GDP – could it be past its use-by date?

The quarterly release of the nation’s Gross Domestic Product (GDP) figures is an event eagerly awaited by economists and policy-makers.

Judging by the growing column space devoted to the figures in the press, the general public is also more interested in GDP than perhaps was once the case. Indeed, knowledge of the figures is now de rigueur for aspiring political leaders. Those of us with long memories will recall the outrage when a Liberal Leader of the Opposition was unable to recall the precise dollar value of Australia’s GDP – seen at the time as a damning case of economic illiteracy (or perhaps that should be innumeracy).

And today, key aspects of debates about issues such as climate change and the tax and welfare system are more often than not viewed through the lens of what policy change would mean for GDP.

As an economic concept, it is all-pervasive. As a goal of public policy, it is paramount.

GDP is an extraordinary economic concept. Open any introductory text on macroeconomics and you will find a chapter, often the first, explaining its intricacies. One of the first surprises students of macroeconomics encounter is that GDP refers not just to one aspect of the nation’s prosperity, but to three. This is because GDP simultaneously measures the value of a nation’s production, income and expenditure. GDP for economists is akin to the principle for which physicists have been searching for centuries – the overarching, unifying glue that binds everything together.

To understand why GDP can represent three quite distinct concepts is to get to the heart of the debate about its practical usefulness as a guide to national prosperity and wellbeing.

For a productive activity to be counted in GDP, it must involve a good or service that is traded in the market economy (or for which there exists enough similarity to a marketed commodity that we can act as if it was traded alongside conventional goods and services). For it is only through trade and exchange that commodities are priced, and it is the price of a commodity that allows it to be counted towards the nation’s GDP.

Through market exchange, commodities create income. And it is income that allows expenditure. It is in response to this expenditure that goods and services are produced. Economists like to refer to this as a circular flow.

Note the key point here; without a price being established for an economic commodity, that commodity will not feature in the calculation of GDP. This is why cleaning one’s own home does not contribute to GDP, while paying someone else to perform the same service does. It is why the output produced by a factory is included in GDP but the environmental degradation caused by that factory is not. It is why asking everyone to work longer hours boosts GDP even if it means a dramatic decline in the time available for family life. It is why GDP is, at best, an imperfect guide to the true prosperity of a nation and the wellbeing of its citizens.

Identifying deficiencies in GDP is easy although if all one wants is a measure of marketed economic activity, GDP is hard to beat. Deciding what, if anything, to do about GDP’s deficiencies is the problem.

Most economists appeal to pragmatism and caution against trying to build a single all-purpose indicator of the quality of life or prosperity. Leave it up to those who wish to obtain a broader perspective than that provided by GDP to trawl through the enormous range of indicators that do exist and try to make some sense of it all. This, in fact, is what Australia’s own Bureau of Statistics (ABS) does. The Bureau produces a regular summary of Measures of Australia’s Progress (ABS cat. no. 1370.0), providing a range of indicators across three categories: society, the economy and the environment.

It is instructive to consider the indicators that the ABS uses to gauge our progress. These comprise a broad range covering key aspects of people’s health, work, family structure and circumstances, income and housing status. Environmental factors are covered as well, with information on biodiversity, oceans, estuaries and so on. It is easy to get lost in the minutiae of the facts and figures. For example, there were 427 threatened fauna species in 2009, up from 312 in 2000; 6.3 per cent of Australians aged 15 years and older were assaulted in 2008-09; and in 2008-09 the productivity of Australian workers fell 2.7 per cent compared with the previous year. For social science trivia buffs, this is a goldmine.

Yet it is hard to know what to make of all this information. Trends or even sudden changes in GDP have a ready interpretation. When we compare GDP across countries, we know what it is that is being compared. Moreover, we know that GDP is measured in pretty much the same way the world over. Moving to measures of social progress or quality of life, however, makes these sorts of comparisons across time or location difficult. Part of the problem is that the diversity of information in the Measures of Australian Progress acts against its easy use as an all-encompassing measure of our quality of life. While a lot of effort has gone into collecting, processing and ultimately making available the information in the Measures of Australia’s Progress, we are still a long way short of a unified measure that would allow us to reflect in an unambiguous way on the extent to which social progress has been made.

Perhaps an all-encompassing statistic is simply not possible. Given that one’s quality of life is inherently multidimensional, how could this multitude of information be aggregated into something as tangible as GDP? And given its cloak of objectivity, would nations be willing to give up GDP as a primary target for policy even if a more broadly based measure of social progress were available?

Interestingly, one country has already taken the step. The Himalayan nation of Bhutan no longer targets GDP but instead uses a measure of Gross National Happiness (GNH) to guide its public policies. Bhutan’s Home Minister, quoted in the New York Times (October 4, 2005), stated the issue as this: “We have to think of human well being in broader terms. Material wellbeing is only one component. That doesn’t ensure that you’re at peace with your environment and in harmony with each other”.

Policies in Bhutan must be assessed against their implications for happiness, similar to many policies in Western countries that require an environmental impact statement. Following the example set in Bhutan, the move to elevate happiness measures over and above the status of GDP in the eyes of policy-makers is gaining momentum through advocacy groups such as the think-tank New Economics Foundation (http://www.neweconomics.org/). Yet there is some way to go before declaring GDP past its use-by date.

For one thing, GDP, has the advantage of direct measurability. For another, GDP is correlated with a great many of the factors believed to be directly related to happiness and wellbeing. The best example is longevity. Access to education, leisure pursuits and labour-saving devices are also all higher in countries with relatively high GDP.

Conspicuous by its absence in the Measures of Australia’s Progress is detailed information on the overall distribution of income. Relativities appear to matter a great deal to people’s perception of their quality of life as does a related concept, fairness. It is not just the level of GDP that matters but how it is distributed. Without knowing this, measuring a nation’s progress in a way consistent with the aspirations of its own citizens may still be some way off.

Is GDP past its use-by date? Like so many things, without a credible universally accepted alternative, the answer has to be no. Can we augment GDP with other information that would help us better gauge what matters most to people? Almost certainly, yes.