GDP Limitations as a Measure of Economic Activity and Wealth - Literature review Example

The GDP is appropriate measure of economic activity and wealth: A critical Perspective Introduction Gross Domestic Product (GDP) has been extensivelyused as a measure of economic activity and wealth of a country from time immemorial. However, GDP as a measure of economic growth is widely incomplete because, there are few activities that cannot be monetized, GDP growth does not ensure a rising living standard for the broader society and its growth does not ensure equal income distribution among people. The purpose of this paper is to explore the factors for which GDP cannot be considered as a perfect measure of wealth and economic growth. Other alternative forms of measurement like GDP Per Capita, Genuine Progress Indicator (GPI), Gross National Happiness (GNH), Human Development Index (HDI) and Green GDP have been discussed. The project addresses the implications of using GDP as a measure of economics activity and wealth. It also discusses the implication on business growth and ways in which business enterprise should consider sustainable measures of development. “GDP can be defined as the total value of final goods and services produced within the geographical boundary of a country in a given time period” (Mankiw, 2014, p. 486). GDP of a nation is calculated irrespective of ownership of productive assets. Foreign firm’s value of goods and services are also considered in calculating a nation’s GDP even if it is remitted to the foreign country (McGuire, 2012). Economic activity of a nation is described as the production, distribution and consumption of goods and services in the economy at each level. GDP is often taken as a proxy measure for economic activity of a country and forecasts of GDP are generally used in predicting the level of economic activity in the country. GDP of a country is also used to measure the level of wealth earned by it (McGuire, 2012). GDP limitations as a measure of Economic Activity and Wealth Over the past few years, there have been severe criticisms regarding the traditional use of GDP to measure the wealth and level of economic activity in a country. The major criticism behind the use of GDP as a measure of wealth and economic costs arise from the fact that, GDP excludes a number of items owing to the fact that they cannot be monetized. For instance, GDP does not take into consideration the depreciation of assets in factories, physical infrastructure, leisure, unpaid and domestic activities, loss of natural ecosystems, depletion of renewable sources, economic losses resulting from pollution (Comparet, et al., 2003, pp. 30-31). Scholars have argued that GDP gives an incomplete measure of the level of economic development of a country as it fails to capture the full picture in which the economy operates (Nordhaus and Tobin, 1972). Economic progress of a country depends on social, natural and human capital and development of these three types of capital in turn depends on the level of net investment in the country. The fact that GDP considers only the money value of goods and services that are produced, implies that it eliminates a large proportion of the well-being of the community (WAVES, 2012). GDP accounting does not take into account the cost of economic degradation of natural resources. It was estimated that the valuation of world’s ecosystem in 1997 was approximately about US$33 trillion and this value was much higher than the level of GDP during that year (Costanza, et al., 2009). The works of researchers had shown that GDP only shows the level of economic state of a nation without considering the future direction of growth of the economy. Their research had also pointed out that GDP can be inflated in a socially perverse way because of events in the economy like war and natural disasters. For instance, how Superstorm Sandy had raised the level of GDP for the U.S. economy. The $50 billion plus spend burying the dead, Cleanup and replacing lost homes and business will make the U.S economy ‘better off’. (Wysham and Talberth, 2012)This however, does not reflect well-being of the nation as a whole. According to the research conducted by Costanza, et al. (2009), it has been found that the level of economic and national well-being of a nation cannot be captured by the traditional GDP. Their research had rather considered alternative indicators to GDP that can measure economic development of a country. “Gross domestic product, the leading economic measurement, is out dated and misleading…It’s like grading a corporation based on one day’s cash flow and forgetting to depreciate assets and others costs.” (Stiglitz, J., 2008 as cited by WAVES, 2012, p. 3). GDP per capita Economists claim GDP does not measure the level of income distribution in a country, which implies it is not a proper measure of showing how is wealth distributed in an economy. Others claim that, GDP per capita should be linked with the concept of human welfare as it considers the distribution of wealth. In many empirical studies it has been found that, GDP per capita is often positively linked to developments in infant mortality and negatively linked with income inequality. GDP per capita is used to measure inequality of income distribution of a country (Lawn, 2003). Measure of GDP per capita as a better measure of economic growth of a country has often been challenged due to the fact that rising level of per capita GDP is not positively linked with the level of rising happiness of a country. Most economists suggest that, growth of GDP per capita as a measure of well-being of a country is based on the assumption of ceteris paribus. However, there ceteris paribus condition does not hold true in a real economic scenario. Therefore, it has been argued that GDP per capita is not a good measure of income inequality of a country. In capitalist economies it has been found that, the income accrued in the economy is unequally shared by the rich and the poor section of the society (Lawn, 2003). Dividing the total income of the country with the population will not be able to capture the dispersion of income from the mean value. It has been observed that in many countries economic growth measured by the overall growth of GDP has not matched with the income distribution of these countries. This implies, wealth earned is unequally distributed in the society. In such societies measuring growth on the basis of GDP is unlikely to capture the true picture of economic well being of the people. Also, economists have argued that overall economic development of a country is not captured by the measure of its GDP. Genuine Progress Indicator For instance, GPI is an indicator that considers sustainable economic welfare of a country. This indicator considers: Economic Indicators – Personal Consumption Expenditures, Income Inequality, Adjusted Personal Consumption, Cost of Consumer Durable, Value of Consumers Durable, Cost of