The Advantages and Disadvantages of GDP as an Indicator of National Well-being

Introduction 

Efforts to measure national wellbeing have a long history and involve the use of indicators such as Gross domestic product (GDP). GDP was introduced in the 1930s to measure the final value of products that are produced in a country or region within a specified period of time (usually yearly or quarterly). It is measured using value-added (production) approach, income method, and expenditure (spending) approach. Therefore, it fluctuates based on the changes in income, production, and consumption. The calculation of GDP using either of these approaches results in a similar value since the three methods are equivalent. Economists use GDP figures to compare different economies worldwide by measuring their relative wealth and prosperity. When a country’s GDP falls, the economy of that nation is said to be on a decline.  On the other hand, countries equate an increase in the gross domestic product with economic progress. GDP estimates the economic performance as well as the social progress of a country.  In the current world, an increase in economic output is directly associated with improved welfare, higher life expectancy and improved standards of living. However, this idea of using GDP to measure national welfare has been under fire in recent decades. Markedly, some economists and analysts claim that there are some shortcomings of using GDP to measure human well-being. Human welfare is determined by several factors that cannot be captured using GDP; they include education and personal safety. Accordingly, economists including the one who introduced GDP have warned that it was not designed to measure national well-being and thus there is a need to use better indicators of human welfare across the globe. Several approaches have been proposed as alternatives to GDP in measuring human welfare; they include gross national happiness (GNH) and capability approach (Fleurbaey 2009, p. 1030). Measures of national well-being are expected to show the overall happiness of individuals in that country. Besides, national well-being is also indicated by prosperity and health. This paper aims to discuss the advantages and shortcomings of using GDP to measure the well-being of a state.

Advantages

GDP Indicates the Overall Standard of Living of a Nation 

A majority of countries across the world measure their living standards based on the level of GDP or GDP per capita. Economic theory has proven that total income is the best indicator of social welfare though under unspecified assumptions (Fleurbaey 2009, 1031). A nation’s standard of living involves anything which contributes to happiness. Research using panel data has shown that the amount of income one earns determines the level of happiness (Clark, Frijters & Shields 2008, p. 97). GDP is considered to be an accurate measure of the national income within a given period of time. When assessing the standard of living in a country, analysts divide GDP with the total population of the nation to get per capita GDP. This measure incorporates many aspects of human well-being including life expectancy, health, and income flow. A high GDP per capita means that the standard of living is high. Besides, research has shown that income raises happiness (Clark, Frijters & Shields 2008, p.98). Countries with low GDP per capita indicate low levels of life satisfaction among their citizens. Furthermore, economists use the equivalent income to assess the living situation within a given population.  Equivalent income is a measure of the total income in a household divided by consumption units. Research has shown that people living in richer economies report higher levels of happiness as compared to those in poor nations (‘Alternative Measures of Well-being’ 2006, p. 140). Additionally, people who earn less than per capita incomes have been found to exhibit low levels of happiness. People’s happiness is affected by the standards of living.  Nonetheless, GDP measures living standards in monetary terms only and thus does not consider non-monetary and certain non-tangible factors. Therefore, in order to provide a comprehensive measure of living standards, there is a need to supplement it with other approaches including human development index (HDI). 

GDP Provides Comparisons across Nations over Time

GDP is a widely accepted measure of economic well-being in the world. Economists use GDP per capita to examine and compare different economies across the globe.  Moreover, each nation measures its GDP using its currency which is later converted to a common currency for international comparisons. For instance, when comparing Brazil’s GDP with that of the United States within a given time, the Brazilian GDP is converted to US dollars.  This provides a better analysis of the economic output of nations across the world. Research has shown that most people migrate from their home countries to those with high GDP per capita. People cannot know where to migrate to unless they use GDP statistics. Again, economists usually convert GDP to a common currency using purchasing power parities (PPP) other than exchange rate in order to eliminate differences which result from different market prices. For example, in poorer economies, goods and services are traded at lower prices as compared the high trading prices in richer countries. The use of the PPP provides GDP and GNI figures that are not affected by the market price levels and this is a reliable way of making international comparisons. Besides, GDP is calculated using the same formula in all countries and hence provides a valid indicator of a nation’s welfare for comparison of standard of living across countries.

