Beyond GDP - The Need for New Measures of Progress

Beyond GDP: The Need for New Measures of Progress Abstract This paper is a call for better indicators of human well-being in nations around the world. We critique the inappropriate use of Gross Domestic Product (GDP) as a measure of national well-being, something for which it was never designed. We also question the idea that economic growth is always synonymous with improved well-being. Useful measures of progress and well-being must be measures of the degree to which society’s goals (i.e., to sustainably provide basic human needs for food, shelter, freedom, participation, etc.) are met, rather than measures of the mere volume of marketed economic activity, which is only one means to that end. Various alternatives and complements to GDP are discussed in terms of their motives, objectives, and limitations. Some of these are revised measures of economic activity while others measure changes in community capital—natural, social, human, and built—in an attempt to measure the extent to which development is using up the principle of community capital rather than living off its interest. We conclude that much useful work has been done; many of the alternative indicators have been used successfully in various levels of community planning. But the continued misuse of GDP as a measure of well-being necessitates an immediate, aggressive, and ongoing campaign to change the indicators that decision makers are using to guide policies and evaluate progress. We need indicators that promote truly sustainable development—development that improves the quality of human life while living within the carrying capacity of the supporting ecosystems. We end with a call for consensus on appropriate new measures of progress toward this new social goal. In addition to all those whose work is mentioned in this paper and the two anonymous reviewers, the authors would like to acknowledge Bill Becker and the President’s Climate Action Project (PCAP) since at least one strand of the idea for this paper came out of the PCAP’s National Leadership Summits for a Sustainable America. We would also like to thank the Johnson Foundation for hosting the Summits at its Wingspread facility, the Suzuki Foundation for its encouragement of our work on this paper, and the National Science Foundation for graduate research assistant support. 1 How GDP Measures Economic Progress For more than a half century, the most widely accepted measure of a country’s economic progress has been changes in its Gross Domestic Product (GDP).1 GDP is an estimate of market throughput, adding together the value of all final goods and services that are produced and traded for money within a given period of time. It is typically measured by adding together a nation’s personal consumption expenditures (payments by households for goods and services), government expenditures (public spending on the provision of goods and services, infrastructure, debt payments, etc.), net exports (the value of a country’s exports minus the value of imports), and net capital formation (the increase in value of a nation’s total stock of monetized capital goods). Figure 1 shows a simple representation of the circular flow of income and expenditures within a market economy: individuals, businesses, and governments use capital to create goods and services. In essence, GDP measures the annual volume of this flow (or throughput) in an economy, similar to an electric meter measuring energy use in a building. Figure 1: Traditional View of economic Activity 1. The Gross National Product (GNP) is another frequently mentioned measure of economic progress. The difference between GDP and GNP is the production boundaries used. GDP measures all goods and services produced in the country whether by domestic or foreign companies. It excludes goods and services produced in other countries. GNP measures all production by domestic companies regardless of where in the world that production takes place. Because its boundaries coincide with the boundaries used to measure a country’s population and employment, GDP is more useful for setting domestic policies and evaluating programs. To simplify the discussion in this document, the term GDP will be used throughout this paper to refer to the measure of economic activity although at times in the past, the actual measure used was GNP. GDP is based on estimates and survey data maintained in a country’s System of National Accounts (SNA). These consist of detailed economic census data collected at regular intervals. Annual and quarterly GDP estimates are extrapolated from the census data combined with annual economic survey data such as retail sales, housing starts, and manufacturer shipments (Marcuss and Kane 2007). GDP measures the flow of goods and services produced within the market (goods and services publicly traded for money). Some ‘nonmarket’ production is included in GDP, such as defense spending by the federal government and nonprofit spending on emergency housing and health care. But many important economic activities are entirely excluded from GDP measurements, such as volunteer work, social capital formation within healthy family units, the costs of crime and an increasing prison population, and the depletion of natural resources. Since its creation, economists who are familiar with GDP and SNA methodology have emphasized that GDP is a measure of economic activity, not economic