mentioned debt. It’s perfectly possible to double GDP by simply borrowing the money and spending it in such a way as to ensure it unproductively accrues to the rich. Some people believe this has already happened.
There is no accounting for debt, and there is no accounting for the depletion of environmental assets. It would be relatively straightforward to do so but this would be contrary to the role of GDP as a propadanda tool. GDP can be maximized by bankrupting the world and destroying the economically productive capacity of the environment, and this unhappy goal is likely to be achieved within a few decades.
We don’t even talk about GNP any more.
Because as a nation we should be conserving our natural resources. Whereas the word “domestic” has a connotation implying welfare even tho’ the two are unconnected qualitatively. The GDP is strictly a quantitative thingy. And intentionally so, as per today’s Matt Stoller post on how the economy was sacrificed. Just so, it was necessary to sacrifice the nation. But who’s really quantifying? Coyle above informs us that it wasn’t a well planned choice – to ignore sustainability and social welfare which are the essence of any nation – it just happened that way…. But how did it just happen that way in spite of the awareness by many people as long ago as 1989 (25 years now) that we needed an indicator of “genuine progress” which required looking at sustainability and social welfare. Sounds like 25 years of agnotology to me.
Maybe we need a simpler word or phrase than ‘agnatololgy’ that people like me could understand. A word/phrase that would ‘self-explain’ upon being heard. Like
‘stupidness management’ or ‘applied stupidness engineering’ or ‘spreading the dummgas’.
Measuring economic progress is easy. You simply ask how many hours in the week an average person dependent upon labor as his means of support is compelled to exchange for the opportunity to live (decently?) and reproduce. In today’s society, that number is probably over one hundred, so it takes a male and a female working full time to manage it, and it works best if they live with in-laws and pay no rent. Why people stand for this continues to puzzle me. It just shows the power of media propaganda and public schooling, which combine to destroy every capacity in the population apart from an interest in watching elite athletes compete in games, drinking alcohol, driving fast, and shopping for dreck that falls apart before one has finished paying for it.
Don’t theorize, organize!
Back away from the ledge slowly jgibbs, you have too much to live for.
Particularly the syndication rights
“…an interest in watching elite athletes compete in games, drinking alcohol, driving fast, and shopping for dreck that falls apart before one has finished paying for…”
You have struck upon the ultimate reality tv show premise, call your attorney.
Public schooling indeed:
holey scat i wish this was the first thing i read today – fantastic recap of our time.
Classical economists have been trained not to see the forest for the trees. What we need is not another indicator but a serious discussion about what kind of a society we want to have for ourselves and each other. We need to look at what resources we have in the land and in ourselves to build that society and what kind of population it can support in a sustainable fashion. We need to look at inequality, the nature of work, in brief the economic relationships between us. And we need to look at our political responsibility and participation as citizens in our society. These are the things we should be looking at and measuring our progress against. Everything else is bullshit foisted on us by corrupt elites and the rich.
I think this true too. Various books and records show “GDP” type measures from antiquity, an obvious UK example being the Domesday Book (people treated as robots to redeploy etc.) – what strikes me is the failure to do what Hugh advocates here. The very fact we don’t prevents much public argument on the matter of economics and finance not working, and, of course, what we might replace them with. I’m for Fred Soddy’s ‘a couple of honest adding machines’.
On some accounts, China has ‘built’ a finance system since 2007 bigger than the US managed in 100 years. Even the BBC’s Peston has noticed they have built a lot of ‘infrastructure’. It’s pretty clear we can just build what we need if we have the materiel and personnel. The idea is to build stuff we actually use and finance is supposed to play the major role in this with businesses in a value chain that makes profit faster than costs are accrued. The lovely Jewish guy next door explained this to me long before I suffered Michael Porter. We have cycle lanes all over the UK thanks to daft government clowning (and almost no cyclists), but then we have 57 channels with little to watch too. Competition is supposed to leave the bad ideas behind. One wonders what crops we would have without farming interventions into weed and competitor animal struggles. Failures are a cost of not getting things right first time, but how has the massive cost of financial success come to prevent us trying the right things and evaded weeding out by commercial pressures itself?
GDP is wrapped up with chronic fear about rational planning and is based on deep argument that prevents societies benefiting from past work. The cost of built property, in a sensible system, would be its maintenance, not the finance-related bubble price that inflates GDP. I’m hanging on to my diseased tulip bulbs in the hope of making a killing as our food enters hyper-inflation.
The egelitarian stuff of Gene Roddenberry.