Broad Indicator of Economic Development

GDP provides an overall picture of the state of an economy, and this helps policymakers in making important decisions. It provides the sum of all active agents of an economy in a single number (Vecchi 2016, p. 255). This means that economic output from private and public companies, as well as non-profit organizations, are combined to form an aggregate. The aggregate nature of GDP helps in assessing national welfare. Moreover, when economists notice that there is a decline in GDP, they put measures to boost the economy. On the contrary, when there is an economic boom, GDP increases immensely prompting decisions that help in cooling down the overheating economy. According to Victor (2010), continued economic growth can be harmful to the planet, in particular, environment since it relies more on natural resources (p.370). Therefore, measures should be put in place to ensure that economic growth does not impact the globe negatively. Notably, this can be achieved through reducing growth in richer nations. Besides, the use of GDP statistics helps in preventing problems and inflation in a country. For instance, research has shown that economic growth in developed countries contributes to inequality caused by wealth disparities. 

Disadvantages

GDP does not Incorporate Important Factors of Welfare

GDP measures the monetary value of goods and services and thus is not an obvious indicator of well-being. This is because it ignores important determinants of welfare such as health, social relations, and personal safety (Fleurbaey 2009, p. 1029). This has prompted OECD nations to propose alternative indicators that measure social welfare. The alternative approaches include corrected GDP that involves non-market aspects of welfare. Other methods include Gross National Happiness (GNH), and synthetic indicators. For policymakers to effectively improve the overall welfare of people, they must take into account important factors like environmental safety and distribution concerns. Furthermore, GDP does not include leisure time since it does not have a price tag; leisure is essential for the human’s well-being (‘Alternative Measures of Well-being’ 2006, p. 131). For instance, working for few hours enhances one’s welfare. Thus, GDP is a monetary indicator that does not take into account factors that make life worthwhile (Rampell 2008, n.p).  An increase in GDP may indicate national prosperity, but this does not mean there is increased happiness among citizens. Fox (2012) argues that the Easterlin Paradox advocates that a richer economy not necessarily contribute to happiness (p.83). Notably, research has shown that despite the increase in GDP in western countries, the level of happiness has not changed for some time. For instance, between 1973 and 2004, GDP per capita in the US almost doubled without any substantial change in level of happiness (Clark, Frijters & Shields 2008, p. 96). On the other hand, some developing countries have been found to have increasing levels of happiness over time. At present, most nations are using happiness as a measure of the well-being.

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GDP Ignores Externalities

A rise in GDP is an indicator of economic prosperity which means increased use of both renewable and non-renewable resources. The use of these resources results in negative externalities such as pollution that affects people’s health. Water or air pollution can cause health problems and hence affects well-being.  GDP fails to consider environmental conditions as determinants of national welfare. Research has shown that in most OECD countries, the emission of pollutants over the last decade has exceeded the growth of GDP (‘Alternative Measures of Well-being’ 2006, P. 140).  This is attributed to fossil fuels and biomasses used in the industries. The emission of pollutants tends to increase with an increase in GDP. Markedly, the fuel used in the last century increased by 800% (Victor 2010, p. 370). Again, the pollutants released to the environment also increased by a larger percentage. These pollutants, in particular, greenhouse-gas emissions contribute to climate change.  Reviving the global economy goes hand in hand with the world climate crisis as it is the case in the United States. The US had experienced a growth in GDP before it faced this crisis. GDP statistics fail to give a signal on climate change which affects national well-being. A good measure of GDP as an indicator of national well-being should take into account sustainability (Stiglitz 2009, p.2). GDP fails to account for the impact of economic activities on human well-being.  So, the impacts of pollution and environmental degradation tend to be counted as benefits when measuring GDP. Exploitation of natural resources as well as environmental degradation affects people negatively.  Consequently, most nations have put measures to adopt a green economy which would improve national welfare while minimizing environmental risks. Nahman, Mahumani & de Lange (2016) argue that such an economy has low levels of emissions, reduced resource use, and is socially inclusive (p. 216). This is essential in achieving sustainable development.

GDP only includes Market Transactions 

GDP fails to account for socially beneficial activities such as caregiving, volunteer labor, and domestic work. These activities play a vital role in enhancing social welfare. Most people spent part of their time to work for free, for instance, collecting litter in towns. If this kind of work done for free was to be paid, then the GDP would go up. This means volunteer work can lower GDP to some extent.  According to Baumol & Blinder (2009, p. 474), domestic work contributes greatly to a nation’s well-being. So, if such work remains unaccounted for, welfare comparisons across nations using GDP become flawed and difficult. Rampell (2008, n.p) claims that GDP fails to capture the value added when one is caring for his or her children; but that value counts in GDP when a parent hires someone to care for their children. Again, GDP does not take into consideration black market transactions that are not put into national accounts and hence affect national wellbeing negatively (Tucker 2008, p. 226). For instance, money received from the sale of illegal goods is not counted in GDP since it does not capture criminal activities. Moreover, goods which are produced and consumed at home also do not get included in the GDP. This means that a majority of developing countries have wrong figures of GDP since what is consumed is mostly produced at home. A fall in GDP due to unpaid work or home production does not necessarily mean there is a fall in a nation’s wellbeing.

