Gross domestic product is the most powerful metric in history – "one of the great inventions of the twentieth century," according to the US Commerce Department. But the utility and persistence of GDP reflect political realities, not economic considerations.
BERLIN – Gross domestic product is the most powerful metric in history. The US Commerce Department calls it “one of the great inventions of the twentieth century.” But its utility and persistence reflect political realities, not economic considerations.
Most of us understand GDP as the measure of a country’s economic output, expressed as a single monetary value. But it’s more than that. GDP, and how fast it is growing, is the universal indicator of development, wellbeing, and geopolitical strength. Positive GDP growth is every government’s goal.
But GDP has well-documented shortcomings. For example, short-term GDP grows as a result of productive activities that pollute or degrade the environment, but not as a result of unpaid housework, childcare, and other obviously valuable activities that it barely accounts for (if at all).
Fundamentally, GDP is a materialistic concept: higher production is the sole imperative; the more goods produced and services rendered, the better. Whether any of this actually makes people better off is a different matter entirely.
Dissatisfaction with the myopia of GDP has led policymakers in recent years to explore alternative, more people-oriented aggregate indicators. But moving beyond GDP has proved difficult, given its history. In fact, the metrics that predate GDP actually were people-oriented, and understanding why this changed may shed some light on GDP’s continuing dominance.
Given GDP’s seeming indispensability today, it may come as a surprise that until the 1930s national governments’ only aggregate statistical measurement of the economy was tax estimates. This all changed on October 29, 1929 – Black Tuesday.
As the Great Depression hit, governments realized that they simply had no information on what was happening to people. In 1931, when the US Congress held hearings on the state of the economy, the testimony it received from corporate and industry leaders was useless.
Congress recognized the need for an aggregate statistical picture of the economy, but it didn’t know how to produce one. It turned to Simon Kuznets, a Soviet émigré economist and future Nobel laureate, who was asked to define and calculate what was then called “national income.”
National income wasn’t a totally new idea – researchers in different countries had made various estimates independently – but it was the first time that policymakers saw fit to use it. As the term suggests, this metric emphasizes income: the money available to citizens at the end of the day. Kuznets’s findings were shocking: Americans had only half of what they had earned before the crisis. For President Franklin Delano Roosevelt’s administration, raising national income and ensuring that people earned more became the top priority.
But when the US entered World War II, the focus shifted. Next to the material production needs of the war effort, how much money people were taking home was no longer a pressing issue. Consequently, policymakers deliberately changed national income to gross national product, which merely showed the total dollar value of goods produced. National income and GNP were numerically identical – overall income generated is, by definition, equal to the value of goods produced. The crucial difference is that GNP doesn’t take into account how income is distributed.
Kuznets argued against making this fundamental change in perspective permanent, and he urged governments to return to focusing on income and its distribution. In wartime, it may be reasonable to concentrate on the production of goods needed to win. But in peacetime, he pointed out, production of goods was just a means to a higher end: the take-home income generated and available to the people.
Kuznets was ignored. Shortly after the war, the US government faced a new set of challenges – reintegrating returning service members, responding to the growing threat from the Soviet Union, and rebuilding a devastated Europe – that it prioritized over individual incomes.
Meanwhile, politicians saw how wartime production had driven massive GNP growth and decided to keep that economic metric growing at any cost. Since the end of WWII, growth in GNP (modified slightly in the 1990s to become GDP) has been seen as the solution to almost every problem.
This kind of growth became a universal goal for those in power because, by focusing on ever-expanding output, it avoids politics. As John Kenneth Galbraith pointed out in his 1958 book The Affluent Society, “… inequality has ceased to preoccupy men’s minds.” Enlarging the pie, the thinking went, meant everyone would get a bigger piece.
This history explains why GDP remains the dominant measure of any national economy, and it poses a challenge for those who believe that a viable alternative exists. Any alternative indicator, and any measurement strategy other than a rise in production, would require politicians to address difficult questions about the public good – and thus risk alienating one constituency or another.
What kind of society do we want to live in? Should wages and incomes be more fairly distributed, especially in light of climate change, a problem that will affect everyone to which a small minority contributes disproportionately?
The political usefulness of GDP, and the narrative that more is better for everyone, will be hard to overcome – even if proven wrong. Until then, it will always be products over people.
