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Gross Domestic Product (GDP) is one of the most commonly used economic indicators. It refers to the value of all the goods and services that a specific economy produces during a given period. GDP, as an economic indicator, is based on the premise that economic well-being cannot occur in any society without the corresponding increase in real Gross Domestic Product. It is an aggregate of value addition in a country, and its widespread use has been founded on its ability to stimulate economic activity in a country. The more market activity there is in an economy, the better the GDP, and thus a country is. GDP, together with most of the alternatives developed after that as measures of economic well-being, have numerous flaws because they do not consider all aspects of economic and social growth, and this necessitates the development of a better index. [Need an essay writing service? Find help here.]
The origin of GDP as an economic index can be traced to the 1940’s, a period when most world economies were facing challenges (Daga, 2014). The great depression, as this period is often referred to, put a lot of pressure on Washington to come up with a way of accounting for government spending on war and provision of services. Economists came up with the GDP as a measure not only to meet the two goals stated above but also to gauge the performance of the economy as the US went into WWII. However, it took more than two years for the GDP to gain global acceptance and use (Daga, 2014). During this time, economists were developing measures to quantify economic prosperity. The outcome was a comprehensive index based on a complicated formula that provided a general view of the economic well-being of a nation. By mid-1960’s, GDP as a measure of economic prosperity had gained global recognition and acceptance (Daga, 2014).[“Write my essay for me?” Get help here.]
The GPD, despite its widespread use, has several shortcomings. One of these faults is that the core tenet on which it is based is not necessarily true. The assumption that a growing GDP corresponds to an improving well-being of the population is not necessarily correct. To exemplify this, GDP in the US estimates the total dollar value of all the goods and services produced (Schwartz, 2015). However, an enhanced production of goods and services does not imply that the standards of living of people are improving. Likewise, a decline in GDP does not mean that the living conditions of individuals are deteriorating. For example, the US economy shrank by a significant margin in the two years in the period ending 2015. In the first quarter of 2015, it decreased by 0.7% (Schwartz, 2015). Thus, the total value of goods and services sold during this period declined.
By applying the logic behind GDP, the living standards of US citizens declined to some extent in that period. However, this was not true for it is during that time that the living standards of U.S citizens climbed to its highest in the last seven years. McCarthy (2015) confirms that 81% of the U.S citizens were satisfied with their living standards, with 61% saying that the living standards were improving. In this case, the principles of GDP did not hold, since the living standards were expected to worsen during the mentioned period.
The other shortcoming of GDP as an economic index is that it does not take into account the amount of debt a country has. In GD, there is the assumption that debt does not exist; to a great extent, failure to take into account the amount of debt a country has compromises its ability to give the accurate picture of an economy. It is not a good measure of a country’s wealth for it ignores the country’s liabilities. A country can have a large GDP, yet its debt compromises its ability to offer services to the citizens and slows down economic activity. Repayment of debt also translates to decreased economic activity in the future. The government will have to raise taxes to repay its current debt. The effect of this debt will be reflected in a decrease in GDP. If GDP rankings took consideration of national debts, some of the countries that rank highly regarding GDP would fall to the bottom of the ranks, and vice versa. [Click Essay Writer to order your essay]
Japan, for example, is ranked fourth in the nominal GDP ranking, after the U.S, European Union, and China (Hollomon, 2015). However, Japan has the highest GDP to debt ratio. If the effects of this debt and its payment were factored into the GDP calculation, Japan would be ranked lower than some sub-Saharan countries such as Zimbabwe, which have smaller GDP to debt ratios (Hollomon, 2015). GDP is thus more accurate as a measure of the economic activity of a nation.
The other shortcoming of GDP is that it does not gauge the quality of the environment. Navarro reiterates that the GDP ignores the effect that the production processes of goods and services have on the environment (2006). A country may, for example, raise its GDP by easing its environmental protection laws. Softening pollution laws may make it easier for companies to produce goods and services. In turn, this will increase the GDP of that country; however, it will destroy the environment. If the adverse effect resulting from such productions are not considered, such a country will be ranked higher than other countries with more stringent pollution laws.
