Why GDP is no longer the most effective measure of economic success

As a macroeconomic indicator, GDP fails to capture much of the value created in the modern world. New metrics promise to track everything from happiness to natural capital

New Zealand Prime Minister Jacinda Ardern announcing the country’s wellbeing budget, reflecting a change in thinking from GDP being the only viable measure of national prosperity 

At the World Economic Forum’s 49th annual meeting in Davos, New Zealand Prime Minister Jacinda Ardern revealed that she would create the world’s first ‘wellbeing budget’ in order to prioritise the health and welfare of her country’s citizens. She said: “We need to address the societal wellbeing of our nation, not just the economic wellbeing.”

Economic growth – and, by proxy, wellbeing – is currently measured by gross domestic product (GDP). As the framework upon which governments build countless policies, GDP aims to track the production of all goods and services bought and sold in an economy each year.

The measure has become a critical tool used by economists, politicians and academics to understand society. It has been labelled “the most powerful statistical figure in human history” by author and lecturer Philipp Lepenies, and named “one of the great inventions of the 20th century” by the Federal Reserve Bank of St Louis. Today, however, GDP’s purpose is being called into question.

GDP is not the precise and flawless figure that many believe it to be – it is
merely an estimate

Coming up short
Having become such a familiar macroeconomic metric, it is easy to forget that GDP is a relatively modern invention. The framework for monitoring economic growth was created for the US Government by Russian-born economist Simon Kuznets in the aftermath of the Great Depression, before modifications made by British economist John Maynard Keynes turned it into the indicator we know today.

In an independent review of the UK’s economic statistics published in 2016, Sir Charles Bean wrote that GDP is often viewed as a “summary statistic” for the health of the economy. This means it is frequently conflated with wealth or welfare, though it only measures income. “Importantly, GDP… does not reflect economic inequality or sustainability (environmental, financial or [otherwise]),” Bean wrote. What’s more, GDP is not the precise and flawless figure that many believe it to be – it is merely an estimate. “This uncertainty surrounding official measures of GDP is inadequately recognised in public discourse, with commentators frequently attributing spurious precision to the estimates,” Bean continued.

Sarah Arnold, Senior Economist at the New Economics Foundation (NEF), told World Finance that GDP as a measure of economic activity is simply a means to an end: “It has become so synonymous with national success that the rationale for pursuing economic growth in the first place seems to have been long forgotten.”

Putting the flaws highlighted by Bean and Arnold aside, GDP is still an inaccurate measure of prosperity, as it fails to convey much of the value created in the modern world. GDP was developed during the manufacturing age and, as David Pilling, Africa Editor of the Financial Times, wrote in his book The Growth Delusion: Wealth, Poverty and the Wellbeing of Nations: “[GDP] is not bad at accounting for production of bricks, steel bars and bicycles.” Where it struggles, though, is with the service economy, a segment that accounts for a growing proportion of high-income countries’ economies (see Fig 1). “[Try GDP] out on haircuts, psychoanalysis sessions or music downloads and it becomes distinctly fuzzy,” Pilling wrote.

GDP’s preference for tangible goods also means it is insufficient at capturing the value of technology. Where disruptive innovations have made life easier for consumers – allowing them to book their own flights rather than paying a travel agent, for instance – GDP only sees a shrinking economy. “Lots of what tech is doing is destroying what wasn’t needed,” Will Page, Director of Economics at Spotify, told Pilling. “The end result is you’re going to have less of an economy, but higher welfare.”

Countless free online services have moved outside the realm of economic activity measured by GDP, including Google, YouTube and Wikipedia. In the eyes of GDP, innovation – even if it means a better quality of service – is often a detractor of economic growth. Elsewhere, valuable areas of work have always existed outside of the GDP framework, including housework, caring for sick family members or friends, and volunteering. The impact of this work is unaccounted for simply because no money changes hands.

In a 2014 speech, Andrew Haldane, Chief Economist of the Bank of England, said the economic value of volunteering could exceed £50bn ($63.7bn) per year – and that is before tallying up the impact on the volunteers’ wellbeing, which includes reducing stress, improving physical health and learning new skills.

The bigger picture
In 1968, Robert Kennedy, the brother of US President John F Kennedy, criticised gross national product – a similar measure to GDP – by saying it “measures everything, in short, except that which makes life worthwhile”. Arnold believes this observation is still true today: “GDP is not a particularly useful measure in and of itself because it doesn’t tell us much about the direction of our economic activity or help us to determine how to govern it.”

The NEF believes there are five indicators that GDP doesn’t take into account that could help measure national success more accurately: job quality, wellbeing, carbon emissions, inequality, and physical health. “We know what a good economy that allows people to flourish should be,” Arnold said. “A good economy meets everyone’s basic needs; it means people are healthy and happy, and it does not stoke potential long-term trouble, such as extreme inequality.”

The World Bank has also created a more robust measure of economic growth: comprehensive wealth. Comprehensive wealth, it argues, takes into account both income and associated costs in a number of areas, providing a fuller picture of economic wellbeing and a more sustainable pathway for growth. “Used alone, GDP may provide misleading signals about the health of an economy,” the World Bank’s The Changing Wealth of Nations 2018 report read. “It does not reflect depreciation and depletion of assets, whether investment and accumulation of wealth are keeping pace with population growth, or whether the mix of assets is consistent with a country’s development goals.”

