Don’t dispose of GDP (adjust it)

Gross Domestic Product (GDP) is the king of economic measurement. While economists, analysts and policymakers may rely on more frequent data to get an earlier picture of the state of a country’s economy, GDP has the final say. It is used not only to assess how fast an economy is growing (or contracting), but also to rank economies against each other and measure each nation’s slice of the global economic pie. But while GDP attempts to distill the economy into a single, comparable number, it is not the only way to measure the economy, and it is not a particularly useful measure of wellbeing. Calls to find alternatives to GDP, therefore, are not new. But the context of the Covid-19 pandemic—during which governments around the world chose to shutdown parts of the economy in order to save lives—further highlights that GDP cannot fully encapsulate the goals of a nation. While several alternatives exist already, any true replacement for GDP will still need to measure the state of the economy.

What is and isn’t in GDP

Criticism of the use of GDP as the end-all determinant of a nation’s wellbeing have been around for a long time. In 1968, US Senator Robert Kennedy, speaking about Gross National Product (a related metric to GDP) said, “[GNP] counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage. It counts special locks for our doors and the jails for the people who break them. It counts the destruction of the redwood and the loss of our natural wonder in chaotic sprawl… the gross national product does not allow for the health of our children, the quality of their education or the joy of their play… It measures neither our wit nor our courage, neither our wisdom nor our learning… it measures everything in short, except that which makes life worthwhile.”

Indeed, GDP measures a lot, but not everything. It is the monetary value of all final goods and services produced within a country’s borders over a given period of time (usually on a quarterly and annual basis). The two most common ways to measure it are by counting up everything that is spent in a country and subtracting that which was spent on imported products and adjusting for changes in inventory (expenditure approach), or by counting the value of everything produced and subtracting out the value of intermediate inputs (production approach). This means that not all spending that is counted in GDP is necessarily associated with positive value added for human welfare. For example, GDP sometimes goes up after extreme weather or a natural disaster due to emergency response spending. Spending on wars or other socially controversial sectors will also be included in GDP. 

At the same time, critics often note that GDP leaves a lot out. The exclusion of value added from unpaid household labour or volunteer work is a highly cited example. GDP also cannot account for changes in the quality of products or in convenience to customers. And it doesn’t account for negative externalities of anything that is produced (e.g. pollution, loss of biodiversity, resource depletion, and all the other costs the climate crisis will cause). Finally, GDP is an aggregate figure that doesn’t reflect inequality within a country. Economists do attempt to address some of GDP’s limitations by looking at GDP per capita or adjusting for different costs of living between nations (purchasing power parity GDP), but many shortcomings remain.

Wellbeing vs. Production

These criticisms of GDP all point to the same known (but often overlooked) fact: GDP is not a measure of wellbeing. Yet it is still treated as an ultimate indicator of a country’s success, which can lead to misleading narratives about policy decisions. This has long been the case in debates about climate change, for example. If the world’s measure of economic success accounted for negative externalities, it would be much clearer that there isn’t a strict tradeoff (at least in the aggregate) between the economy and sustainable policy. Now, the Covid-19 crisis provides another important example. Government measures taken to stem the crisis in the first half of 2020 were often framed as a trade-off between the economy and the health of the population. GDP did drop significantly in the quarter when strict lockdowns were imposed (Q1 2020 for China and Q2 2020 for the US and Europe). But the additional deaths that may have occurred without such measures cannot be ignored. In other words, GDP is not the end-all arbitrator of a country’s wellbeing.

Don’t forget the economy

But the ability to assess the health of the economy itself is still crucial. In the above two examples, economic considerations cannot be ignored either. Rising unemployment and wage losses as a result of Covid-19 induced lockdowns have their own enormous social toll. And looking forward, the ecological transition to mitigate climate change will likely impact some countries, sectors and individuals economically harder than others. As such, policymakers need some sense of the state of the economy in order to implement good policy. Businesses also need a way to assess the economy and the current state of the business cycle in order to make sound business decisions. In sum, GDP may not be a substitute for wellbeing, but it is a component of it.

For this reason, alternatives to GDP that don’t measure the state of the economy, may be interesting, complementary indicators, but they cannot fill the same roll. The Kingdom of Bhutan’s Gross National Happiness Index, which was later adopted by the UN, is perhaps the most high-profile of such alternatives. It is based on 9 domains: psychological wellbeing, health, education, time use, cultural diversity and resilience, good governance, community vitality, ecological diversity and resilience, and living standards. An offshoot of this indicator, the annual World Happiness Report (Figure 1), does use GDP to help explain relative happiness, but it relies on subjective survey data to actually compile its ranking. Thus, while happiness indices do reflect important indicators for a country’s success, they do not measure economic developments.

Subtracting externalities

There are, however, many alternative measures to GDP that do reflect on the economy. One such example is the World Economic Forum’s Inclusive Development Index. This index consists of 12 key indicators, including GDP per capita, employment, labor productivity, healthy life expectancy, median household income, the poverty rate, income Gini, wealth Gini, dependency ratio, and the carbon intensity of GDP. While this indicator arguably does a better job than GDP of quantifying the economy in a way that matters to most individuals, it still relies on GDP as an input, arguably only adding to GDP’s primacy. 

The alternative then, would be to reform GDP itself, and indeed there are proposals on how to do so. Researchers Mohan, Thyagarajan and Muller, for example, propose deducting the monetary damage caused by emissions and pollution from GDP to estimate an indicator that takes sustainability into account.¹ Theoretically this type of adjustment could be made for other areas of welfare as well, as long as a monetary cost can be derived (for example the monetary cost of inequality, poor health outcomes, etc.). Such an adjusted GDP figure would better capture a country’s welfare and relative success, and it would still be a useful tool for policymakers and businesses.

^{1. https://voxeu.org/article/growth-sustainability-and-measurement-global-gross-product}