China best exemplifies the phenomenon described above. To a large extent, China’s economic growth has been enhanced by its lax environmental protection laws. Chinese companies have little to worry about regarding the damage they cause to the environment, and this makes it easier for them to produce goods and services (Navarro, 2006). In the US, environmental pollution rules are very strict, and in some way, it limits their abilities to produce goods and services. On this perspective, China is likely to have a larger GDP than the USA. However, if the amount of pollution caused by the production of goods and services in the two countries were factored in, this would not hold. The higher GDP in China comes at a significant environmental cost because, in the process, air, water, and other resources are increasingly polluted.
Another inadequacy of the GDP is that it relies on statistics that are not easy to gather. According to a report by the OECD Observer (2004), total production occurring in a given country over a specified period is not easy to quantify; it is hard to accurately sum up the total value of goods and service produced. Some activities and products produced are not captured. Also, some aspects such as domestic work done at home are often not captured in the statistics used in GDP calculations. The report suggests that care given by a mother to her children at home, for example, increases domestic output and needs to be considered. Revenue from the underground economy also should be included in the calculation of GDP. Also, it is not easy to accurately quantify output from services that do not have specific prices such as public health and education (OECD Observer, 2004).
The flaws (of GDP) discussed above portray it as largely inefficient. It is depicted as an inconclusive economic index that measures income without considering inequality. Moreover, it is a value that measures growth without taking into account destruction and also a measure that ignores factors such as economic destruction and social cohesion. However, despite all these limitations, governments still continue using it. The main reason for this illogicality is that no other economic index gives a more comprehensive view of the economy as GDP. From this single number, you get an idea of whether the economy is growing or not, which is a crucial data for economists. It enables them to make policies to steer the economy towards growth and prosperity. Economic growth has its benefits. With a few amendments to its policies, GDP would become more accurate and the best economic index. I strongly advocate for its use over other economic indices.[Click Essay Writer to order your essay]
Evaluation of Alternative Economic Indices
With time, the use of GDP as a measure of the economic well-being started to attract a lot of criticism. Critics argue that economies need a measure that considers both the positive and the negative aspects. GDP was seen to ignore all the negative factors that affect the economy. More elaborate measures, ones that appreciated the fact that people live in an environment of risk, were developed. Human Development Index (HDI), Green GDP, and Genuine Progress Indicator (GPI) were some of them (Worstall, 2014).
Green GDP
Green GDP, as an economic index, is a modification of the normal GPD. It was developed by Joseph Stiglitz in the 60’s. Stiglitz was motivated by the need to create an index that could measure externalities to separate them from economic development. By developing such an index, Stiglitz would solve the main shortcoming of GDP (Daga, 2014). Stiglitz’s efforts culminated into a measure that accurately measures costs and as well as benefits that were not measured in the normal GDP. These are the costs and benefit
According to Gertner (2010), the basic premise behind Green GDP is that there exist significant differences on unmeasured aspects of economic welfare, and failure to take them into account makes the comparison of different economies challenging and inaccurate. Factoring in these externalities in the measurement of a country’s economic well-being would provide an accurate picture of how countries compared. Pollution, congestion, and insecurity are examples of these externalities.
To exemplify the effect of these externalities on GDP, traffic jams and congestion can be used. Increased traffic jams and congestion can lead to a higher GDP in the essence that vehicles stuck in traffic jams will consume more fuel. More fuel consumption translates to increased money pumped into the economy. However, this does not translate to improved standards of life for citizens.
Also, citizens of a country such as China where air pollution is rampant may have numerous concerns about the quality of air. If such complaints are ignored when measuring the living standards of citizens, then the results of the economic comparison between countries would be wrong. Since pollution can be monitored and measured, it is appropriate that it is factored in in GDP calculations as an externality affecting the wellbeing of citizens.
The main shortcoming with Green GDP is that it fails to consider the physical and mental welfare of citizens. Spiritual wellness, emotional well-being, cultural awareness, and mental health are for example not taken into consideration. These may seem trivial, but they have a huge bearing on social capital measurement (Gertner, 2010). Due to the dynamic nature of the externalities rating, the overall progress that a country makes over time becomes challenging. New externalities appear and existing ones disappear over time. Also, international comparisons become difficult to make due to the complexity of the approach used to arrive at the final Green GDP figure.