well-being. In 1934, Simon Kuznets, the chief architect of the United States national accounting system, cautioned against equating GDP growth with economic or social well-being. The US Bureau of Economic Analysis’ description of GDP states the purpose of measuring GDP is to answer questions such as “how fast is the economy growing,” “what is the pattern of spending on goods and services,” “what percent of the increase in production is due to inflation,” and “how much of the income produced is being used for consumption as opposed to investment or savings” (McCulla and Smith 2007). To understand how GDP continues to be misused as a scorecard for national well-being, it is important to consider how the current system has evolved. It is also important to recognize that GDP is not inherently bad—it measures what it measures. Rather it is being misused as an indicator of something it doesn’t measure and was never intended to measure. A Brief History of GDP When GDP and SNA methodologies were initially developed in the US and UK2 in the 1930s and 1940s, the world was in the midst of major social and economic upheaval from two global wars and the Great Depression. President Roosevelt’s government used the statistics to justify policies and budgets aimed at bringing the US out of the depression. As it became more likely that the US would become involved in World War II (WWII), there was a concern about whether this would jeopardize the standard of living of US citizens who were just beginning to recover from the depression. GDP estimates were used to show that the economy could provide sufficient supplies for fighting WWII while maintaining adequate production of consumer goods and services (Marcuss and Kane 2007). The use of GDP globally as a measure of economic progress was further strengthened as a result of the Bretton Woods Conference. A key factor in the outbreak of WWII was economic instability in a number of countries caused by unstable currency exchange rates and discriminatory trade practices that discouraged international trade. In 1944, in order to avoid a recurrence of such instability, leaders of the 44 allied nations gathered in Bretton Woods, New Hampshire, to create a process for international cooperation on trade and currency exchange. The intent of the meeting was to “speed economic progress everywhere, aid political stability and foster peace” (IBIBLIO/AIS 1946). International trade would create jobs in all countries. Those jobs would provide income that would allow people everywhere to obtain adequate food, housing, medical care, and other amenities. Improving economic well-being was thus key to creating lasting world peace. Growing the economy was seen as the path to economic well-being. The key outcomes of the meeting were the establishment of the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD—now part of the World Bank). The IMF was created as a forum for collaborative management of international monetary exchange and for stabilization of the exchange rates of countries’ currencies. 2. Work by the US and UK Treasuries in the 1930s and 1940s was the foundation of GDP methodologies. Since then the work has been expanded on by many nations and has been formalized in the System of National Accounts. 1993 documentation available at http://unstats.un.org/unsd/nationalaccount/ The World Bank was established to provide investment funds for infrastructure reconstruction and development in war-torn areas and less developed nations in areas such as Latin America. In theory, the governing structures of these institutions were supposed to provide an equal voice to all member countries. In practice, because of its political and economic strength following WWII, the US dominated both institutions for the first quarter century. As a result, the US dollar, economy, and economic policies became the de facto standards against which other countries were compared. In addition, the work done by the US and UK Treasuries developing GDP methodologies for analyzing economic activity informed much of the discussion at the Bretton Woods meeting. Thus GDP came to be used by the IMF and the World Bank as the primary measure of economic progress in the ensuing 60 years. With the restructuring of these institutions in the 1970s, the US has had a less dominant position within the World Bank and the IMF; however, GDP remains the most widely used measure of economic progress. Economists have warned since its introduction that GDP is a specialized tool, and treating it as an indicator of general well-being is inaccurate and dangerous. However, over the last 70 years economic growth—measured by GDP—has become the sine qua non for economic progress. Per capita GDP is frequently used to compare quality of life in different countries. Governments often use changes in GDP as an indicator of the success of economic and fiscal policies. In the US, GDP is “one of the most comprehensive and closely watched economic statistics: it is used by the White House and Congress to prepare Economists have warned since its the Federal budget, by the Federal introduction that GDP is a specialized Reserve to formulate monetary tool, and treating it as an indicator of policy, by Wall Street as an indicageneral well-being is inaccurate and tor of economic activity, and by dangerous. However, over the last 70 the business community to prepare years economic growth—measured by forecasts of economic performance