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Comparing economies

Wealth measurement 2.0

by Nina V. Michaelis
French President Nicolas Sarkozy asked a commission of well-known experts to develop an alternative to GDP as the measure of national prosperity. The body’s final report provides a solid basis for further international debate on the matter. [ By Nina V. Michaelis ]

Gross domestic product (GDP) measures the value of all goods and services produced in a specific country in a given time. For decades, these data have served as the crucial indicators of the prosperity a society enjoys and of its development. The many shortcomings of this indicator have long been known, however:
– GDP does not account for housework, volunteer work or the informal sector.
– GDP does not take into consideration environmental damages, but it does count remediation efforts. Two examples of such paradoxical effects are that, in statistical terms, exhausting natural resources for production is considered progress, and so is simply repairing environmental damages.
– GDP does not consider income distribution or the quality of investments (for example in education).

Therefore the concept of GDP does not agree with the principle of sustainable development. Sustainability means that future generations will start off in a situation at least as good as the one people experience today.

So far, however, GDP volume and growth are used as the internationally recognised units to measure a country’s development. Governments base their action on GDP data. Many of their strategies fail since they are based on a distorted vision of reality. The global financial and economic crisis we are now going through is merely one example of what can happen when decision-makers rely on inappropriate data without understanding underlying risks.

For decades, experts have been trying to improve the methods for measuring national prosperity. Policymakers are interested in the topic. Germany, for example, developed an environmental accounting system to complement existing statistics. Bhutan caused a stir among experts by designing the concept of Gross National Happiness (GNH), taking into consideration issues that matter to people, such as culture, the environment and traditions. The UNDP’s Human Development Index (HDI) has gained traction at the international level. It measures countries’ standard of life by combining GDP per capita with average life expectancy and literacy rates.

In spite of all such efforts, the GDP approach remains the guiding principle of politics. However, the final report of a commission that French President Nicolas Sarkozy established provides a solid basis for further productive debate. The commission had the task to develop a reliable system to measure well-being of nations. Twenty-two renowned economists and social scientists, among them five Nobel Prize winners, participated in the Commission on the Measurement of Economic Performance and Social Progress (CMEPSP). It was headed by Joseph Stiglitz, Nobel laureate and former chief economist at the World Bank. Other prominent members were Amartya Sen, Jean-Paul Fitoussi, Bina Argarwal, François Bourguignon and Nicholas Stern.

A thorough approach

The commission presented its 285-page long final report in September. All existing approaches and concepts were analysed thoroughly. On that basis, several reasonable proposals were put forward. The following points are among the central recommendations on how to best measure the standard of living of nations.
– Instead of recording the average production per inhabitant, it would be better to analyse what each individual can afford. This proposal boils down to looking at national income along with consumption and real household incomes.
– A move away from a macroeconomic to a household perspective would also make sense because real household incomes often grow at a slower rate than GDP. This is due to taxes, social security contributions, interest payments, international economic relations and other effects.
– In order to make household income an international standard to compare national prosperity, one also needs to consider government services (free education, state-financed or at least partially funded healthcare, unemployment benefits et cetera). Such contributions differ markedly at the global level. For example, in France the government pays a much greater share of such costs than in the United States.
– It is also important to include goods and services derived from self-sufficiency systems. For example, many farmers grow and consume their own food. GDP, however, does not include such data because no money is exchanged. Similarly, GDP does not factor in people who take care of their own children, or their elders without compensation. Such activities obviously have a strong bearing on prosperity, but they do not make a dent in GDP statistics. Therefore, measured by their GDP, especially developing countries look poorer than they really are.
– To properly assess the level of prosperity one must also look into the future and compare assets and liabilities. The balance must include material capital as well as natural, social and human capital.
– How income, consumption and wealth are distributed is also relevant. Averages are not particularly useful because the data of a few exceptionally rich people will increase the average disproportionately. For example if billionaire Bill Gates enters a room, everyone present is suddenly – on average – a multimillionaire. Median values offer better orientation, indicating, for instance, the income of the richest person of the worse-off 50 %, a figure which is not influenced much by the absence or presence of Bill Gates.

No doubt, it is a daunting challenge to collect data that meet these recommendations. Research, however, has been making promising progress in recent years.

Beyond material needs

Human well-being does not only depend on material factors, as the commission highlighted. A long list of facts and possibilities – Amartya Sen speaks of capabilities – is also important. Some elements are particularly crucial: healthcare, education, individual activities such as work, the right to participate in political decision-making, the quality of administrative and political leadership, social relations, the current and future environmental situation and the level of insecurity (both material and physical).

Solid and reliable indices are needed to assess political participation, social relations and the degree of insecurity. Additionally, interdependence and interactions between these individual dimensions (including those determined by the level of income) need to be sufficiently analysed. It also matters to record data on the unequal distribution of capabilities between individuals, social groups, gender and generations. Finally, even subjective assessments such as “how happy/content am I?” are relevant.

One of the central questions the commission dealt with was how to measure and assess sustainable development. This topic is very complex given the many environmental and socio-economic interactions. A monetary aggregated indicator such as the genuine saving rate of an economy – which the World Bank has been calculating since 2006 – assumes counterfactually that diverse kinds of capital can substitute one other. This approach tends to value monetary, quantifiable economic capital more highly than other kinds of capital (such as a stable climate, for instance). The risk is that economic growth will thus come at the expense of other kinds of capital because many components of natural and social capital cannot be measured in monetary terms.

In the strongest sense, sustainable development requires, as explained by the commission, that all forms of capital are at least maintained, if not increased (natural resources as well as human, social or economic capital). Any irreversible damage is unacceptable. Accordingly, non-monetary indicators must be included. Above all, dangerous and irreversible environmental trends such as climate change or the loss of biodiversity have to be recognised.

Never before have the chances of improving the measurement of national prosperity been better. The commission, with its top-class experts, has made pragmatic proposals that are applicable to any country. It is true that the report does not yet offer a detailed concept in all fields. However political decision-makers should take its advice to heart in order to advance reforms on measuring prosperity at the international level. By doing so they would do themselves a favour: it would help them better understand what makes people happy – and that ultimately determines voter satisfaction.