GDP per Capita and Its Challengers - Research Proposal Example

Gross Domestic Product or GDP has become an important indicator for economic health of a since the beginning of industrial revolution. Generally, GDP of a country reflects the market value of all final goods and services produced within its borders for a set time period. There are several methods of GDP calculation, but since all of them are correct it is sufficient to state the most popular one: GDP = consumption + investment + government spending + (exports - imports); where 'consumption' shows personal expenditures of households, 'investment' is a non-financial purchases made for capital accumulation, 'exports' indicates products and services produced domestically but sold overseas, and 'imports' reflects goods from abroad sold within the country. As for 'government spending' it is the sum of government expenditures on final goods and services, including salaries of public servants, purchase of weapons for the military, and any investment expenditure by a government. Despite the wide use of GDP as a reliable measure of country's economic health, it is often criticised for numerous issues, some of which are described below. First of all, it should be noted that GDP was not designed to evaluate the well-being of a country. Instead, it measures particular types of economic activities within the country, which does not necessarily refer to a standard of living. For one crude example, a country with all goods and services exported will have a high GDP but low well-being of its citizens. Second, GDP takes into account only documented operations. It does include neither black market, nor non-monetary operations, like bartering, showing inaccurate information for countries where any of these issues plays an important role. Moreover, some companies commit a cross-border trade within themselves in order to escape high taxation - this distorts GDP, creating additional imports/exports data. Third, GDP indicator shows little information for changes in ecology, society, and lifestyle. For instance, ecological damage is treated by GDP as a double growth: at first, it counts natural resources retrieved, and then it counts services used to replenish natural resources, but it would be far better if the disaster had never occurred in the first place. Additionally, the philosophy of GDP shows wars as contributors to economy, but child upbringing and housework as valueless actions. It ignores volunteer and unpaid work, but instead GDP counts work that produces no net change or that results from repairing harm (e.g. the healthcare industry, where economic activity increases along with a number of unhealthy population). Fourth, people buy often low-durability goods, and make rare purchases high-durable products, because of their longer use. Sometimes it is possible that the monetary value of the items sold in the first case is higher than that in the second case, in which case a higher GDP is simply the result of greater inefficiency and waste. Fifth, since GDP does count financial purchases as investments, then if a nation does not spend, but saves and invests overseas, its GDP will be diminished in comparison to one that spends borrowed money. Therefore, accumulated savings and debt are not taken into account so long as adequate financing continues. Sixth, sometimes different calculations of GDP confuse each other. There are two different types GDP calculation for cross-border comparison: current currency exchange rate, where GDP is calculated by exchange rates prevailing on international currency markets) and purchasing power parity (PPP) exchange rate, where GDP is calculated by PPP of each currency relative to a selected standard. By PPP cross-border comparisons will be different than by current exchange rate method. This causes the so-called Penn effect: real income ratios between high and low income countries are systematically exaggerated by GDP conversion at market exchange rates. (Samuelson 202) Also GDP does not take into account local differences in quality of goods, which is especially true for goods that are not traded globally, e.g. housing. The last but not least two arguments against the use of GDP as a well-being indicator stated frequently are lack of information on sustainability of growth, and no evidences of disparity between poor and rich people provided. All these signs of inadequacy of GDP as a well-being indicator make the following question justified, if not obvious: if it has so many drawbacks, why it is used as an indicator for standards of living at all' It seems that GDP still has some experts advocating it. They often state three advantages of GDP: its frequent use, its wide use, and its consistency (Anoruo and Dipietro 699). This means, most countries provide information on GDP on a quarterly basis, which makes it readily available for up-to-date monitoring of economic trends. Since almost every country in the world provides some measures of its GDP, it can be used to compare any countries. Finally, the methods for GDP measurement are well known; that is the same thing is being measured in each country. Thus, it is the universality of GDP, which makes it the most popular indicator of a country's economic health. Analysing pluses and minuses of GDP use as an indicator for living standards