GDP Should Be Corrected, Not Replaced
The hazards of relying solely on gross domestic product as a measure of overall economic activity have become obvious over time, especially as corporate profits have outpaced GDP growth in key economies. But none of the flaws in GDP are fatal, and policymakers should focus on fixing them, rather than seeking an entirely new framework.
ZURICH – Respected economists have long pointed out that gross domestic product is an inadequate measure of economic development and social well-being, and thus should not be policymakers’ sole fixation. Yet we have not gotten any closer to finding a feasible alternative to GDP.
One well-known shortcoming of GDP is that it disregards the value of housework, including care for children and elderly family members. More important, assigning a monetary value to such activities would not address a deeper flaw in GDP: its inability to reflect adequately the lived experience of individual members of society. Correcting for housework would inflate GDP, while making no real difference to living standards. And the women who make up a predominant share of people performing housework would continue to be treated as volunteers, rather than as genuine economic contributors.
Another well-known flaw of GDP is that it does not account for value destruction, such as when countries mismanage their human capital by withholding education from certain demographic groups, or by depleting natural resources for immediate economic benefit. All told, GDP tends to measure assets imprecisely, and liabilities not at all.
Still, while no international consensus on an alternative to GDP has emerged, there has been encouraging progress toward a more considered way of thinking about economic activity. In 1972, Yale University economists William Nordhaus and James Tobin proposed a new framework, the “measure of economic welfare” (MEW), to account for sundry unpaid activities. And, more recently, China established a “green development” index, which considers economic performance alongside various environmental factors.
Moreover, public- and private-sector decision-makers now have far more tools for making sophisticated choices than they did in the past. On the investor side, demand for environmental, social, and governance data is rising steeply. And in the public sector, organizations such as the World Bank have adopted metrics other than GDP to assess quality of life, including life expectancy at birth and access to education.
At the same time, the debate around gross national income has been gaining steam. Though it shares fundamental elements with GDP, GNI is more relevant to our globalized age, because it adjusts for income generated by foreign-owned corporations and foreign residents. Accordingly, in a country where foreign corporations own a significant share of manufacturing and other assets, GDP will be inflated, whereas GNI shows only income the country actually retains (see chart).
Ireland is a prominent example of how GNI has been used to correct for distortions in GDP. In 2015, Ireland’s reported GDP increased by an eye-popping 26.3%. As an October 2016 OECD working paper noted, the episode raised serious questions about the “ability of the conceptual accounting framework used to define GDP to adequately reflect economic reality.”
The OECD paper went on to conclude that GDP is not a reliable indicator of a country’s material well-being. In Ireland’s case, its single year of astonishing GDP growth was due to multinational corporations “relocating” certain economic gains – namely, the returns on intellectual property – in their overall accounting. To address the growing disparity between actual economic development and reported GDP, the Irish Central Statistics Office introduced a modified version of GNI known as GNI*) for 2016.
The gap between GDP and GNI will likely close soon in other jurisdictions, too. In a recent working paper, Urooj Khan of Columbia Business School, Suresh Nallareddy of Duke University, and Ethan Rouen of Harvard Business School highlight a misalignment in “the growth in corporate profits and the overall US economy” between 1975 and 2013. They find that, during that period, average corporate-profit growth outpaced GDP growth whenever the domestic corporate-income-tax rate exceeded that of other OECD countries.
In late December, this disconnect was addressed with the passage of the 2017 Tax Cuts and Jobs Act. By lowering the corporate-tax rate to a globally competitive level and granting better terms for repatriating profits, the tax package is expected to shift corporate earnings back to the United States. As a result, the divergence between GDP and GNI will likely close in both the US and Ireland, where many major US corporations have been holding cash.
Looking ahead, I would suggest that policymakers focus on three points. First, as demonstrated above, the relevant stakeholders are already addressing several of the flaws in GDP, which is encouraging. Second, public- and private-sector decision-makers now have a multitude of instruments available for better assessing the social and environmental ramifications of their actions.
And, third, in business one must not let the perfect become the enemy of the good. We have not solved all of the problems associated with GDP, but we have come a long way in reducing many of its distortions. Instead of seeking a new, disruptive framework to replace current data and analytical techniques, we should focus on making thoughtful, incremental changes to the existing system.