GDP—has become the sine qua non for that provide the basis for produceconomic progress. tion, investment, and employment planning” (McCulla and Smith 2007,1). Internationally, changes in a country’s GDP are used by both the IMF and the World Bank to guide policies and determine how and which projects are funded around the world. Today GDP in particular and economic growth in general is regularly referred to by leading economists, politicians, top-level decision-makers, and the media as though it represents overall progress. In fact, a report recently released by the World Bank says that nothing besides long-term high rates of GDP growth (specifically, a doubling of GDP each decade) can solve the world’s poverty problem (Commission on Growth and Development 2008). This is like measuring a building’s energy use and saying that the more electricity, the better the quality of life for the building’s inhabitants. Although electricity powers some of life’s amenities, a higher electric bill, as many people are beginning to find out, does not equate to a better life. GDP measures everything “…except that which makes life worthwhile.” “Our Gross National Product…counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage. It counts special locks for our doors and the jails for the people who break them. It counts the destruction of the redwood and the loss of our natural wonder in chaotic sprawl. It counts napalm and counts nuclear warheads and armored cars for the police to fight the riots in our cities..., and the television programs which glorify violence in order to sell toys to our children. Yet the Gross National Product does not allow for the health of our children, the quality of their education or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our wit nor our courage, neither our wisdom nor our learning, neither our compassion nor our devotion to our country, it measures everything, in short, except that which makes life worthwhile. And it can tell us everything about America except why we are proud that we are Americans.” Robert F. Kennedy, speech at the University of Kansas, March 18, 1968 Problems with Using GDP to Measure Quality of Life and Economic Progress In presenting the GDP to Congress in 1934, Simon Kuznets discussed its uses and limits. After presenting an itemized list of the things measured by the GDP, Kuznets noted, “The boundaries of a “nation” in “national” income are still to be defined; and a number of other services, in addition to those listed above, might also be considered a proper part of the national economy’s end-product.” He went on to list “services of housewives and other members of the family,” “relief and charity,” “services of owned durable goods,” “earnings from odd jobs,” and “earnings from illegal pursuits” among others (Kuznets 1934, 3–5). His stated reasons for excluding these things from the GDP are several, but largely boil down to his intent that the GDP be a precise and above all a specialized tool, designed to measure only a narrow segment of society’s activity. This is reflected in his fear that the simplicity of the GDP makes it prone to misuse: “The valuable capacity of the human mind to simplify a complex situation in a compact characterization becomes dangerous when not controlled in terms of definitely stated criteria. With quantitative measurements especially, the definiteness of the result suggests, often misleadingly, a precision and simplicity in the outlines of the object measured. Measurements of national income are subject to this type of illusion and resulting abuse, especially since they deal with matters that are the center of conflict of opposing social groups where the effectiveness of an argument is often contingent upon oversimplification” (Kuznets 1934, 5–6). Because GDP measures only monetary transactions related to the production of goods and services, it is based on an incomplete picture of the system within which the human economy operates. A more complete picture of how the human economic system fits within the social and environmental systems upon which it depends is shown in Figure 2. Figure 2: View of Economy as Part of a Larger System Figure 2 shows that the economy draws benefits from natural, social, and human capital and that the quantity and quality of such capital, in turn, is affected by net investment from the economy. By measuring only marketed economic activity (the inner circle), GDP ignores changes in the natural, social, and human components of community capital on which the community relies for continued existence and well-being. As a result, GDP not only fails to measure key aspects of quality of life; in many ways, it encourages activities that are counter to long-term community well-being. Of particular concern is that GDP measurement encourages the depletion of natural resources faster than they can renew themselves. Another concern is that current economic activity is degrading ecosystems, thereby reducing the services that, until now, have been provided to humans virtually for free. For example, in 1997 it was estimated that the world’s ecosystems provided benefits valued at an average of US$33 trillion per year. This was significantly larger than the total global GDP at the time (Costanza, d’Arge et al. 1997). GDP encourages depletion because clear-cutting a forest for lumber is valued more in GDP terms than the ecosystem services that forest provides if left uncut. These services—including biodiversity habitat, reducing flooding from severe storms, filtration to improve water quality in rivers and lakes, and the sequestration of carbon dioxide and manufacture of oxygen—are not part of the market economy and as a result are not counted in GDP. As Herman Daly, formerly the senior economist at the World Bank, once commented, “the current national accounting system treats the earth as a business in liquidation” (cited in Cobb, Halstead et al. 1995). Another concern that has been raised about GDP as a measure of progress is the ‘threshold effect.’ As GDP increases, overall quality of life often increases up to a point. Beyond this point, increases in GDP are offset by the costs associated with increasing income inequality, loss of leisure time, and natural capital depletion (Max-Neef 1995; Talberth, Cobb et al. 2007). An increasingly large and robust body of research confirms that, beyond a certain threshold, further increases in material well-being have the negative sideeffects of lowering community cohesion, healthy relationships, knowledge, wisdom, a sense of purpose, connection with nature, and other dimensions of human happiness. In fact, a strikingly consistent global trend suggests that as material affluence increases, these critical components of psychic income often decline amidst rising rates of alcoholism, suicide, depression, poor health, crime, divorce, and other social pathologies. In his recent book Deep Economy, author Bill McKibben provides an excellent overview of findings from this emerging field (McKibben 2007). In addition, GDP conceals a growing disparity between the haves and have-nots. An article by Anna Bernasek (The New York Times, June 25, 2006) discusses the links between income disparity and poorer A number of ways of measuring naoverall health in a country, detional-level progress have been procreased worker productivity, and posed, developed, and used to address increased social unrest. “A highly this growing realization that GDP is unequal distribution of income a measure of economic quantity, not can be detrimental to economic economic quality or welfare, let alone welfare by increasing crime, resocial or environmental well-being. ducing worker productivity, and The measures also address the conreducing investment. Moreover, cern that GDP’s emphasis on quantity when growth is concentrated in encourages depletion of social and the wealthiest income brackets natural capital and other policies that it counts less towards improving undermine quality of life for future overall economic welfare because generations. the social benefits of increases in conspicuous consumption by the wealthy are less beneficial than increases in spending by those least well off ” (Talberth, Cobb et al. 2007). Other Ways to Measure Progress A number of ways of measuring national-level progress have been proposed, developed, and used to address this growing realization that GDP is a measure of economic quantity, not economic quality or welfare, let alone social or environmental well-being. The measures also address the concern that GDP’s emphasis on quantity encourages depletion of social and natural capital and other policies that undermine quality of life for future generations. In general, these new measures can be categorized as: (1) indexes that address the issues described above by making ‘corrections’ to existing GDP and SNA accounts; (2) indexes that measure aspects of well-being directly; (3) composite indexes that combine approaches; and (4) indicator suites. Like GDP, all these measures are abstracted indicators showing a view from 30,000 feet, not comprehensive reports on the heart and soul of individual communities. However, some can and are being used to inform local and regional decisions. This is an improvement on the misuse of GDP and economic growth as a proxy for well-being. An ongoing debate within the indicators community is whether GDP should be improved on, replaced by these other approaches, or supplemented. A case can be made for relying on measures that improve GDP because it would be rather straightforward to rearrange the accounting protocols to recognize that some expenditures now counted as beneficial should actually be counted as harmful or defensive in nature. The case for replacing GDP altogether rests on the fact that GDP is not, in fact, a true measure of welfare and was never meant to serve that purpose at all. Advocates for supplementing GDP with these other measures point out that GDP, while a poor measure of welfare, nonetheless “serves crucial and helpful roles in macroeconomic policy” and is “unique in that it combines simplicity, linearity, and universality as well as carries the objectivity of the observable market price as its guiding principle” (Goossens, Mäkipää et al. 2007, 60). Below we consider some of the candidates. This is not a comprehensive list, but simply some of the better-known examples. Indexes that ‘Correct’ GDP Some alternative indicators of economic well-being use the national accounts and GDP as the foundation and then add or subtract quantities in an attempt to address some of the issues discussed above. These include the Index of Sustainable Economic Welfare, the Genuine Progress Indicator, Green GDPs, and Genuine Wealth. Because these measures are based on much of the same economic data as GDP, these measures still have limitations, including: • Lack  of consensus on how to value