There is more to life than the GDP
Not everything that counts can be counted, and not everything that can be counted counts.” This old adage is particularly pertinent as we look ahead to 2020 and beyond. Part of the popular backlash against political and business elites may simply be that people feel the elites are not really focused on what matters to them. But while the single-minded obsession with maximizing market output and profits is being challenged, a more meaningful replacement is not yet in clear view.
Gross domestic product (GDP) has long been the preeminent metric for measuring the size and success of national economies. It is the key target of economic policy, closely watched by politicians, economists, businesses, and investors. But GDP is also deeply—and increasingly—flawed.
Widely regarded as a reliable and objective benchmark, GDP is actually a complex statistic shaped by a history strewn with errors, unresolved controversies, and changing methods and definitions. The core problem is that GDP is not a measure of economic welfare, but rather of output. Its architect in the 1930s, the economist Simon Kuznets, would have preferred to place greater emphasis on welfare. But the US government had tasked him with devising a metric that could guide fiscal policy and shape taxation and spending decisions, so that is what he did.
The result was a statistic focused solely on market-based activities, based on final goods and services to avoid the double-counting of intermediate inputs like raw materials. Yet non-market activities, such as home care and housework, contribute to welfare. Likewise, some market activities harm welfare: think of negative side effects of production such as pollution. Moreover, normative judgements have driven multiple changes in the definition of GDP over the years. Notably, government services, and later financial services, were eventually deemed productive and valuable, and so were added to the definition of GDP. Remarkably, none of this has stopped GDP being widely used as a measure of welfare.
But the problems don’t stop there. Another issue is how to account for inflation, given that rising prices can boost nominal GDP even when the volume of output hasn’t increased. Measuring output has become increasingly tricky as the mix and features of products and services evolves ever more rapidly.
Consider the complications posed by digitalization, embodied in smartphones, which have little in common with the mobile phones of just a dozen years ago. Statisticians have been trying to account for the advent of smartphones (and the relative demise of cameras, calculators, portable music players, and other devices) by adjusting prices to reflect quality changes, but, in the process, they are making a distinction between market prices and value, that is, their contribution to well-being.
A related problem is that more money does not always make people happier. In part, this is because people are concerned about their status and may be content with less money so long as they have more than others. As such, the distribution of GDP, not just its total, also matters for national welfare. Or as one woman put it in response to an economist’s warnings about how Brexit might reduce the UK’s output: “That’s your bloody GDP. Not ours.”
Yet another problem is that GDP does not take account of future prosperity. If the current output comes at the expense of future output, future welfare may be jeopardized.
True, statisticians do calculate Net Domestic Product by accounting for depreciation (wear and tear) of physical assets. But NDP still tells only part of the story. To get a fuller picture of the sustainability of economic activity, one would also need to account for investments in human capital and the adverse effects of resource depletion.
If it is true that “you manage what you measure,” these problems with GDP are particularly troubling, because they are liable to distort government policy and economic decisions. Moreover, if we accept that GDP is not a measure of welfare, we have to ask whose interest it is really serving.
To be sure, GDP at least has an established infrastructure of statistical collection, and its market focus is useful for fiscal decision-making.
Moreover, while GDP can be distorted in various ways, there are economists who doubt that such distortions are growing over time. In their view, GDP may be flawed, but it is still the best indicator of national prosperity that we have.
After all, GDP has maintained its dominant position largely because there are no ready-made alternatives without shortcomings of their own—many involving conceptual questions, such as what an aggregate measure is actually for. Is it to measure household welfare? To capture changes in sustainable national wealth? Other issues are more practical: Do we have the right data? Are we missing forms of capital, such as intangibles and natural endowments?
But whatever the drawbacks, GDP’s obvious flaws—and the public backlash against GDP-obsessed elites—suggest that a suite of alternatives is needed. Ironically, while digitalization has made GDP all the more difficult to measure, it could also facilitate the creation of alternatives. The explosion of data collection—some of it real-time and geolocated—that we are now witnessing could open up many new measurement possibilities.
There is a parallel here to the growing range of indicators for corporate performance. Quarterly and annual profit figures once came in a plain vanilla, standardized form. Now, they come in a wide variety of flavours, and are supplemented by a range of additional indicators of balance-sheet health. Moreover, the Business Roundtable, an organization of American CEOs, announced a seminal shift in August by committing to delivering value not just to shareholders, but also to customers, employees, suppliers, and communities.
This is not the first time that the corporate sector has pledged to look beyond short-term profitability. But as we enter 2020—amid a climate that is deteriorating both literally and figuratively—businesses and politicians alike will be under intense pressure to improve societal welfare.
To succeed, they must first figure out how to count what counts.
Mark Cliffe is chief economist and head of global research of the ING Group.