This past September, the “International Commission on the Measurement of Economic Performance and Social Progress,” which had been appoined by French president Sarkozy and was chaired by the well-known economist Joseph Stiglitz, issued a report of almost 300 pages criticizing Gross Domestic Product as a measure of social welfare and proposing a variety of alterations and alternatives. Such criticisms are nothing new, but Stiglitz relates them to the deficiencies of GDP as a measure of our current economic situation, and this makes the report especially timely. For U.S. GDP (and that of many other countries) grew in the third quarter of this year, leading a number of economists and journalists to declare the end of the recession that began in December 2007 and that dramatically intensified in the financial collapse of September 2008.
There are three types of objection to the GDP as a measure of welfare. The first is that it is defective even from the narrowest economic perspective. GDP is the market value of all goods and services produced in a year. It thus explicitly excludes nonmarket values. But its treatment even of market values is defective because it excludes depreciation. Suppose the calamitous effects of Hurricane Katrina on New Orleans and other parts of the Gulf Coast had caused (it probably did cause) a surge in the output of various services such as emergency relief, building repairs, and construction. The market value of those services would be counted as part of GDP, without subtraction for the depreciation of the value of property that the flooding triggered by the hurricane caused.
Another objection to GDP as a measure of economic welfare, also a criticism based on economics though now viewed a little more broadly, is failure to adjust for monetizable, but not monetized, economic values. An obvious example is household production, which can be valued in money terms by estimating what the household producer would earn in the market; that is only a lower-bound estimate, but it is better than nothing. Leisure, which is also a value, can be monetized similarly.
Quality is another economic dimension that can be monetized, as is recognized in calculating the consumer price index; without an adjustment for quality change, the rate of inflation would be greatly overstimated. More to the point, it would be wrong to conclude that if the cost of making a product declines and competition forces the producers to cut price, there has been a loss of value. A great deal of the modern increase in the standard of living is due to improvements in product quality that do not result in cost increases commensurate with the improvements, and often result in lower costs. A dramatic example is modern dentistry. A possible further example is increased longevity, which can be monetized; the problem is relating increased longevity to the enormous expenditures on health care.
Turning to bads, economists can and do estimate the costs imposed by crime, pollution, and traffic congestion, but these costs are not subtracted, in the calculation of GDP, from the costs of police and prisons, costs of pollution control, and costs of dealing with congestion—all those costs (except a loss of production from congestion delays) are included in GDP. Put differently, the monetizable value of investments in police, pollution control, and reducing congestion does not enter into GDP.
Even with all the suggested corrections made, GDP would be an imperfect measure of economic output, because government provides many services that are difficult to value: expenditures on the military and on foreign and domestic intelligence and counterintelligence are conspicuous examples. It would be odd to say that the “market value” of a bomber that costs $100 million to build and is sold only to the U.S. Air Force has a market value equal to the purchase price. Its market value in a meaningful sense would depend on its contribution to reducing the expected costs of foreign threats to
Which brings me to the third and broadest problem with GDP as a measure of welfare--that even if improved along the lines I have just suggested it would not really measure happiness or well being. Market value is a function mainly of cost. The value that people derive from goods and services is better measured by what they would pay for them if competition did not reduce their price to or near the cost of production; but that value (“consumer surplus”) is difficult to estimate. Or consider—coming closer to current events that have sharpened traditional concerns with GDP’s adequacy as a measure of welfare—the anxiety that people who are involuntarily unnemployed experience.
The second in command at the international commission was the economist Amartya Sen, a pioneer (along with the philosopher Martha Nussbaum) in attempting to develop measures of human “capabilities” and ranking countries according to their ability to equip their citizens with such capabilities (long life, adequate nutrition, education, etc.). The United Nation’s Human Development Index attempts such a ranking, and some might think it a candidate for replacing GDP.
So should GDP be changed or abandoned or supplemented or supplanted? I think not, for three reasons. The first is that even the adjustments that every economist would favor in principle, such as subtracting depreciation from market value, involve contestable judgments (there is a measure called Net Domestic Product that subtracts normal depreciation from GDP). If private economists want to make such adjustments and offer up their own estimates of the economy's output, fine; but GDP is an official government statistic, and to avoid the suspicion and perhaps reality of political interference it is essential that government statistics be calculated in a thoroughly objective, uncontroversial manner. An extreme example is the
The objection to adjusting GDP would grow with every adjustment. And adjustments that were not monetizable would require controversial decisions on weighting. That is a standard problem with multicriteria rankings.
Second, crude as it is, unadjusted GDP is at least roughly correlated with adjusted measures of welfare. In the international commission’s report, adjustments for leisure and other nonmonetized but monetizable values boost France’s GDP from being 66 percent of America’s to 87 percent. In another words,
Third, except at extremes (Norway versus Zimbabwe, say), the significance of GDP lies not in its use as a method of ranking nations, but its use as a method of measuring the business cycle in an individual nation. A chart of U.S. GDP oscillates around a trend line of about 3 percent per annum; there is a big dip in the Great Depression of the 1930s and a smaller though still significant dip since 2007. The oscillations in GDP since 2007 provide a rough but serviceable starting point in appraising the performance of the economy—a sharp drop of GDP in the last quarter of 2008 and the first quarter of 2009, a smaller drop in the second quarter, an increase (of 2.8 percent) in the third quarter, which still leaves GDP well below its trend line.
But it is necessary to emphasize that it is just a starting point. I disagree with economists who say the “recession” ended in the third quarter. The depression (as I think we should call it if only because of its enormous potential political consequences) has caused massive unemployment with all the associated anxieties and hardships, has greatly reduced household wealth, has caused private investment to turn negative, has cost the government trillions of dollars in lost tax revenues and recovery expenditures (TARP, the fiscal stimulus, the mortgage-relief programs, the auto bailouts, etc.), has undermined belief in free markets and altered the line between government and business in favor government, and is threatening a future inflation while deepening our dependence on foreign lenders. To view a change in GDP from negative to positive as signifying the end of a depression (by which criterion the Great Depression ended in 1933 and again in 1938) is to misunderstand the utility of GDP as a measure of economic activity.