It is time to ditch gross domestic product (GDP). Its limitations were recognised as far back as the 1930s. Even the founder of national income accounting, Simon Kuznets, acknowledges it is a tool for measuring economic output rather than a gauge of human wellbeing.
Focusing on GDP (and its sister measure gross national product, or GNP) distorts decision-making and leaves most of us worse off. Raising expectations of GDP growth has only encouraged populist politics. It is essential that we search for better metrics to guide decision-making.
Leading economists, such as Nobel Laureate Joseph Stiglitz, have for years argued that GDP should be dropped as a decision-making tool. GDP growth does not reflect the experiences of the mass of the population. GDP may rise but that can all too easily disguise a sharp increase in incomes for the rich and stagnant incomes for the bulk of the population.
Such an approach leads to scepticism of mainstream politics. Those left behind, not surprisingly, resent hearing talk of a robust recovery when their own incomes are lagging behind. Populist parties are the beneficiaries as mainstream politics loses credibility.
One reason for GDP’s appeal among policymakers is that it is easily measurable. It can therefore be held up as something to be managed. But the recovery from the global financial crisis has revealed that economic growth does not lead to commensurate increases in human welfare.
Robert F Kennedy, the former US attorney general, recognised these limitations as far back as the 1960s. In a prescient speech at the University of Kansas in March 1968, he stated that GNP (then more widely used than GDP) “measures everything – in short, except that which makes life worthwhile”.
He went on to argue that: “It can tell us everything about America except why we are proud that we are Americans. If this is true here at home, so it is true elsewhere in the world.”
The by-products of unrestrained growth include the pollution of the air we breathe, the food we eat and difficulties in finding clean water supplies. The fastest growing megacities in emerging markets, such as Beijing and Delhi, are also the most afflicted by smog. China’s astounding double-digit rates of GDP growth seen in the past are not only difficult to sustain but also entail sacrifices in the quality of life that are increasingly seen as unacceptable within the country.
US Representative Hansen Clarke of Michigan commissioned a report a few years ago seeking to answer the overarching question: how should the US government institute supplemental national accounts that better reflect the welfare of the nation’s people? As the report points out, the US Department of Commerce has described GDP as “the crowning achievement” of 20th century US economic policy.
In the eight decades since the introduction of US national income accounts, GDP has become the official barometer of business cycles, an indispensable measure of government performance, and a leading benchmark of living standards. It has, in other words, become a headline indicator of economic, political, and social progress. Yet GDP was never intended for such a role.
“The use of GDP as the main measure by which governments define their objectives has serious drawbacks”
GDP is a measure of economic activity rather than wealth creation. That means that it can give misleading signals about the health of an economy. An obvious case is where natural resources are depleted. This may give rise to a boost to GDP but could result in a long-term degradation of wealth and hence future income for that country. Incorporating the value of natural resources as well as human capital is a key requirement for assessing the health of a nation.
The World Bank released a fascinating analysis of the changing wealth of nations in 2018. Promoting an analysis of changing wealth both in absolute terms and per head as the World Bank argues for, provides a forward-looking analysis of the health of nations. It also emphasises the need for sustainability in the exploitation of natural resources. For investors it is worth noting that ESG issues underpin many of the conclusions.
For low income countries, not surprisingly, natural capital accounts for the largest component of wealth. But the World Bank argues that getting rich is not about liquidating natural capital to build other assets – natural capital per person in the developed countries was three times that in low income countries. That was even though the share of natural capital for developed countries was only 3%. The report concludes that growth is about more efficient use of natural capital and investing the earnings from it into infrastructure and education. Renewable resources in the form of agriculture and forestry managed sustainably can produce benefits in perpetuity. In contrast, non-renewables such as fossil fuels and minerals can offer a one-off opportunity to finance development.
But, as the report points point out, nearly two-thirds of countries that have remained low-income since 1995 are resource-rich, or fragile and conflict states, or both. What is clear is that resources alone cannot guarantee development. Strong institutions and governance are also needed. Clearly the private sector can play a critical role, particularly if a strong stance is taken on ESG issues.
The use of GDP as the main measure by which governments define their objectives has serious drawbacks. It is not surprising that the negative externalities of GDP growth in the form of pollution, increased social inequalities and the destruction of the natural environment become problems that governments cannot ignore. It is analogous to the shareholder profit maximisation mantra to the exclusion of all other stakeholders in the world that has driven investment institutions and corporate management for the past half century. The tidal wave of interest in incorporating ESG within investment decision-making suggests that a change in philosophy is under way.
So what should replace GDP? One alternative is to focus on happiness rather than material production. Determining how that should best be measured is perhaps the greatest challenge. Measuring and monitoring the impact of economic activity in a country on its natural wealth, and the impact of corporations on the external world, should be seen as being as important as GDP growth.
No single metric is likely to provide an objective measure of happiness. But that does not mean the concept has no value. Finding the most appropriate combination of metrics that politicians can be judged against to create sustainable ‘happy’ societies may not be such a bad idea.
Joseph Mariathasan is director of GIST Advisory and a contributing editor to IPE