NEW YORK – Striving to revive the world economy while simultaneously responding to the global climate crisis has raised a knotty question: are statistics giving us the right “signals” about what to do? In our performance-oriented world, measurement issues have taken on increased importance: what we measure affects what we do.
If we have poor measures, what we strive to do (say, increase GDP) may actually contribute to a worsening of living standards. We may also be confronted with false choices, seeing trade-offs between output and environmental protection that don’t exist. By contrast, a better measure of economic performance might show that steps taken to improve the environment are good for the economy.
Eighteen months ago, French President Nicolas Sarkozy established an international Commission on the Measurement of Economic Performance and Social Progress, owing to his dissatisfaction – and that of many others – with the current state of statistical information about the economy and society. On September 14, the Commission will issue its long-awaited report.
The big question concerns whether GDP provides a good measure of living standards. In many cases, GDP statistics seem to suggest that the economy is doing far better than most citizens’ own perceptions. Moreover, the focus on GDP creates conflicts: political leaders are told to maximize it, but citizens also demand that attention be paid to enhancing security, reducing air, water, and noise pollution, and so forth – all of which might lower GDP growth.
The fact that GDP may be a poor measure of well-being, or even of market activity, has, of course, long been recognized. But changes in society and the economy may have heightened the problems, at the same time that advances in economics and statistical techniques may have provided opportunities to improve our metrics.
For example, while GDP is supposed to measure the value of output of goods and services, in one key sector – government – we typically have no way of doing it, so we often measure the output simply by the inputs. If government spends more – even if inefficiently – output goes up. In the last 60 y ears, the share of government output in GDP has increased from 21.4% to 38.6% in the US, from 27.6% to 52.7% in France, from 34.2% to 47.6% in the United Kingdom, and from 30.4% to 44.0% in Germany. So what was a relatively minor problem has now become a major one.
Likewise, quality improvements – say, better cars rather than just more cars – account for much of the increase in GDP nowadays. But assessing quality improvements is difficult. Health care exemplifies this problem: much of medicine is publicly provided, and much of the advances are in quality.
The same problems in making comparisons over time apply to comparisons across countries. The United States spends more on health care than any other country (both per capita and as a percentage of income), but gets poorer outcomes. Part of the difference between GDP per capita in the US and some European countries may thus be a result of the way we measure things.
Another marked change in most societies is an increase in inequality. This means that there is increasing disparity between average (mean) income and the median income (that of the “typical” person, whose income lies in the middle of the distribution of all incomes). If a few bankers get much richer, average income can go up, even as most individuals’ incomes are declining. So GDP per capita statistics may not reflect what is happening to most citizens.
We use market prices to value goods and services. But now, even those with the most faith in markets question reliance on market prices, as they argue against mark-to-market valuations. The pre-crisis profits of banks – one-third of all corporate profits – appear to have been a mirage.
This realization casts a new light not only on our measures of performance, but also on the inferences we make. Before the crisis, when US growth (using standard GDP measures) seemed so much stronger than that of Europe, many Europeans argued that Europe should adopt US-style capitalism. Of course, anyone who wanted to could have seen American households’ growing indebtedness, which would have gone a long way toward correcting the false impression of success given by the GDP statistic.
Recent methodological advances have enabled us to assess better what contributes to citizens’ sense of well-being, and to gather the data needed to make such assessments on a regular basis. These studies, for instance, verify and quantify what should be obvious: the loss of a job has a greater impact than can be accounted for just by the loss of income. They also demonstrate the importance of social connectedness.
Any good measure of how well we are doing must also take account of sustainability. Just as a firm needs to measure the depreciation of its capital, so, too, our national accounts need to reflect the depletion of natural resources and the degradation of our environment.
Statistical frameworks are intended to summarize what is going on in our complex society in a few easily interpretable numbers. It should have been obvious that one couldn’t reduce everything to a single number, GDP. The report by the Commission on the Measurement of Economic Performance and Social Progress will, one hopes, lead to a better understanding of the uses, and abuses, of that statistic.
The report should also provide guidance for creating a broader set of indicators that more accurately capture both well-being and sustainability; and it should provide impetus for improving the ability of GDP and related statistics to assess the performance of the economy and society. Such reforms will help us direct our efforts (and resources) in ways that lead to improvement in both.
Can We Increase Gross National Happiness?
