Globally, whenever policy-makers promise to deliver “growth”, they are often exclusively referring to Gross Domestic Product. But is this really the best way to measure economic growth? Economies are complex with their web of internal and external feedback loops. Hence, does GDP accurately reflect all that complexity, or is the indicator too simplistic? Cameron Broome will evaluate the usefulness of GDP as an indicator of development.
In the 1930’s, America was plunged into a deep economic depression as a result of the Wall Street Crash, caused by currency speculation and “margin-buying”. Influenced by the work of John Maynard Keynes, President Roosevelt was keen to adopt expansionary fiscal policies to revive the US economy. However, before designing policy-prescriptions, Roosevelt wanted to improve his understanding of the state of the economy. Only sketchy data such as stock indices and freight car loading was available. Thus, Simon Kuznets and his team developed the first set of national income accounts, akin to what we now refer to as “GDP”.
Gross Domestic Product refers to the sum of the value of goods and services produced within an economy in a given period of time; “real” means the figure has been adjusted for inflation, while “per capita” means the total value has been divided by the population size. GDP is simple, easy to understand and facilitates (historical) comparison between countries.
However, GDP does not take into account the economic effects of environmental degradation. In Kenya in 1963, land cover by forest was 10%. By 2006, this had dropped to 1.7%. Deforestation creates huge amounts of valuable timber; if sold, GDP increases, indicating an increase in “growth”. But Kenya’s economy relies heavily on agricultural exports (e.g. tea and flowers) and eco-tourism. Deforestation increases the risk of soil erosion and desertification, damaging Kenya’s ecological health. Agricultural yields could be thus be reduced leading to a loss of income. Eco-tourism revenues could also be diminished, due to the deterioration of Kenya’s physical environment. Hence, overall, deforestation is likely to have negative economic impact on Kenya (and that is before you even consider the economic losses resulting from global warming, fuelled by deforestation). But GDP suggests deforestation results in a net economic benefit, highlighting the simplicity of the indicator.
Real GDP per capita also refers to an average hypothetical citizen and ignores inequality; GDP may increase but only a limited few may be better off. Income and wealth inequalities matter because they can weaken future economic growth prospects. Politically, inequality can fuel anti-globalization sentiments, as exhibited by Britain’s EU referendum result. Social and political instability of this kind not only makes countries less attractive in terms of foreign direct investment but it can also fuel the resurgence of dangerous economic nationalism. Significantly, low-income households also have a higher “marginal propensity to consume” than higher-income households. After taxation and mandatory spending, low income households have little disposable income left. Overall, they are thus more likely to spend a higher percentage of their income than high income households. Hence, by redistributing wealth from higher income households to lower income households, economic growth is likely to be stronger. Scholars like Stiglitz refer to this as “trickle-up economics”, in contrast to “trickle-down economics” as part of orthodox economic thinking.
The biggest question of all is does uber-consumption really make us happy? It is a remarkable paradox that despite being at an historic global high in terms of technical advancement and technological development, global levels of happiness are low (with high spatial geographical variation). Western societies are often anxiety ridden, burdened by mental health issues. The pursuit of money can reduce leisure time, particularly with family. Illustrating this idea, a recent poll suggests that 65 per cent of employees on zero hours contracts are happy with their work-life balance, compared to 58 per cent of people on regular contracts. Thus, Sweden have introduced a six hour work day to try improve the work-life balance of Swedes. Stressed individuals are likely to be less productive; they are also more likely to be ill (both mentally and physically) leading to greater healthcare costs. Hence, some scholars suggest development indicators should reflect levels of happiness.
Undoubtedly, there will never be a perfect indicator of development. Measuring happiness is difficult and highly subjective. Estimating the economic losses from environmental degradation is also difficult; ecosystems are complex with their web of internal feedbacks. In addition, wealth is often hidden in secretive offshore bank accounts. Hence, attempting to measure all three of the variables discussed in one indicator is an impossible task. Instead, policy-makers should use a range of indicators to measure development, each focused on a particular element of economic activity. GDP is still a useful indicator. But it is far too simplistic to be used on its own, as it offers a very narrow view of a country’s development.
The views expressed in this article are those of the author and do not necessarily represent the views of Development in Action.
Have an opinion on this or another topic? Why not write for our blog? Click here to find out more and get in touch.