Limitations of GDP as a measure of living standards

Benefits of using GDP/GNI

Allows for Comparisons over time

Using the same measure of economic activity allows for more consistent comparisons of economic activity over time. For example, using Real GDP over time make it easier for a government to identify changes in an economy's levels of output and to be able to identify clear trends or changes to the levels of output.

Allows for Comparisons between countries

Having a standard measure for all economies allows for a clear comparison between countries' economic performance. This standardised measure helps decision makers, such as Governments, Firms (MNCs), and even individuals to make clear comparisons between countries.

Limitations of GDP/GNI as a Measure of Economic Output

Does not include non-market output

GDP/GNI figures do not include goods that are produced but not sold in markets. For example, if an individual was to repair a leaking pipe in their own home rather than getting someone to fix it. The person completing the work themselves does not add any value to the overall GDP/GNI compared to that same person calling a company comes to fix the leak. The company coming to fix the leak will add to an economy's GDP/GNI as it would be classed as a service.

This is particularly true for developing economies, where lower incomes may limit how many people access these services and instead tend to be self- sufficient. As such, GDP/GNI figures may be lower in countries where non market output is higher.

Does not measure Quality improvements

GDP/GNI measures the value of Economic Output only. It does not take into consideration changes in product quality. Firms using newer technologies to produce a good or service at lower prices that benefit consumers is not reflected in GDP/GNI figures.

Does not include output from underground markets

Parallel Markets (or underground markets) are markets that are unrecorded. In these markets, goods and services are sold but the transaction is not recorded. Sometimes called informal markets, the transactions in these markets do not contribute to GDP/GNI figures however they do generate an income for the person selling these goods/services. For example, if a person was to complete work for cash and then did not declare that income to avoid paying tax, this would also mean a lower GDP/GNI figure. Therefore, governments have to estimate figures to try to get a figure that better reflects the true GDP/GNI figure.

Limitations of GDP/GNI as a Measure of Living Standards

Does not show the distribution of the Economic value

One of the biggest limitations to using GDP/GNI as a measure of Economic Well Being is that whilst it shows the value of all economic output, it does not show how that value is distributed. For example, in the US the top 1% of the population accumulates nearly 30% of the overall income. So in a population of 325million people, 30% of the income is received by just 1.6m people. At the same time, about 5.3 million people live in absolute poverty in the US, living on less than $1.25 a day. Therefore, whilst GDP/GNI is good for measuring Economic Output, it does not show the distribution of this Economic Value. (This will be looked at more here)

Does not include social costs created by production (externalities)

As we have seen in the section on Market Failures, one of the problems with free markets is that they do not include the negative externalities or external costs to society of the production of a good. Therefore, an increase in GDP/GNI due to increased production may not reflect any increase in the social costs of production, such as increased pollution or the depletion of common access resources such as deforestation. For example, increases in GDP/GNI may not reflect the increased social costs of increased health care costs due to higher pollution or effects of increased flooding. Therefore, measures such as Green GDP may be more useful in measuring the environmental impacts of increased production and consumption. Green GDP tries to quantify the costs of environmental damage in relation to a countries GDP. Therefore, the higher a country's negative externalities of production, the lower its green GDP value will be.

No distinction about products being produced

As GDP/GNI is a measure of the total goods and services produced in an economy, over a period of time, it does not distinguish between the goods being produced. Therefore, a country could have a high GDP but could be producing mainly capital goods or goods such as ammunition or weapons. Whilst this contributes to a higher GDP/GNI, it does not contribute to the Economic Well Being of people within an economy.

Does not include measures of improvements in health or education levels

Similar to how it does not distingush between the goods being produced, GNI/GDP does not measure improvements in an economies health or education levels. These factors are necessisary for improving well being of people. Higher education levels and better healthcare equal higher standards of living due to higher incomes and overall well-being. However, when GDP/GNI rises for an economy, we can't tell what is happening to the levels/quality of healthcare and education. Therefore GNI/GDP is a poor indicator to determine economic well being. To try to overcome this, as well as the measures mentioned below, countries may measure Human Development Index (HDI), a composite measure that looks at GNI per capita, Life Expectancy and Education Index to produce an overall measure. We will look at this more later on in Measuring Economic Development.

Alternative Measures of Economic Well Being

Happiness Index

The Happiness Index is a measure created by the UN Sustainable Development Network. It using a range of measures to try to address the interdependent economic, social, and environmental issues. These measures include:

real GDP per Capita
Social Support
Healthy Life Expectancy
Freedom to make life choices
Generosity
Perceptions of Corruption

In order to gather the data, from the Gallup World Poll (based on telephone surveys). Using this data, the UNSDN gives each country a score of 1-10 on each of the above measures (1 being worse, 10 being best).

You can see the rankings of each country that participated in the report on the right for 2020. (Scroll to page 22 onwards for the values)

This measure does have a number of limitations and has had criticisms on the data and variables it uses. It also faces criticism for it being based on the concept of "happiness" given the difficulties of trying to quantify a subjective concept that can be influenced by cultural and societal norms.

WHR20.pdf

Click here to visit the OECD Better Life Website

Using the tutorial video, access the OECD better life website and learn more about the OECD better life measure of Well Being

OECD Better Life Index

Happy Planet Index

Explore the website below to find out more information of the HPI

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