GDP as a measure of development - Essay Example

?GDP as a measure of development GDP is a good measure of the health of a developing country’s economy. What else should be considered and why? The gross domestic product or GDP is “the value of all final goods and services produced in the country within a given period” (Dornbusch et al., 23). Todaro and Smith elaborates that GDP is “the total final output of goods and services produced by the country’s economy, within a country’s territory, by residents and non-residents, regardless of its allocation between domestic and foreign claims” (815). GDP is different from the gross national product or GNP in this sense: while the GNP refers to the final value of goods and services produced by citizens of a country, the GDP refers to the final value of goods and services produced by a territory or the country. Thus, the GDP includes all outputs of goods and services in the territory of the country, whether that output were from aliens or citizens. In contrast, the GNP covers only the output of goods and services of citizens whether that output was produced inside or outside the territory of a country. The term “final goods and services” are meant to emphasize that the concept of the GDP seeks to avoid double counting of goods and services. For example, if a certain input is part of a certain output, the value of the input is not counted but only the value of the final output. The GDP count only the output currently produced (Dornbusch, 36). Thus, for example, the value excludes older houses but includes new house construction (Dornbusch, 36). Dornbusch et al. noted the following difficulties of GDP measurement (36-38): 1. GDP is unable to measure some of a territory’s outputs because they are not traded in the market. 2. GDP does not subtract anything for environmental pollution. Goods and services may have been produced but at high costs to the environment of the nation. 3. GDP does not factor the quality of goods or the improvements in the quality of goods. Baumol and Binder defined GDP as “a measure of the size of the economy” or the total amount it produces in a year and noted the following limitations of GDP as a measure (23, 90-91): 1. GDP is not a measure of a country’s well-being but, at the same time, it was never intended to be one. 2. Only market activity is included in the GDP and this explains why African countries can survive on $ 5 per week. 3. International comparisons can be misleading if we use GDP because we are not comparing the same economic activities: many things that are counted in the GDP of the rich countries are not counted in the GDP of the poor countries. 4. GDP places no value on leisure. Baumol and Binder argued that as a country gets richer, its citizens acquire more leisure time and the value of the leisure goes up. 5. GDP can also overstate how a country is well-off because even the bads are counted in GDP accounting. According to Baumol and Binder, even disaster can bloat the GDP as houses or properties are reconstructed once a natural or man-made disaster strikes similar to the 9/11. Hall and Lieberman enumerated the following problems with regard to measuring the GDP (539-540): 1. GDP statistics can be inaccurate, especially among developing countries. 2. Many countries, especially developing economies have an underground economy. The underground economy includes hidden economic activity. The hidden economic activity can also include illegal economic activities, especially those involved in drugs, prostitution, many gambling activities, and those that seek to avoid taxes. 3. Many countries, especially the developing economies, have large areas where food is grown and consumed by farmers and many goods do not enter the market. 4. Household activities are also not included in GDP accounting. Parenting is not counted in the GDP unlike daycare programs. Takeouts are counted in the GDP but not homecooked food. Therapy is counted in the GDP but not talking to a friend. For Scott and Miles, there are at least two issues in using GDP as a measure. The first issue pertains to how GDP is accurately measured (27). For instance, they pointed out that a large amount of economic activity may not have been reported to government. Scott and Miles pointed out that GDP may not be accurately measuring economic growth because a large part of the economy is underground (27). It can also be that, as Hall and Lieberman have pointed out, a large part of the economy is illegal (27). According to Scott and Miles, an underground economy can be fairly high relative to the GDP (27). Scott and Miles estimate that an underground economy can be as high as more than 70% of the economy. Table 1 from Scott and Miles shows that the underground economy or the economy that does not enter valuation in the market has been more than 75 