items that are not regularly reported in monetary terms (e.g., volunteer labor or illegal activities); • Subjectivity  in deciding which expenses are beneficial and therefore should be added to the total and which are detrimental and therefore need to be subtracted (i.e., junk food and home security systems); and • Lack  of consensus on how to quantify the costs of depleting natural resources. However, applications of these new accounting systems provide compelling evidence of a widening gap between GDP and true economic well-being, indicating that, over time, more and more economic activity may be selfcanceling from a welfare perspective (Max-Neef 1995). index of Sustainable economic welfare/ Genuine Progress indicator The Index of Sustainable Economic Welfare (ISEW), later revised and renamed the Genuine Progress Indicator (GPI), is a measure that uses GDP as a foundation. It was first proposed in 1989 by Daly and Cobb in their book For the Common Good as “a way of measuring the economy that will give better guidance than the GNP to those interested in promoting economic welfare” (Daly and Cobb 1989, 401). In developing the ISEW, the authors built on work by Zolotas on the Index of Economic Aspects of Welfare (EAW) and Nordhaus and Tobin’s Measure of Economic Wealth (MEW). In particular Daly and Cobb wanted an index that accounted for both current environmental issues and long-term sustainable use of natural ecosystems and resources. In 1995, a group called Redefining Progress issued a revised methodology and changed the name of the measure to the Genuine Progress Indicator (GPI). While GDP is a measure of current income, GPI is designed to measure the sustainability of that income, essentially measuring whether progress is a result of living off the interest of community capital or spending it down. “Both the GPI and ISEW use the same personal consumption data as GDP but make deductions to account for income inequality and costs of crime, environmental degradation, and loss of leisure and additions to account for the services from consumer durables and public infrastructure as well as the benefits of volunteering and housework. By differentiating between economic activity that diminishes both natural and social capital and activity that enhances such capital, the GPI and its variants are designed to measure sustainable economic welfare rather than economic activity alone” (Talberth, Cobb et al. 2007, emphasis added). Figure 3: Real GDP and GPI Per Capita 1950–2004 Figure 3 shows the trend in GDP and GPI for the US from 1950 to 2004. Despite steady growth in GDP, the US economy, measured by GPI, has actually stagnated since the late 1970s as income inequality, environmental degradation, and the US’s failing international position take their toll on real economic progress (Talberth, Cobb et al. 2007). Green GDP Numerous attempts have been made to develop Green GDPs—GDPs that factor estimates for environmental degradation and depletion of natural resources into the national income accounts to arrive at a single number. Work on a Green GDP for Japan in the 1980s informed the Daly and Cobb efforts on the ISEW. Green GDP calculations also have been developed for countries as diverse as Australia, Canada, China, Costa Rica, Indonesia, Mexico, Papua New Guinea, and the US, although none of these efforts have resulted in regular reporting of the results. The recent efforts by China to measure and report on a Green GDP are described below in the section on barriers. Genuine Savings Genuine Savings (GS) was developed for the World Bank (World Bank 1997) and is defined as “the true level of saving in a country after depreciation of produced capital; investments in human capital (as measured by education expenditures); depletion of minerals, energy, and forests; and damages from local and global air pollutants are taken into account” (Hamilton, Ruta et al. 2006, xv). This includes the value of global damages from carbon emissions. GS measures the built, natural, and intangible capital that is required for human society to exist and to thrive. Intangible wealth is related to the social and human capital of a nation and includes skills and know-how of the labor force, trust and cooperation/collaboration, efficient judicial systems, clear property rights, and effective government. Like the GPI, the national income accounts are the underpinnings of GS. The calculation subtracts amounts for environmental degradation and resource depletion and adds in amounts for investments in human capital. GS attempts to measure sustainable use of resources although it does not take into account equity issues related to consumption. The GS has been calculated for 120 countries. One significant finding detailed in the World Bank’s 2006 report Where is the Wealth of Nations? Measuring Capital for the 21st Century is that increased wealth in a country is primarily the result of an increase in intangible wealth—human capital and the formal and informal institutions that humans create. As shown in Figure 4, 25 percent of the wealth of poor countries is natural capital—this percentage declines as a country gets wealthier because high income countries have a larger percentage of wealth in intangibles (human and social capital). One conclusion from this is that, especially for the poorest nations, increasing economic activity by selling off natural resources actually results in lower welfare in the long run.