Gross domestic product and its deficiencies as an economic indicator have been in the news lately, especially in context of an initiative by French President Nicolas Sarkozy to find a better measure of a nation’s economic well-being. Sarkozy convened an international panel that includes two Nobel laureates, Joseph Stiglitz and Amartya Sen, together with prominent French scholars to find a better measure.
As an economics teacher, I’m glad to see attention being paid. The more the general public learns about such basic indicators, the better. But it is frustrating to see this particular indicator, together with economists as a group, set up as a straw man to be knocked down by journalists and public officials.
There is nothing new about GDP’s limitations that has not been taught systematically in introductory economics courses for 50 years. Moreover, in the past 40 years, many economists have made similar efforts to find a reliable quantitative indicator of well-being, with little enduring success.
GDP is a measure of a nation’s production of goods and services. The carpenter’s hammer I carry in my pickup is a tool for pounding things. GDP is a very imperfect measure of the well-being of a nation’s populace, just as my hammer is a poor tool for removing fence staples. That doesn’t mean there is anything wrong with GDP per se, any more than there is with my hammer. One should not judge either on the basis of how good it is for a task other than the one for which it was designed.
Yes, there are some economists who give GDP greater importance than it deserves, although these are far rarer than many believe. Yes, news stories and political speeches that cite GDP often read more into it than they should. But this is not a fault of the indicator itself. Nor is it easy, even with a panel of Nobel laureates, to find an objective indicator to do all the things at which GDP is alleged to fail. There are some things that are nearly impossible to measure quantitatively, and human well-being is one of them.
GDP measures output, the “market value of all final goods and services produced in an economy in a year.” “Market value” means the tabulation is in money terms and that the value of any item is whatever it actually sells for. “Final goods” means there is no double counting in the production chain. We count a loaf of bread, but we don’t also count the flour, the wheat that was milled for flour, or the seed, fertilizer and diesel fuel used to grow the wheat, and so forth.
As recent news stories point out, tabulated GDP does not take into account the value of natural resources used up or any environmental damages that may occur. It does not take into account nonmarket household production. Paint your own house or care for your own child, and it is not tabulated. Hire a painting contractor or drop your kid off at day care, and it is.
Nor does GDP distinguish between “good” and “bad” output. If we shelter people in new housing or lengthen lives with more medical devices, GDP goes up. But it also will rise if we drink more alcohol and smash more cars. Business for undertakers, orthopedic surgeons and body shops would all go up, but we would not necessarily be better off.
Neither does GDP take into account hours worked versus leisure time. It ignores differences in the values of resources devoted to protective measures like police and military expenditures that seem much more necessary in some societies than in others.
Moreover, as Sarkozy is well aware, the methods of tabulating goods and services provided by government often undervalue them compared to the same goods produced in the private sector. So European nations in which governments provide rail transport and health care, for example, see a smaller value for these services in tabulated GDP than in countries where the same services are provided by private business.
You can find all of these limitations and more explained in economics textbooks from the 1950s. So why haven’t we developed a better indicator of true human well-being?
It isn’t that we haven’t tried. Textbooks I used 25 years ago described an indicator called “Measurable Economic Welfare” developed in 1972 by James Tobin, also a Nobelist, and William Nordhaus. One can find other attempts between then and Sarkozy’s recent initiative.
All these attempts came to little, because it is very hard to reach an agreement on things for which there is no market price and which people in different circumstances value differently. The value of oil or copper kept in the ground for future use may be less in a nation where much of the population lives in poverty than in industrialized societies. Clean air is worth more to people with full bellies than to hungry ones. Defense against national enemies means more to Israel or Taiwan than to Norway or New Zealand.
This does not mean the most recent commission should abandon its task. As Mao Tse Tung said, “let a hundred flowers blossom.” New well-thought-out indicators of a nation’s well-being can never hurt.
It may be more important, however, to educate the media, government leaders and the general public about the limitations of GDP, a very useful indicator, however imperfect. Just because my hammer is not a good pincers does not mean I should toss it away.
© 2009 Edward Lotterman
Chanarambie Consulting, Inc.