How Much GDP Is Able to Capture a Nations Welfare - Essay Example

1. Introduction To correctly judge the ment it is necessary to understand how much GDP is able to capture a nation’s welfare. It can be said that the statement is true if we find that GDP is a good measure of a country’s welfare. Because then, if country A has higher GDP compared to country B, it can be inferred that country A’s welfare level is higher as well relative to the welfare level of country B. However if we find that GDP is not really very reflective of any nation’s true welfare level, then the statement cannot be justified. Because then it may be true that even if country A has higher GDP, country B’s welfare level is higher. Therefore, to understand how much the given statement can be justified, we need to understand the strength of GDP as a measure of welfare. For that, first we need to understand what exactly GDP is and what is captured through it. Then we have to consider the concept of welfare and see whether GDP is able to capture it or not. Finally, based on this understanding we shall be able to judge the validity of the statement. So in the following, first GDP shall be introduced as a concept. Then the concept of welfare shall be discussed. Finally GDP and welfare shall be related to examine how strongly GDP may reflect the welfare level of any country. Finally, the discussion will be concluded by commenting upon the validity of the statement based on the understanding developed in the previous sections. 2. Understanding GDP GDP or Gross Domestic product is the sum total of the market value of all final goods and services produced within the boundaries of any nation in a given year (McConnell & Brue, 2005). It aims to measure the national income of any economy. Only the market value of final goods and services are included and the market value of all goods used as intermediaries in the process of production are excluded in the measurement of national income to avoid the problem of double counting. Sometimes as an alternative, to avoid the double counting problem, to measure national income, the value added at each stage of production is calculated and added up. However, the objective remains to estimate the national income on an economy as adequately as possible. It is important to note that GDP can be expressed in two forms – nominal GDP and real GDP. Nominal GDP represents the money value of all final goods and services produced within an economy in any given year. Real GDP is the nominal GDP divided by the price level. Dividing real GDP by the population of the economy we get per capita real GDP. We shall in the remainder consider real GDP and per capita real GDP only as it is more directly related to the values that are important to welfare. 3. Understanding Welfare National Welfare refers to the state of wellbeing of the people of a nation. Therefore the level of welfare is actually dependent upon the quality of life enjoyed by the national citizens (Strengmann-Kuhn, 2002). The quality of life depends upon a variety of socio-economic and political factors. These factors determine the standard of living as well as other aspects of life such as social security. Real income directly determines the standard of living. Apart from the standard of living, quality of life depends upon other factors that are both physical as well as psychological. While aspects of like health and protection against disease belong to the group of physical factors that influence quality of life, and thus welfare. Aspects like tension, stress, pleasure etc psychological factors also affect the state of wellbeing of individuals. Thus all factors that have effects on these aspects of human life indirectly affect the welfare level of any society (Ravallion & Lokshin, 1999). Now, evidently, it is difficult to measure these aspects of human life quantitatively. Further many of these factors vary subjectively. For instance, the presence of crime in society has different effects on different individuals. Some people fear being subject to some crime more than others. Therefore if reducing crime involves a trade-off such as higher taxes, it is difficult to determine whether welfare shall rise or fall if such a crime reducing step is taken. As a result it is very difficult to quantify the effects these factors have on quality of life, and thus on welfare levels. Therefore there are no measures that capture welfare perfectly. Though attempts are being made to develop methodologies that are able to measure well being in the forms of various indices such as the “quality of life index” or the Vanderford-Riley well-being schedule, these are more estimates than exact measures and none of these can be said to capture well being perfectly (Ravallion & Lokshin, 1999). Thus we find that income is an important determinant of welfare. But welfare depends upon a lot of factors. National income influences some of these and therefore there is an indirect relation here as well. But all of the factors that influence economic welfare are not dependent only upon income. 4. GDP and Welfare From the previous sections it becomes clear that welfare depends upon a very broad set of factors. National income does influence some of these but not all. In this section we shall deal with the specific shortfalls of GDP as a measure of welfare. First, improvements in quality of products remain unaccounted for in real GDP. That is, if the price of the product remains unchanged though its quality is improved, though that increases the welfare of the consumer who now gets better value for money, GDP remains unchanged. Therefore this increase in welfare due to improvement in quality tends to be neglected if GDP is considered as measure of welfare. Secondly, productive activities that are done within the household and not marketed are not included in real GDP. However such activities such as a mother’s service to her children or the free service offered to his/her family members by a doctor significantly contribute to the welfare of that family although these are not included in real GDP. Third, the black market or the underground economy is excluded from the calculation of GDP. That is, illegal income or income that is legal but not reported to avoid tax payment is not included in real GDP. However these do significantly influence welfare. Fourth, the equality in the distribution of income is not captured in real GDP. Although per capita income is supposed to reflect the real income of the ‘average’ person, since it is merely the total real income divided by the population. Thus a high per capita real income can be true for an economy even if it is true that only a few earn very highly in real terms with others having little real income, if the high earnings are high enough to offset the downward drag effect of the lower income for the majority. Thus, even if the distribution of income is not equitable, a nation can have high GDP. So though the low distributional equity may lead to low welfare, real income shall be high. Fifth, although health and life expectancy plays a significant role in determining the welfare level of any nation, these are not accounted for in calculating the GDP. Therefore, this is another aspect for which GDP does not reflect the welfare level truly. Sixth, leisure, a very important determinant of welfare is not taken into consideration in calculation of real GDP. Finally, another very important aspect that influences the nation’s welfare is the state of its environment and natural resources. But the adverse impacts of degradation in environment or depletion of natural resources are not considered in real GDP. Thus, we find for all these reasons, GDP does not reflect the state of welfare of any economy adequately. 5. Conclusion So, we see that although GDP, or any form of national income is a very important determinant of a nation’s welfare, it does not entirely serve as a good measure of welfare. GDP determines the access any nation’s people have to resources, healthcare and various other aspects that determine the standard of living. But welfare, or over all human well being depends upon the quality of life that the people of the nation enjoy. And there are a number of factors that determine quality of life that are not included in real GDP. For instance, the equitability of income distribution, extent of social security, quality of products, valuations of leisure time etc all are excluded from the GDP. Therefore, although due to increase in total output per capita though country A’s GDP may have risen above country B’s, if factors unaccounted for in real GDP that influence welfare such as quality of goods improves in country B or the distribution of income becomes more equitable, it may be that country B’s welfare level is actually greater than that of country A. Therefore, it has to be concluded that the given statement cannot be justified. Reference: McConnell, C.R, & Brue, S.L., (2005) “Macroeconomics (16th Ed)”, McGraw-Hill, NY Ravallion, M. & Lokshin, M. (1999) “Subjective Economic Welfare”, World Bank Policy Research Working Paper 2106 Available online: http://www.csir.res.in/csir/external/heads/aboutcsir/governance/rules/volume3/new/section31.pdf Strengmann-Kuhn, Wolfgang, (2002) “Theoretical Definition and Empirical Measurement of Welfare and Poverty: A Microeconomic Approach”. Available at SSRN: http://ssrn.com/abstract=345022 or DOI:  10.2139/ssrn.345022 Tarasofsky, A., (1998) “GDP and Its Derivatives as Welfare Measure: A Selective Look at the Literature”, www.csls.ca/events/oct98/taras.pdf Read More