GDP does not take all Aspects of Quality Life into Consideration

GDP alone cannot be a good indicator of the quality of life which is measured using many factors including employment levels, education standards, housing, and life expectancy (Pettinger 2017, n.p).  For example, most countries in Africa have been found to have low GDP, but this does not in any way mean the quality of life is bad. Markedly, between 1970 and 1999, literacy levels in sub-Saharan Africa doubled. Additionally, life expectancy in northern Africa rose from 48 years in 1962 to 69 in 2002 (Press 2011, p.24).  Furthermore, the number of children joining primary education has also gone up. This is a clear indication that GDP does not measure the quality of life. Africa is viewed as a nation with low quality of life because of its low GDP.  Therefore, GDP is a poor indicator of well-being. Life expectancy and education are better indicators of well-being as compared to the economic output. Moreover, GDP statistics can indicate that a nation is doing well when its citizens are lacking basic services. GDP does not show wealth distribution among populations. In most societies, there are increased levels of wealth disparities that are not captured by GDP.  Wealth distribution is a very crucial determinant of national welfare. Again, GDP per capita does not essentially indicate income distribution among the citizens of a country. Thus, GDP fails to identify differences in incomes and cannot provide a true picture of national well-being. Furthermore, when some people are richer within a society, the average income can go up regardless of the fact that some individual’s income might be reducing at the same time (Stiglitz 2009, p.2). Thus, GDP gives a false impression of people’s well-being that can easily be captured using metrics of health and education. 

GDP Ignores Disaster Costs

GDP only measures national output without considering the fact that some economic activities do not increase the wealth of a nation but rather deplete its resources; they include disaster costs (Fox 2012, p.81). GDP cannot distinguish between a disaster and a positive economic indicator. For instance, in the case of a natural catastrophe, the GDP is more likely to increase since it ignores stocks of capital destroyed by calamities (Dopke & Maschke 2016, p. 266). Disasters such as earthquake and hurricanes affect the economy negatively as they cause a lot of destruction of property. Additionally, people also die, and others are left injured and homeless leading to the loss of quality of life. Furthermore, when such tragedies strike, they cause the destruction of buildings and hence builders will be required to rebuild the destroyed structures.  For instance, In 1995, an earthquake struck in the Kobe city in Japan causing damage of more than 250 000 buildings and killed 6500 people while leaving several others homeless (Krueger 2001, n.p). Government spending on disasters increases output in the long run which in turn increase GDP without taking into consideration the economic losses that resulted from the disaster. Another example is when disasters such as oil spills occur; they require cleanup which means the government will spend more to pay those who participate in clearing the oil spills. Such kind of government spending is considered to be part of GDP, and this makes GDP a flawed indicator of national welfare since it overstates how well-off a nation is.

GDP does not Provide Future Directions

It only measures the current situation of an economy without giving directions for the nation’s future growth (Fleurbaey 2009, 1029). For instance, a country can have a high GDP but have a low quality of life which cannot be measured by GDP. So, that nation is more likely to experience a downward trend irrespective of its high GDP.

Conclusion

In conclusion, GDP is a widely accepted indicator of national well-being across the globe. It measures the health of an economy on a quarterly or yearly basis to check how a nation is fairing. Economists apply GDP per capita as a determinant of living standards in a country. This has been essential for international comparisons. Nonetheless, using GDP as a measure of welfare has received criticisms. In fact, even the economist who established GDP does not support its use as a measure of welfare. It was introduced to measure economic output. Welfare economists believe that GDP has several shortcomings as a measure of national well-being. First, it only takes into account market transactions and thus does not capture black market dealings and domestic production. Again, it is not adjusted to capture negative externalities such as pollution costs. GDP does not measure the quality of life (life expectancy, education, wealth disparities) which is the best indicator of welfare. Additionally, it fails to incorporate important factors of welfare such as happiness and this has prompted economists to propose other alternative approaches that can be used to supplement GDP; they include genuine progress indicator (GPI) and gross national happiness. Despite these criticisms, GDP still continues to be a measure that analysts of wellbeing rely on.