To begin with, gross domestic product excludes a great deal of production that has economic value. Neither volunteer work nor unpaid domestic services (housework, child rearing, do-it-yourself home improvement) make it into the accounts, and our standard of living, our general level of economic well-being, benefits mightily from both. Nor does it include the huge economic benefit that we get directly, outside of any market, from nature. A mundane example: If you let the sun dry your clothes, the service is free and doesn't show up in our domestic product; if you throw your laundry in the dryer, you burn fossil fuel, increase your carbon footprint, make the economy more unsustainable -- and give G.D.P. a bit of a bump.
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This points to the larger, deeper flaw in using a measurement of national income as an indicator of economic well-being. In summing all economic activity in the economy, gross domestic product makes no distinction between items that are costs and items that are benefits. If you get into a fender-bender and have your car fixed, G.D.P. goes up.
A similarly counterintuitive result comes from other kinds of defensive and remedial spending, like health care, pollution abatement, flood control and costs associated with population growth and increasing urbanization -- including crime prevention, highway construction, water treatment and school expansion. Expenditures on all of these increase gross domestic product, although mostly what we aim to buy isn't an improved standard of living but the restoration or protection of the quality of life we already had.
Yes, Hurricane Katrina is mentioned too. (Although he doesn't mention the broken windows fallacy by name.) So what should we do about this? Fortunately he's got it all figured out.
Common sense tells us that if we want an accurate accounting of change in our level of economic well-being we need to subtract costs from benefits and count all costs, including those of ecosystem services when they are lost to development. These include storm and flood protection, water purification and delivery, maintenance of soil fertility, pollination of plants and regulation of our climate on a global and local scale. (One recent estimate puts the minimum market value of all such natural-capital services at $33 trillion per year.)
Nature has aesthetic and moral value as well; some of us experience awe, wonder and humility in our encounters with it. But we don't have to go so far as to include such subjective intangibles in order to fix the national income accounts. As stressed ecosystems worldwide disappear, it will get easier and easier to assign a nonsubjective valuation to them; and value them we must if we are to keep them at all. No civilization can survive their loss.
Given the fundamental problems with G.D.P. as a leading economic indicator, and our habit of taking it as a measurement of economic welfare, we should drop it altogether. We could keep the actual number, but rename it to make clearer what it represents; let's call it gross domestic transactions. Few people would mistake a measurement of gross transactions for a measurement of general welfare. And the renaming would create room for acceptance of a new measurement, one that more accurately signals changes in the level of economic well-being we enjoy.
Our use of total productivity as our main economic indicator isn't mandated by law, which is why it would be fairly easy for President Obama to convene a panel of economists and other experts to join the Bureau of Economic Analysis in creating a new, more accurate measure. Call it net economic welfare. On the benefit side would go such nonmarket goods as unpaid domestic work and ecosystem services; on the debit side would go defensive and remedial expenditures that don't improve our standard of living, along with the loss of ecosystem services, and the money we spend to try to replace them.
Not as easy as it sounds. Let me speak for just a moment as a consumer of economic data. Measuring what GDP measures is important--even if it is a terrible measure of national welfare. And consistency is paramount. If it becomes a subjective matter of how much value to put on negative transactions, then trust me, those estimates are going to be a moving target, and probably (I am being characteristically charitable here) politically influenced. Measuring economic activity is hard enough just concentrating on the market activity. If we were to include these other things it would be useless for economic research. The only value of his alternative measure would be to make the public feel good about reducing their carbon footprint or guilty for not doing so. Guilt-tripping is not the point of economic statistics, and you know that's where this would end up.
Of course one response is to just teach this and all future generations of university students why GDP is useful for what it says and why it is limited by what it doesn't say. We could engage students in discussion of this topic and make sure that they leave the university able to interpret economic news intelligently. Just a thought.
I always discuss the limitations of GDP in my macro courses, and often I even bring this up as an example of attempts to do what Mr. Zencey suggests. Old news. But it keeps on coming up, so obviously we need to do a better job.
Thoughts?
Within the economic arena, as opposed to general welfare, does an incomplete and possibly inaccurate measurement of GDP lead to misstatements about the economy and misleading research? For example, at beginnings of unemployment increases are there greater proportions of workers who take on non-measured home based jobs like caring full-time for an invalid parent, doing major home repairs, etc. A reconstructed unemployment might be lower than measured, GDP might be higher at early stages of recessions, and it might explain some of the inability of the market to reduce measured unemployment.
