Beyond GDP: Exploring the Limitations of GDP as a Measure of Economic Welfare

The main metric has been differences in income or gross domestic product per person. But economists have long known that GDP is an imperfect measure of well-being, counting just the value of goods and services bought and sold in markets. GDP, as currently defined, should retain its stature as a major economic statistic.

The authors did not receive financial support from any firm or person for this article or from any firm or person with a financial or political interest in this article. Neither is currently an officer, director, or board member of any organization with an interest in this article. While this new attention is welcome, economists and others who engage in this conversation do not always start on the same page. Conversations are impeded by a lack of understanding of how the statistics are defined and how they are limited, both in terms of the underlying concept and in terms of how they are calculated given the concept. Activities that result in benefits to others are called positive externalities.

1. It cannot be measured in any precise way, unlike phenomena in the physical world.
2. Moreover, a substantial number of services that women primarily provided in the non-market economy are now part of the market economy that GDP counts.
3. So, improvements in health will not only elevate welfare directly but are also likely to result in higher incomes and future welfare improvements in a virtuous cycle.
4. Getting these new measurements into the mainstream policy debate and reflected in political choices, however, is another matter.
5. GDP growth fueled by industries that do not enhance wellbeing can mislead us into believing that living standards are improving when they may be stagnant or even declining.
6. While GDP remains a crucial tool for economic assessment, there’s a growing consensus that it should not stand alone.
7. A high level of GDP should not be the only goal of macroeconomic policy, or government policy more broadly.

Ever-evolving technology

The environmental price of economic growth is becoming clearer—and higher. This is why economists and statisticians have been working to introduce estimates of natural capital and its rate of loss (World Bank 2016). When they do, it will be clear that sustainable GDP growth (that enables future generations to consume at least as much as people today) is lower than GDP growth recorded over many years. Getting these new measurements into the mainstream policy debate and reflected in political choices, however, is another matter. It is possible to explain the limitation of gdp as welfare. adjust GDP to take account of distribution and other nonmarket aspects of economic welfare. Dale Jorgenson of Harvard University proposes combining distributional information from household surveys with the national accounts (Jorgenson, forthcoming).

Short-term measure

But GDP prevailed because the demands of wartime called for a measure of total activity. But coming up with a better gauge of welfare is easier said than done. GDP includes production that is exchanged in the market, but it does not cover production that is not exchanged in the market. For example, hiring someone to mow your lawn or clean your house is part of GDP, but doing these tasks yourself is not part of GDP.

However, this research has not been extended to the far wider range of goods and services affected by digital transformation, and there are some conceptual questions that need to be resolved. For example, is a streamed music service equivalent to a digital download or buying compact discs, or is it a new good? In other words, is the consumer buying a specific format or simply the ability to listen to music? If the former, ideally there would need to be a quality-adjusted music price index. In principle, price indices calculate what people have to pay to attain the same level of “utility” or satisfaction from all their purchases, but putting this calculation into practice is not straightforward.

Limitations of GDP as a welfare measure

It cannot be measured in any precise way, unlike phenomena in the physical world. Economists and statisticians understand, when they stop to think about it, that it is an imperfect measure of economic welfare, with well-known drawbacks. Indeed, early pioneers of national accounting, such as Simon Kuznets and Colin Clark, would have preferred to measure economic welfare.

1. As a group, the top fifth of countries based on income has a combined welfare index almost 7 percent below the US benchmark.
2. A long-standing criticism of reliance on GDP as the measure of economic success is that it excludes much unpaid work by households.
3. In principle, price indices calculate what people have to pay to attain the same level of “utility” or satisfaction from all their purchases, but putting this calculation into practice is not straightforward.
4. Yet in the financial crisis of 2008, the spreads rose due to uncertainty, making the economy appear to be producing more from financial services than it was before.
5. But have you ever stopped to wonder if GDP truly captures the essence of economic welfare?
6. Those who use GDP growth as a measure of economic performance must keep in mind that it has never been a complete measure of economic welfare.

Sure, it tallies up the value of goods and services produced, but does it paint a full picture of a nation’s wellbeing? Let’s dive into the intricacies of GDP and uncover why this economic scoreboard might not be the ultimate measure of prosperity. To return to the shoe example, if the nominal value of shoes rose 10 percent over a year, the nominal GDP for that year would reflect a 10 percent increase in shoe output. If the price of shoes rose 8 percent, then a deflator applied to the shoe price part of GDP would turn that 10 percent nominal increase into a 2 percent real increase (in statistical lingo, the volume of shoes produced rose 2 percent). While GDP focuses on production that is bought and sold in markets, standard of living includes all elements that affect people’s well-being, whether they are bought and sold in the market or not. To illuminate the difference between GDP and standard of living, it is useful to spell out some things that GDP does not cover that are clearly relevant to standard of living.

Welfare Versus GDP: What Makes People Better Off

As more women work for pay, the market for services such as cleaning and child care has grown, and households can and often do switch between performing and buying these services. There is no logical reason not to treat household work like any other work. Gross Domestic Product measures the total value of goods produced and services provided in a country, calculating the net value added by each economic “actor”. So if you produce a car sold for £10,000 but you bought parts and materials worth £8,000, then your contribution to the GDP is £2,000. GDP assesses the size of an economy as well as the incomes it generates and the pace at which it grows (or shrinks) over time. In certain cases, it is not clear that a rise in GDP is even a good thing.

In many cases we just add up the cost of a public good in the GDP calculation yet this is clearly wrong. Why the question To evaluate the limitations of GDP as a welfare measure and explore alternative indices that provide a more comprehensive view of national well-being. While GDP remains a crucial tool for economic assessment, there’s a growing consensus that it should not stand alone.

Not necessarily, since it is also true that the average U.S. worker works several hundred hours more per year more than the average German worker. Calculating GDP does not account for the German worker’s extra vacation weeks. However, modern economies have lost sight of the fact that the standard metric of economic growth, gross domestic product (GDP), merely measures the size of a nation’s economy and doesn’t reflect a nation’s welfare. Yet policymakers and economists often treat GDP, or GDP per capita in some cases, as an all-encompassing unit to signify a nation’s development, combining its economic prosperity and societal well-being. As a result, policies that result in economic growth are seen to be beneficial for society. A high level of GDP should not be the only goal of macroeconomic policy, or government policy more broadly.