of a particular country provides us the following outcome: GDP can be used as an indicator, but a rather crude one. It does not indicate the standard of living, however, usually standard of increases with the increase of GDP per capita. When workers bring more value to their employers they usually increase their salaries to retain the added value. Thus, GDP can be seen as a proxy for well-being of a country rather than a direct measure. Eventually, other indicators were developed addressing the problems GDP could not solve. Some of them are rather simple, like disposable/discretionary income per capita. Disposable income is the total amount of income an individual makes after direct taxes. Discretionary income is the similar concept, but it is equal to disposable income less the cost of fixed expenses of life (e.g. rent/mortgage, food, car payments, insurance, etc.). Discretionary income per capita defines how much an individual can spend on goods/services he wants but does not needs. Despite its simplicity this indicator is still very narrow, since it does not solves issues of GDP, related to natural resources and disparity of income. The group of indicators is known as income inequality metrics and is used to determine the degree of poverty of population within the country. It includes many measures, but two of them will be enough to get the whole picture. The poverty line is a measure of level of income required for living in a society. The poverty index is calculated as follows: (number of people below the poverty line)/(total number of people in society)*(poverty line income - average income of people below poverty line)/(average income of people below poverty line). This index is helpful when determining the amount of poverty in society. Another index, known as Gini coefficient, helps to determine the inequality in the society. It is a statistic summary, showing results from 0 to 1, where 0 corresponds to perfect income equality (Mills and Zandvakili 140). Critics of income inequality metrics argue that since each of these indexes is based on income, it should be clear how income is defined. It is unclear, whether capital gains, imputed house rents from home ownership, and gifts should be included. It is also unclear whether an individual or household should be a unit for these indexes. Still income inequality metrics bring some light into income distribution within the country. The next indicator was designed to answer the problem of depletion of natural resources. It is called Genuine Progress Indicator (GPI)and it is suggested as a replacement for GDP in welfare economics, since it distinguishes worthwhile growth from uneconomic growth (Lawn 107). GPI attempts to measure whether a state's growth was helpful in increasing the welfare of its citizens. Additionally, GPI reflects sustainability of growth and depletion of natural resources through 'costs' of economic activity (e.g. cost of resource depletion, cost of crime, cost of family breakdown, etc.), which is why it is thought to better than GDP in reflection of a country's well-being. In future, it may indeed substitute the GDP as a universal measure of standard of living, but currently most of the countries do not provide any information on their GPI values. Possibly, the most close to GDP substitution is the UN Human Development Index (HDI). It is used to determine and indicate whether a country is a developed, developing, or underdeveloped country and also to measure the impact of economic policies on quality of life. (Davies and Quinlivan 870). In general, it transforms raw variables into indexes through the following formula: Ind(x)=(x-minimal value of x)/maximum change of x. In this way HDI measures literacy, life expectancy, education and standard of living. It also uses GDP per capita as one of its variables. Quality of life and human happiness are very hard to measure in numbers. Even the standards of living are subjective measures. Despite the numerous criticisms of GDP as a measure for well-being of a country, it is still the most commonly used indicator, and yet it is rough, and should be used with caution of its drawbacks, especially for developing countries with economies significantly different from Western countries. However, several indicators may be better in determining the welfare of a country. The most developed of them is the UN Human Development Index. Another measure that may substitute GDP in future but currently is underused is the Genuine Progress Indicator. References Anoruo, Emmanuel and Dipietro, William. "GDP per capita and its challengers as measures of happiness". International Journal of Social Economics 33.10 (2006): 698-709. Davies, A. and Quinlivan, G. "A Panel Data Analysis of the Impact of Trade on Human Development", Journal of Socio-Economics 35.5 (2006): 868-876. Lawn, Philip. "A theoretical foundation to support the Index of Sustainable Economic Welfare (ISEW), Genuine Progress Indicator (GPI), and other related indexes". Ecological Economics 44.1 (2003): 105-118. Mills, Jeffrey and Zandvakili, Sourushe. "Statistical Inference via Bootstrapping for Measures of Inequality". Journal of Applied Econometrics 12.2 (1997): 133-150. Samuelson, Paul. "Facets of Balassa-Samuelson Thirty Years Later," Review of International Economics 2.3 (1994): 201-226. Read More