Tuesday, December 11, 2012

Economics and wellbeing: beyond GDP

Economic Society, Sydney, Tuesday, December 11, 2012

We had been hoping to have a speaker willing to argue that GDP was good enough to guide our policy decisions without need for modification or supplementation, but he’s unable to attend - which is a pity because I would have been interested to hear his arguments. In the absence of someone in the audience willing to argue that position, I think there’s a lot we can agree on. Where we’re likely to differ is in our degree of enthusiasm for the beyond-GDP project and how exactly we should go about developing a supplementary measure or range of measures.

Starting with the ‘agreed facts’, as the lawyers say, I doubt there are many if any economists who need to be lectured by greenies or lefties on the various reasons why GDP is an inappropriate measure of wellbeing or social progress. We all know about defensive expenditures and so forth. Further, we all know GDP was never intended or designed to be such a measure.

And I think all of us here tonight can agree that GDP is a reasonable measure of what it was designed to measure - production and income - and that the continued calculation of GDP is vitally important as an aid to the management of the macro economy. So no one here wants to abolish GDP.

It’s worth noting, however, that the 2009 report of President Sarkozy’s Commission on Economic Performance and Social Progress - the Stiglitz, Sen, Fitoussi report - did offer some significant criticisms of GDP just from a quite conventional, narrow, material wellbeing perspective. It noted that GDP had given Americans in particular an exaggerated impression of how well they were doing in the years leading up to the GFC, with company profits overstated because they were based on asset values inflated by a bubble and with a lot of the growth built on consumers and governments spending money they’d borrowed rather than earnt. It argued that in measuring material wellbeing, the focus should be shifted from production (GDP) to real household income and consumption, since household income can grow at a different rate to GDP. It further argued that income and consumption should be judged in conjunction with households’ net wealth, and that focusing on median income rather than average income is a better, easy way to take at least some account of the distribution of income.

A lot of the report’s criticisms can be met merely by switching from GDP to another aggregate published each quarter in the national accounts (but given almost no attention): real net national disposable income - ‘rinndi’. This measure switches from production to disposable income, takes account of the depreciation of manmade capital, the effect of movements in our terms of trade and the truth that, particularly for an economy with a huge net income deficit like ours, national product is a more appropriate measure than domestic product.

As you may know, I’ve been banging on about the limitations of GDP, and the need for it to be supplemented by a better, broader measure of wellbeing for some time. I was greatly reinforced in this view by the report of such luminaries as Stiglitz and Sen. For more than a year now, Fairfax Media has commissioned Nicholas Gruen to prepare such a broader measure, the Herald-Age Lateral Economics wellbeing index, for publication a few days after the quarterly national accounts.

The HALE index starts by turning GDP into real net national disposable income - rinndi - but then it adds adjustments for as many wider aspects of wellbeing as Nicholas could find decent measures of: the value of the net depletion of natural resources (after allowing for new discoveries), the estimated cost of future climate change, the gain in human capital from all levels of education and training, changes in income inequality, the gain or loss from various measures of the nation’s health and the state of employment-related satisfaction.

If you’re interested in getting your teeth into what a beyond-GDP measure of wellbeing might look like, we’re happy to explain and defend the HALE index. I asked Nicholas to come up from Melbourne tonight for that purpose. We don’t make any claim the index is a complete measure of every dimension of wellbeing, we don’t claim there’s nothing about its methodology that’s open to debate, but we do claim it’s an honest attempt to measure broader wellbeing - welfare, if you like - not some lefty attempt to think of as many negatives as possible to subtract from GDP.

The most obviously debatable part of the methodology is the decision to produce a single, modified-GDP figure for wellbeing. We know Stiglitz and Sen opted for the ‘dashboard’ approach - produce a range of relevant indicators of the various dimensions of wellbeing - rather than a single magic number. And we know the Bureau of Statistics, with all the effort it has put into its MAP project - Measures of Australia’s Progress - is also very much in the dashboard, they-can’t-be-added-up camp. So what are the reasons to prefer a single measure and, once you’ve decided to go down that track, how on earth do you add them together?

These are questions Nicholas, as the designer of the index, is far better qualified to respond to than I am. But I do want to say something from a more psychological, behavioural economics, political economy perspective. Why is it so many people have fallen into the habit of treating GDP as though it was a measure of social progress, even though it isn’t? The first part of my explanation is that economists, by their behaviour rather than their conceptual understanding, have led the uninitiated - politicians, business people, the media - into assuming GDP is the only indicator that matters because they get so excited about it so often, and don’t get so excited about anything else.

They say that what gets measured gets managed, and what doesn’t get measured doesn’t get managed, so if you accept there’s more to our wellbeing that just GDP (or even rinndi) that’s the first reason for wanting to publish something to sit beside GDP. In terms of human psychology, part of the reason for the great attention GDP gets is that new figures are published so frequently and that they’re always changing to an interesting extent.

Finally, we know from the findings of neuroscience that, contrary to our assumption of rationality, humans have surprisingly limited mental processing power and can’t weight up more than one or two dimensions of a problem at the same time, which - among many other implications - means humans are irresistibly attracted to bottom lines - to ‘net net’, as they say in the markets. People want a bottom line, will probably pick one by default, and GDP looks likes it is one. Dashboards may be more methodologically pure, but in a world of human frailty and limited attention, they just don’t cut it.