For GDP, which does not distinguish between good and bad production, bigger is always better. “GDP includes activities that are detrimental to our economy and society in the long term, such as deforestation, strip mining, overfishing and so on,” Arnold said. Wars and natural disasters, too, can be a boon to GDP as a result of the associated increase in spending. Comprehensive wealth, on the other hand, accounts for all of a country’s assets, including: produced capital, such as factories and machinery; natural capital, like forests and fossil fuels; human capital, including the value of future earnings for the labour force; and net foreign assets.

GDP’s neglect of natural capital in particular has received more attention in recent years. Natural assets, such as forests, fisheries and the atmosphere, are often regarded as self-sustaining, fixed assets. In actual fact, all of these resources can be – and are being – depleted by humans. Since the 1990s, economists have looked into the possibility of putting a price tag on natural resources to ensure their value is taken seriously. Ecological economist Robert Costanza published a paper entitled The Value of the World’s Ecosystem Services and Natural Capital in Nature in 1997 that valued the whole of the natural world at $33trn. While Costanza’s research was highly controversial, the idea of accounting for natural depletion within the landscape of economic growth is becoming more common. As Pilling wrote: “If you don’t put a monetary value on something, people tend not to value it at all.”

The price of happiness
Experts are working to pin down a number of intangible qualities that contribute to the health of an economy, such as happiness and knowledge. Several indicators have been developed to provide a means for countries to monitor their progress in these areas. One such example is the UN’s Human Development Index (HDI), which evaluates a nation’s citizens in terms of their health, knowledge and standard of living. To do this, it tracks achievements in areas such as life expectancy at birth, years of schooling and gross national income per capita.

The UN admitted its index only provides a window into human development and fails to account for aspects such as inequality, poverty, human security or empowerment. But since its development in 1990, the UN has also introduced other composite indices, including the Inequality-adjusted HDI, the Gender Inequality Index and the Gender Development Index. Other surveys and indices, meanwhile, aim to measure the even more subjective quality of happiness: Lord Richard Layard, a professor at the London School of Economics, has been a pioneer in this area, and believes the government should prioritise policies that boost happiness over growth. His research has gone on to influence international efforts to track happiness, such as the UN’s World Happiness Report, which provides an annual snapshot of how happy people around the world perceive themselves to be.

New Zealand’s wellbeing budget is not perfect, but it is a clear step away from a purely growth-driven view of success

Arthur Grimes, a professor of wellbeing and public policy at Victoria University of Wellington and a former chair of the Reserve Bank of New Zealand, pointed out that these lists still show some correlation between GDP and happiness: “It’s very rare to find a country that, overall, has higher wellbeing that isn’t rich.”

According to the 2019 World Happiness Report, the top five happiest countries in the world are Finland, Denmark, Norway, Iceland and the Netherlands. South Sudan, the Central African Republic, Afghanistan, Tanzania and Rwanda, meanwhile, sit at the bottom of the list. Grimes told World Finance that the top-ranking countries on happiness lists tend to be wealthy nations with a welfare state, adding: “Unfortunately, we’re all in that situation where you do have to keep up on things like GDP. But you shouldn’t focus on that solely.”

While GDP does have a part to play, other aspects that contribute to the World Happiness Report’s ranking include social support, healthy life expectancy, the freedom to make life choices, perceptions of corruption, and generosity. These traits provide pockets of insight often missed by other metrics, helping to explain why the US and the UK, which rank among the top five richest countries by GDP, sit 15th and 19th on the list in terms of happiness, or why Costa Rica, which ranks somewhere in the 70s in terms of GDP, wound up in 12th place.

“There are some rich countries that aren’t quite as happy as the others,” Grimes said. “They’re still in the top 20 in the world, [but] that measure is a really useful one because it does say, in countries like the US and the UK, there is something going a bit wrong there – they should be happier than they are.”

A New (Zealand) approach
While countries such as the UK, France and Australia have long been driving the conversation on welfare, New Zealand’s wellbeing budget – the specifics of which were unveiled in May 2019 – has been recognised as one of the first attempts to explicitly zero in on wellbeing across different parts of society.

For example, the budget set aside NZD 1.9bn ($1.25bn) for mental health initiatives in a bid to address New Zealand’s youth suicide rate, which is among the highest in the world. Spread over five years, the funding will establish a universal frontline mental health service aimed at helping the more than 300,000 people with moderate mental health and addiction needs in the country. “Mental health is no longer on the periphery of our health system,” Grant Robertson, New Zealand’s Minister of Finance, said at the budget’s unveiling. “It is front and centre of all of our wellbeing.”

In terms of mental health, Grimes said the budget has delivered above expectations. It also performed well in areas such as family violence and sexual violence – other categories New Zealand has typically struggled with in comparison to other developed countries. A record sum of NZD 320m ($210.6m) was announced for reducing domestic violence, while NZD 1bn ($656.3m) was earmarked to help vulnerable children.

Despite these positive steps, Grimes criticised the budget’s lack of concrete targets, with the exception of child poverty: “We have some major new expenditure initiatives, but they lack a corresponding set of outcome targets, making it difficult to evaluate whether the programmes are effective or not.”

New Zealand’s wellbeing budget is not perfect, but it is a clear step away from a purely growth-driven view of success. In order to accurately measure an economy’s health and wellbeing, and to change the way we think about prosperity, a range of robust indicators is needed. As Arnold said: “We pay attention to what we measure. Headline indicators that are widely reported shape the way we think about what it means to be successful.”

While GDP provides important insight into a country’s economic position, it is far from the whole picture. Armed with a clearer understanding of where true economic value is created, policymakers and business leaders will be able to determine new pathways to success.