percent in Nigeria, 70 percent in Thailand, more than 60 percent in Egypt, 60 percent in Guatemala, and 50 percent in the Philippines (27). Further, even in the developing countries, there are underground economies. The underground economy is close to 10 percent in Norway and Switzerland, more than 50 percent in Sweden and the United States, and also more than 10 percent in about 10 developed countries. Figure 1. Estimates of Underground Economy as Percentage of GDP Source: Scott and Miles (27) Scott and Miles explanation for a large underground economy is this: in many developing countries, families have an adult who works in an economic activity that enters the market and another adult who remains outside the market but provides goods and services just the same (27). Further, the goods and services of the adult working outside of the market place can consist of the following: childcare, cooking meals, and household administration (Scott and Miles, 27). Scott and Miles argued that the said activities produce an output even if they do not enter the market. Thus, the actual economy output is higher even if many of the activities do not enter the market (Scott and Miles, 27). Scott and Miles’ second issue on the use of the GDP is conceptual (27). They pointed out that even if GDP is accurately measured, GDP may not be measuring welfare (27). Welfare may involve equity, quality of life and the like and must be measured in terms other than output of goods and services. Output of goods and services may be growing but people may get unhappier. For example, Scott and Miles pointed out that survey indicate that people who are very happy slightly decreased from 1980 to 1990 and happiness or contentment figures may be vary across time as in the case of Figure 2 below for the United States (29): Figure 2. Happiness in the United States, 1972-1990 Source: Scott and Miles, 29 According to Scott and Miles, life satisfaction over time may improve or worsen in various countries and this is not measured by the GDP (29). In other words, GDP may not be measuring welfare (29). This is indicated in Figure 2. Figure 3. Percentage of Sample Reporting “Very Satisfied” in Life Source: Scott and Miles, 29, from As indicated in Figure, despite increasing GDP from 1973 to 1990, three countries deteriorated in terms of the percentage of the sample who reported they were “very satisfied” in their lives (Scott and Miles, 29). These countries were Belgium, Ireland, and the United Kingdom. Fortunately, countries who reported an increasing proportion of people who have been “very satisfied” with their lives” given an increasing GDP were Denmark, France, West Germany, Italy, Luxemburg, and the Netherlands. Related to the second issue, Scott and Miles pointed out that environmental concerns are an important component of welfare (28). For instance, they pointed out that if environmental damage is taken into consideration, actual GDP in Costa Rica will be lower and this probably applies to many countries (Scott and Miles, 28). The Scott and Miles illustration for this is shown in Figure 4. Figure 4. Costa Rica’s Gross Domestic Product (Green GDP) when Environmental Damage is Accounted Source: Scott and Miles, 28, from a World Bank 1996 Report In Figure 4, the environmental damage comes from pollution or destruction on natural resources generated by the output of goods and services (Scott and Miles, 28). Outputs may be produced but the output may cause severe damages to the air, bodies of water, and ecology. The environmental damage have a value and these values can be deducted from the final value of the output of goods and services leaving us a GDP that is adjusted for environmental damages or the “Green GDP”. Given the discontent with GDP as a measure of welfare, various proposals have been raised. For example, Clemens and Pritchett devised a measure called income per natural and propose the measure as a measure for welfare (395). They argued that the measure they have devised could measure people’s welfare rather than the measure the development of places that the GDP measures (396). The income per natural they have proposed was actually derived from a composite of data from several variables. Notable among these variables are per capita income, labour supply, infant mortality, and the like. Unfortunately, their proposals do not seem to be different from earlier proposals on the matter. In several editions of his book, Todaro has reported that some of the proposals for alternative measures to the GDP include the human freedom index, human poverty index, human development index, income index, quality of life indices, and even a weighted GDP or gross national product or GNP measure (22, 50, 53, 60, and 206-207). Goldberg and Pavenik raised an intereting point: GDP may be growing but distribution of incomes are