If there are problems measuring GDP, then do we know how GDP responds? For example, in Cash for Clunkers, the new car purchases are added to GDP, but the destruction of the older vehicles is not subtracted. If instead we had a trade in program for new energy efficient homes that required destroying the older, less energy efficient home, we would reach a different result about GDP effects. The new home purchase would add to GDP as for cars, but the destruction of the old home would result in a reduction of GDP because imputed rent on homes is included in GDP unlike cars.
We would get different economic multiplier effects, etc. about two very similar programs and draw misleading conclusions unless we recognized the data inconsistency. Given what we know about the problems with GDP and recognizing that there are also hidden problems, do we know how economic research and measurements are biased by the GDP inaccuracies? Have we adopted mistaken policies due to inaccurate data?
"Within the economic arena, as opposed to general welfare, does an incomplete and possibly inaccurate measurement of GDP lead to misstatements about the economy and misleading research?"
Definitely. More to the point, we don't even understand the ways in which we are being misled. (If we did, we could correct them just like we make adjustments for seasonal variations, for example.) One goal of research should be to try to identify these problems. Anyone who takes up that challenge gets my immediate respect as it would be a formidable challenge.
The point about the difference between cars and houses is a good one in this context. Of course it is even more complicated because of depreciation.
"Have we adopted mistaken policies due to inaccurate data?"
Possibly. Although I do believe that obvious problems are probably caught and addressed by the policy wonks who do that sort of thing for a living. Academic economists generally do not do the same sort of detailed work that the policy wonks do, and for that reason we would tend to ignore this problem. That, of course, does not absolve us.
The devil is in the details, and there are many details in the calculation of GDP that are pretty obscure to anyone but BEA statisticians. But maybe we should pay more attention to those details.
Bringing this back to a discussion of national welfare, some of the same points are relevant. However, any quantitative adjustments on this basis are going to be a lot more controversial. But these are the sort of things that academic economists discuss over the lunch table--or at least they should.
I agree that renaming it to reflect what it actually is would be a step forward. What gets measured gets optimised.
The argument that it is too difficult to measure meaningful numbers reminds me of the joke about the drunk looking for his key under a lamppost.
Perhaps a better proxy for welfare could be much simpler - it needed be very good to be be much better than GDP/GDT which is not only inaccurate but perverse.
I agree that renaming it to reflect what it actually measures would be a big step forward and create room in the public mind for a better measure. What gets measured gets optimised.
The argument that it is too difficult to measure more meaningful numbers reminds me of the joke about the drunk looking for his key under a lamppost.
Perhaps a better proxy for public wealth changes could be derived - it needn't be very good to be much, much better than GDP/GDT, which is not only inaccurate but perverse. See your own post on cash for clunkers.
The joke about the drunk looking for his key under the lamppost makes us laugh, but remember why it's funny. It's funny because we can laugh at the stupidity of the drunk, not because there is something wrong with the lamppost.
Statistics are the lamppost. They are what they are. Yes, we can build more and better statistics just like we can build more and better lampposts. Such work is costly but has social value if done right.
The real moral of the story is, don't be like the drunk. Don't fall for the trap of thinking that the only thing of value is under the lamppost. It might be, but it might not be. Only a sober mind would know.
As an economist, one of my frustrations is the way that so many people want to be able to reduce things to one dimension--whatever that dimension might be. To me, that's being like the drunk in the joke.
Claiming that one figure, GDP, or anything else, can fully describe economic welfare is wrong. My mind is capable of dealing with multiple statistics to describe the many dimensions of economic well-being. I can also accept that different people (and populations) might want to improve different dimensions of well-being.
I wouldn't want a discussion of economic welfare to begin and end with GDP alone. But it is where I would want to start.
Ok, plain english please, if the GDP goes up is that good or bad for the Stock markets??
why national income is not sufficient in the measurement of standard of living of the people?
I agree with the opinion the one indicator can't show real economic welfare. There are substitutes to GDP, like GPI (genuine progress indicator) or a Happy Planet Index, but i think they should not be considered as a better option than gdp, they just emphasise on different things.