PRINCETON – The small Himalayan kingdom of Bhutan is known internationally for two things: high visa fees, which reduce the influx of tourists, and its policy of promoting “gross national happiness” instead of economic growth. The two are related: more tourists might boost the economy, but they would damage Bhutan’s environment and culture, and so reduce happiness in the long run.
When I first heard of Bhutan’s goal of maximizing its people’s happiness, I wondered if it really meant anything in practice, or was just another political slogan. Last month, when I was in the capital, Thimphu, to speak at a conference on “Economic Development and Happiness,” organized by Prime Minister Jigme Y. Thinley and co-hosted by Jeffrey Sachs, Director of The Earth Institute at Columbia University and Special Adviser to United Nations Secretary-General Ban Ki-moon, I learned that it is much more than a slogan.
Never before have I been at a conference that was taken so seriously by a national government. I had expected Thinley to open the conference with a formal welcome, and then return to his office. Instead, his address was a thoughtful review of the key issues involved in promoting happiness as a national policy. He then stayed at the conference for the entire two and a half days, and made pertinent contributions to our discussions. At most sessions, several cabinet ministers were also present.
Since ancient times, happiness has been universally seen as a good. Problems arise when we try to agree on a definition of happiness, and to measure it.
One important question is whether we see happiness as the surplus of pleasure over pain experienced over a lifetime, or as the degree to which we are satisfied with our lives. The former approach tries to add up the number of positive moments that people have, and then to subtract the negative ones. If the result is substantially positive, we regard the person’s life as happy; if negative, as unhappy. So, to measure happiness defined in that way, one would have to sample moments of people’s existence randomly, and try to find out whether they are experiencing positive or negative mental states.
A second approach asks people: “How satisfied are you with the way your life has gone so far?” If they say they are satisfied, or very satisfied, they are happy, rather than unhappy. But the question of which of these ways of understanding happiness best captures what we should promote raises fundamental questions of value.
On surveys that use the first approach, countries like Nigeria, Mexico, Brazil, and Puerto Rico do well, which suggests that the answer may have more to do with the national culture than with objective indicators like health, education, and standard of living. When the second approach is taken, it tends to be the richer countries, like Denmark and Switzerland, that come out on top. But it is not clear whether people’s answers to survey questions in different languages and in different cultures really mean the same thing.
We may agree that our goal ought to be promoting happiness, rather than income or gross domestic product, but, if we have no objective measure of happiness, does this make sense? John Maynard Keynes famously said: “I would rather be vaguely right than precisely wrong.” He pointed out that when ideas first come into the world, they are likely to be woolly, and in need of more work to define them sharply. That may be the case with the idea of happiness as the goal of national policy.
Can we learn how to measure happiness? The Center for Bhutan Studies, set up by the Bhutanese government 12 years ago, is currently processing the results of interviews with more than 8,000 Bhutanese. The interviews recorded both subjective factors, such as how satisfied respondents are with their lives, and objective factors, like standard of living, health, and education, as well as participation in culture, community vitality, ecological health, and the balance between work and other activities. It remains to be seen whether such diverse factors correlate well with each other. Trying to reduce them to a single number will require some difficult value judgments.
Bhutan has a Gross National Happiness Commission, chaired by the prime minister, which screens all new policy proposals put forward by government ministries. If a policy is found to be contrary to the goal of promoting gross national happiness, it is sent back to the ministry for reconsideration. Without the Commission’s approval, it cannot go ahead.
One controversial law that did go ahead recently – and that indicates how willing the government is to take tough measures that it believes will maximize overall happiness – is a ban on the sale of tobacco. Bhutanese may bring into the country small quantities of cigarettes or tobacco from India for their own consumption, but not for resale – and they must carry the import-tax receipt with them any time they smoke in public.
Last July, the UN General Assembly passed, without dissent, a Bhutanese-initiated resolution recognizing the pursuit of happiness as a fundamental human goal and noting that this goal is not reflected in GDP. The resolution invited member states to develop additional measures that better capture the goal of happiness. The General Assembly also welcomed an offer from Bhutan to convene a panel discussion on the theme of happiness and well-being during its 66th session, which opens this month.
These discussions are part of a growing international movement to re-orient government policies towards well-being and happiness. We should wish the effort well, and hope that ultimately the goal becomes global, rather than merely national, happiness.