changing. For example, a rich person today may be a poor person tomorrow and poor person yesterday may be rich tomorrow. Some of the middle class persons may be poorer today and some may be well-off tomorrow. An increasing GDP may be failing to capture the distribution of income effects that globalization brings on the world economy (39). Goldberg and Pavenik also pointed out that while “globalization was expected to help the less skilled who are presumed to be the locally abundant factor in developing countries, there is overwhelming evidence that these are generally not better off, at least not relative to workers with higher skills or education levels” (39). Goldberg and Pavenick also pointed out that the differential between white collar and blue collar wage exacerbated from 1970 to 1990 as a result of globalization even as income inequality stabilized and decline during the period (48). Skills premium across jobs decline and then increased from 1970 to 1990 (Goldberg and Pavenick, 48). Dyson raised the point that increases in GDP may be accompanied by an increased in the burning of fossil fuels in developing countries (117). Further, the same GDP increase can associated with a momentum in a major rise of carbon dioxide or green house gases in the atmosphere. Thus, the GDP rise can be associated with global warming that can threaten the safety of humans in the planet (Dyson, 117). GDP rise in developing countries can be associated with higher contribution to global warming and climate change in planet earth (Dyson, 118). In 2002, precisely because of the perceived inability for the GDP to measure welfare, Islam and Clarke had proposed an adjusted GDP measure of welfare. Just like the other literature, Islam and Clarke recognized that GDP is unable to account household production and excludes illegal or informal economies (208). Further, Islam and Clarke recognize that GDP calculates the economic impact of positive and economic activities without being discriminating or that values of output are not computed without taking account of associated economic activities or by-products that may be degrading to overall economic output (208). Islam and Clarke proposed a measure of national social welfare that factors in GDP but adjusted the GDP figures for capital equipment destroyed, benefits that were derived from the economic growth, the social costs of economic growth, and the loss of natural resources associated with the economic growth (209). Meanwhile, in 1990, Swan has raised the possibility that taxes may be artificially bloating GDP through the share of government revenues in the economy. However, this may be resolved through a “mere” adjustment of the GDP accounting system, especially with computerization. In summary, perhaps the more important argument on what the GDP is failing to measure are those related to household production, underground economy, distribution, environment, and the like. The reasons for these are explained in the body of this work. The options for addressing the concerns may lie in developing measures other than GDP or developing measures that can supplement the GDP as a measure of economic activity. It must be emphasized though that the GDP measures only one facet of development and, by design, it was not intended to measure development at all but only one facet of development. Work Cited Baumol, William, and Alan Binder. Macroeconomics: Principles & Policy. 11th Ed. Australia and United Kingdom: South-Western Cengage Learning, 2009. Clemens, Michael, and Lant Pritchett. “ Income per Natural: Measuring Development for People Rather than Places”. Population and Development Review 34.3 (2008): 395-434. Dornbusch, Rudiger, Stanley Fischer, and Richard Startz. Macroeconomics. 10th Ed. Boston and London: McGraw Hill, 2008. Dyson, Tim. “On Development, Demography and Climate Change: The End of the World as We Know It?” Population and Environment 27. 2 (2005); 117-149. Goldberg, Pinelopi Koujianou, and Nina Pavenik. “Distributional Effects of Globalization in Developing Countries.” Journal of Economic Literature 45.1 (2007): 39-82. Hall, Robert, and Marc Lieberman. Macroeconomics: Principles and Applications. 3rd Ed. Thomson-Southwestern, 2005. Islam, Sardar, and Matthew Clarke. “The Relationship between Economic Development and Social Welfare: A New Adjusted GDP Measure of Welfare.” Social Indicators Research 57.2 (2002): 201-228. Scott, Andrew, and David Miles. Macroeconomics: Understanding the Wealth of Nations. 2nd Ed. West Sussex, England: John Wiley & Sons, 2005. Swan, Peter. “Inflation or Taxation in Drag: Responsible for the Rising Share of Government in Australian GDP?” Public Choice 65.2 (1990): 143-145. Todaro, Michael, and Stephen Smith. An Introduction to Economic Development. 9th Ed. Harlow and London: Pearson Addison Wesley, 2006. Read More