Why relying on GDP as a measure of national wellbeing is misleading
Gross domestic product does not cater for cashless economy dominated by peasant farmers. Photo/Denish Ochieng
What you need to know:
Although many countries prefer the assessment tool, its limitations are ignored.
In my column last week, I made an argument cautioning us against being overly celebratory about the positive effects of the planned rebasing of Kenya’s gross domestic product (GDP).
The debate that ensued online as well as offline clearly portrayed to me that the simplicity of basic economic theory cannot be taken for granted.
Sampling some of the random readers’ mail I received, I sensed that while many of us are increasingly enlightened on matters economics, for a number of us, we still fall into the trap of consuming all economic theories as unquestionable facts.
Like the fact of GDP being the final measure of a country’s economic growth and wellbeing.
Suffice it to say, this is not true and has prompted me to seek to establish this very GDP attribute as a fallacy in today’s column.
As stated last week, GDP can be loosely defined as the market value of all goods and services produced within a country over a certain period of time (mostly one year).
For an item to be included in the GDP, generally, it must be final — intermediate goods are not valued — produced within the country regardless of the producer’s nationality, sold at a legal market, during the period under review.
Since GDP measures the value of the output, it lacks a mechanism of qualitatively measuring that output.
Take, for instance, a city like Nairobi. Assuming there is a traffic jam that causes cars to use more fuel than is otherwise normally the case over the same distance.
So, if before the traffic jam the total value of fuel consumed was $1,000 (Sh86,000) in a particular year and after the gridlock the total fuel used rises to $1,200 (Sh103,200) the following year, with all other factors like the price of fuel being constant, GDP measurement will show that household consumption will have increased by $200 (Sh17,200) and hence register nominal GDP growth of a massive 20 per cent.
While it is clear that this consumption has obviously increased, this rise is not a positive attribute and in a way actually erodes the standards of living of Nairobi residents.
Further, this consumption increases depletion of non-renewable natural resources like oil as well as increased emission of greenhouse gasses.
Yet, in showing a 20 per cent growth, statisticians would want the city residents to believe they are 20 per cent better off than the previous year, thanks to the new GDP numbers.
Indeed, the confession that the approach is an inaccurate indicator of national welfare was made by none other than one of the fathers of modern GDP measurements, Simon Kuznets, winner of the 1971 Nobel Memorial Prize in Economic Sciences.
In his 1933 treatise, he warns against the temptation to translate GDP into a welfare measure.
“A welfare measure runs in terms of subjective feelings, whose commensurability for various individuals is to be doubted and whose relation to the objectively perceptible economic goods is not, in the present state of knowledge, determined with sufficient precision to permit even purely qualitative economic analysis. Consequently, the concept of income enjoyed has to be abandoned.”
He is even more direct in his 1941 treatise: “Market prices (which determine GDP) are of course a far from perfect measure of how well goods satisfy society’s needs. But they are the sole practicable basis if the estimator is to follow the consensus of social opinion.”
While this limit of GDP as an economic statistical tool has been in existence for close to eight decades now, somehow, it has still gained root as the single most utilised economic measure in the world today with its shortcomings rarely given the prominence they deserve.
Actually, it wasn’t until February 2008 that French President Nicolas Sarkozy, unsatisfied with the available statistical information about the economy, commissioned renowned economics Professor Joseph Stigiltz alongside Amartya Sen and Jean-Paul Fitousi to conduct what has come to be accepted as the most comprehensive academic study into the limits of GDP as a measure of economic and social progress.
Their findings titled, ‘‘Report by the Commission on the Measurement of Economic Performance and Social Progress,’’ freely available online for download though voluminous, is a must read for all political leaders, policymakers, academics, civil society as well as anyone who cares about economics.
As expected, the report gives a damning indictment on the overreliance on GDP as a measure of economic welfare.
It proposes to introduce a new dynamic into economic measurement — sustainability where we not only measure our wealth today but also try to extrapolate whether it can last over time for future generations.
The report makes it clear that one of the biggest inadequacies of GDP compilation is a lack of capacity to compute goods and services produced at the household level.
This is extremely true, especially for third world countries. Take for instance a Kenyan rural economy. Consider a peasant farmer with a half an acre piece of land.
He keeps two cattle, rears some chicken and plants various crops for family consumption. He draws water from a nearby stream, does not sell any produce and really doesn’t need to buy anything to survive. Such a farmer operates what we may refer to as a cashless economy.
By GDP calculation, such a peasant farmer adds zero value to the economy because there is no market value to what he produces and consumes.
Even more absurdly, such a farmer is still considered to be living below poverty level since he earns less than a dollar a day.
Yet, consider a young man in the city who works for a cigarette manufacturer and is paid $2,000 (Sh172,000).
If he spends $1,800 (Sh149,400) on rent, food, clothes and entertainment, we say that he is not only building the GDP, but he is also reducing unemployment and is among the growing ‘middle class’.
This despite the fact that by working for a cigarette maker, he is doing more to hurt rather than build quality of life.
Alternative
Indeed, the absurdities of GDP as an economic measurement tool and national welfare indicator are so glaring, that it may be time to reconsider its usage altogether as we employ alternative indices.
Let me finish with remarks from former US Attorney General and Senator Robert Kennedy whose thoughts about GDP so much echo mine:
“GDP includes air pollution and advertising for cigarettes and ambulances to clear our highways of carnage...it does not allow for the health of our families, the quality of their education, or the joy of their play...It does not include the beauty of our poetry or the strength of our marriages, or the intelligence of our public debate or the integrity of our public officials. It measures everything, in short, except that which makes life worthwhile.”