Vanishingly low likelihood in our Society. When have we ever had even a modestly “serious discussion” that resolved anything as a Society? For better or worse our Society has evolved acorriding to the pressure of special interests and I dont see that changing anytime over the horizon
That is the class war talk kleptocrats want to hear. You are already defeated so why bother to organize and change things for the better? Nothing has happened so nothing can happen. Just keep repeating that. And nothing will happen that is until things fall apart or explode. Such thinking is incredibly destructive. We can and have the moral necessity to do better.
I’m not into class warfare, merely offering a personal (cynical?)assessment.
If I were to put on my Taleb hat for a moment, things often behave very stably (good or bad based on perspective) until they dramatically change, or as you say, explode.
For our society to become truly organized around resource stewardship and sustainability, I expect we need a paradigm shift “explosion” in our society –an utter failure to meet minimally sufficient needs of a critical number of people.
File under: Soviet Union
Incidentally, I’ve mentioned it here before, the outgoing CEO of Exxon Lee Raymond, ~5-7(?) years ago speculated during an interview, when asked about the possible ascension of (China) to the place of global dominance in the 21st Century: “Whichever Society most efficiently creates value from it’s resources will be the preeminent Society.” I think an astute notion on his part.
Note he did not say the Society that grows the fastest or converts the most raw material into goods.. Just the Society that is most efficient. Efficiency captures resource management and sustainability.
Now can our Society transcend it’s trivial preoccupations and become wise enough to get there from here without a major reboot?
I’m not sure I like the concept of measuring social well being in the context of GDP. This and behavioral economics presumes “you” (“they”) know what is best for me. It implies morality. I don’t want Harvard et al defining morality.
Re: Sustainability in economic measures
How about “subtracting” use of non-renewable resources from measures of economic “health”? In other words, use of non-renewables, such a mining, logging, and oil drilling would be a separate number – thereby highlighting the size of our efforts here. Another number would show the use of renewables.
A final number would reflect the subtraction of non-renewables and would indicate roughly our economic health.
To actually measure “progress” or “welfare” we need to define our terms at least to some degree. In the past, frenetic activity and turbulence was seen as good thus GDP was a good indicator of welfare. But what of happiness? Shouldn’t that be the highest indicator? There are measurements out there and there is some validity to them.
Under the pressure of failure and criminal disgrace, our self-appointed economic stewards are creeping toward the solution of foreign devils Chávez and Maduro, who simply manage the economy to the performance standards of the CESCR. Western bureaucrats can’t go too far, of course, because they too would get toppled or killed as Bolivarian insurgents. It’s particularly interesting to see OECD reinventing the wheel with its Better Life Index, which displaces the public participation and larger freedom of human rights law with an index for technocratic central planning.
These efforts will go nowhere. The civilized world took care of this when it adopted the Paris Principles and the CESCR, which the US works furiously to suppress and pervert at home. For a good laugh, try using the US government’s National Human Rights Institution to protect your economic rights. You will disappear into a bureaucratic labyrinth of tiny incoherent programs.
How do you know the new flavor of cereal is better or worse than the average cereal that already existed? I can easily argue that the emergence of high-sugar cereals directed at children was a massive quality loss, in that it has led to almost incalculable health deficiencies since them and into the foreseeable future.
Harvard measures happiness too Bangor. At a recent conference two oafs from there told us it was difficult to criticise obscene wealth and bankster bonuses because Wayne Rooney was getting paid such a massive amount and that to be happy we should try to be happier. Apparently the topic was moral philosophy. The people making sense here tend to be social epidemiologists. Wilkinson is a good start. I go for the screaming monkey, pissed because it’s pal is getting grapes when it gets cucumber. I don’t tell my MBAs the screamer will eventually eat the cucumber if you keep it hungry enough. They’d work out a model of starving workers into submission.
I wonder how wise it is to even try to measure such things- it leads one to the illusory sense of control, and all the disastrous consequences that flow from that conceit.
I really think the key is separating the concept of measuring transactional activity from the concept of measuring social welfare. One is objective measurement of exchange of currency, the other is subjective measurement of personal preferences. As long as people don’t claim that the former instructs the latter, that multiple viewpoints aren’t necessary, then information can be communicated well.
They have been separated which is why massive wealth inequality is tolerated and even touted as a positive and billionaires like Bill Gates, and Warren Buffett are looked to as founts of wisdom and role models.
Transactional activity uses money, and money is a call on society’s resources. So money (and such transactional activity) can not be legitimately separated from the social purposes that created and allowed them.