Underemployment and Net Capital Investment; Environmental Indicators – Cost of Water Pollution, Cost of Air Pollution, Loss of Wetlands, Loss of Farmland, Loss of Primary Forests and Damage from Logging Roads, Carbon Dioxide Emissions Damage, Cost of Ozone Depletion and Depletion of Non-Renewable Resources; Social Indicators – Value of Housework Work and Parenting, Cost of Family Changes, Cost of Crime, Cost of Household Pollution Abatement, Value of Volunteer Work, Loss of Leisure Time, Value of a Higher Education, Value of Highways & Streets, Cost of Commuting and Cost of Automobile Accidents. (Lawn, 2003; Genuine Progress, 2013). Gross National Happiness This is another interesting measure of measuring the well-being of a country by considering the gross happiness index of the country. This idea was originally developed by the King of Bhutan to measure the extent of happiness of the country. GNH argue that economic welfare programs should be complimented with social welfare. There are four pillars of GNH namely sustainable development, conservation of natural environment, human governance systems and preservation of culture (Costanza, et al., 2009; Ura, et al., 2012.). “Not everything that count can be measured, not everything that can be measured counts: can – and should happiness be measured?”(Chang, 2014, p.231). Human Development Index The HDI was launched for the first time in 1990 by the United Nations Development Programme (UNDP) it was introduced to divert attention from income towards a more comprehensive measure of human development (Neumayer, 2001). It is a composite measurement of well-being of a nation based on three primary aspects namely life expectancy at birth, living standard and literacy rate of a country. This composite index takes care of the health aspects of individuals along with their education level making it a better measure for overall sustainability (Sagar and Najam, 1998). Implications for Business Most of the research works conducted in the field of sustainable business practices have shown that business and society depends on each other. In other words, business derives their resources from the society for its own growth. Growth of the business is in turn reflected in the increase of the GDP of the country. However, it has often been observed that business firms neglect their harmful impacts on the environment due to profit-maximizing objective. Environment is a necessity for the business to grow, but, GDP fails to incorporate the negative externality that businesses impose. The importance of sustainable business accounting practices has become imperative in the management literature. Focusing solely on economic growth by considering GDP of a nation has become inadequate on multiple levels. Researchers are now suggesting that businesses have to focus on four different aspects to ensure sustainability. The first one is the economic perspective that which coincides with the profit-maximizing motive of the firm. Second perspective is ecological one, that reflects accounting of environmental damages that are caused by the business activities. Third perspective is social, where corporate entities must take into consideration the facts of social inequity, conflicts and concentrate on community well-being. Developing community is considered to be one of the strongest social responsibilities of business enterprises. The final aspect is the ethical perspective, which focuses on refraining from any unethical practices in the business and conducting business with integrity (Harvie and Lee, 2005). Activities of business expansion in globalization cannot be solely based on economic growth of a country based on GDP. In the era of globalization, businesses have to rely on sustainable business practices by internalizing their marginal private cost. Majority of business decisions are now being taken on grounds of ecological transparency. Green GDP The concept of Green GDP considers the total level of environmental degradation in accounting progress. For instance, in China it has been found that the level of economic growth as measured by the GDP of the country has been growing with rising level of pollution. China had officially launched its green GDP measure as a part of development of its natural capital. The Chinese government had begun to subtract the costs of resource depletion and pollution from the overall level of GDP of the country. It is expected that this will allow businesses to take sustainable approach to economic development (Yin, 2008). Green GDP should be considered as a part of corporate responsibility of the business in order to minimize their negative externality on the society. Researchers are now arguing that the business enterprises had previously focused only on production of corporate outputs by completely ignoring the impacts of environmental sustainability (Yin, 2008). It can be argued that in order to consider the all round development, use of GPI or human development index is much more acceptable. It is strongly accepted that in order to achieve sustainable economic development of a country at a national level, it is imperative that the individual business enterprises start adopting sustainable measures by considering the dimensional aspects of sustainability. Following economic perspective by businesses can lead to their failure to sustain in the long-run. One of the methods suggested in considering proper measurement of wealth is by taking into consideration both physical capital and natural capital. Wealth accounting of a country is related to the measurement of all the assets that measure the well-being of individuals. It is increasingly being suggested that countries take into consideration the process of natural income accounting in their valuation of assets. Institutions like RaboBank and Standard Chartered bank have incorporated natural capital accounting in their products and services to ensure that growth is sustainable in the long-run (WAVES, 2012). Conclusion Corporate strategies should consider factors like depletion of natural capital and societal well being as a whole. Green GDP is an effective concept that has been adopted by countries like China to account for the loss of natural capital of the economy. GDP fails to capture overall development of the society as it fails to account for the equitable distribution of income in the society. Though, GDP per capita is devised to capture income distribution, it fails to ensure growth in living standard for the entire society. GDP per capita is a mere reflection of average GDP of a country and hence, it does not capture income inequality in the society. Therefore, using composite index like the HDI can be helpful in capturing multiple aspects of human life like income growth, literacy and health. Based on the ongoing discussions, it can be suggested that business enterprises should no longer focus only on economic perspective for growth. 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