Genuine Progress Indicator (GPI)
The genuine progress indicator is another alternative to normal GDP in the measurement of the economic well-being of an economy. Daga (2014) mentions that the main strength of the GPI is that it is expressed in monetary terms, a fact that makes it a more comparable index. It is easier to compare the economic prosperity of nations when using the GPI. In arriving at the final GPI figure, economists consider annual income, net savings, environmental costs, wealth, among other factors (Daga, 2014).
Specifically, GPI takes into account a total of 26 social, economic, and environmental factors (Daga, 2014). With such a wide range of factors taken into consideration, the economic well-being metric obtained is more accurate compared to the one obtained through standard GDP. Genuine Progress Indicator gives a more precise picture of the progress of a country, as well as the setbacks that are holding its economic prosperity.
The GPI, as a measure of economic well-being, takes into consideration factors such as pollution, crime, the value of education, congestion, volunteer work, leisure time, and infrastructure (Kubiszewski et al., 2013). In that case, it tries to show the actual impact of policies and gives a vivid picture of economic progress.
As Worstall (2014) writes, the main shortcoming of the GPI is the long process used to arrive at the final figure. When calculating GPI, there is always the risk that some expenses and costs may be included twice. Many controversies exist on how specifically the GPI should be obtained, and how the 26 stated factors are to be quantified. However, it is a better measure of economic progress when compared to normal GDP.
Human Development Index
The human development index (HDI) is one of the few alternative economic indices that take a purely social approach. Daga (2014) expresses that the HDI was developed by Mahbub Haq and Amartya Sen as an economic index meant to measure development and well-being of people using UNDP’S annual publication on human development. Basically, the HDI emerged as a critic to the ordinary GDP. It specifically came to address the inconveniences brought about by the assumption that the better the economy, the better the living standards for the citizens of a country. Mahbub and Amartya sought to develop an index that was not just a mere indicator of a country’s economic output; they came up with the HDI, which according to them, would rank countries from the highest to the lowest by three factors (Daga, 2014).
One of these factors is the longevity of life which is measured through life expectancy ratings at birth (Daga, 2014). A country with higher life expectancy rates was to be given a better longevity rating than one that has lower life expectancies. This was, it was possible for economists measuring economic well-being of countries to incorporate the effect of morbidity and mortality rate into the economic prosperity calculations. Mortality and morbidity rates are important indicators of the quality of life in a given country. Higher mortality and morbidity rates are associated with poverty, a high prevalence of diseases, and illiteracy.
The other factor is knowledge; it is measured as a weighted average of adult literacy and the mean years of schools (Daga, 2014). It is vital to consider the knowledge and education in the measurement of the economic well-being of a country because education is tied to economic productivity and welfare of a country. Countries with more educated people tend to have better standards of living and vice versa.
Income is the third factor put under consideration in the HDI method of measuring economic well-being of a country. The HDI usually categorizes countries into four levels of human development; countries with higher lifespan, better education, her per capita GDP, and lower fertility rates score higher than those with the opposite traits (Daga, 2014). When calculating per capita GDP, economists using this approach are required first to adjust for currency variations. In the year 2010, a new concept aimed at factoring in income inequalities was introduced in the measurement of HDI. According to Talberth, Cobb, and Slattery (2015), inequality-adjusted the HDI, unlike normal HID, shows the actual levels of human development by adjusting for disparities in income.
The major criticism for the HDI is that it fails to consider ecological and technological development and how they affect human civilization. It is also criticized for giving too much attention to national performance ranking (Daga, 2014).
The three alternative economic well-being indices all have strengths and weaknesses. Just like the GDP, none of these indices is self-sufficient. Despite the fact that they address most of the shortcomings of GDP, none of them can be more useful in economic planning than GDP. The complexity of the processes used to attain the final figure and the many opportunities it creates for errors and gives the GDP an edge over them. They make it difficult for economists to compare the economic performance of nations on similar grounds
Suggested Future Economic Index – CEIU Indicator
All the indices reviewed above have one flaw in common: they do not strike a balance between their consideration on economic development and social welfare of people. A measure either places too much focus on economic development ignoring major aspects of social welfare or vice versa (Stahel, 2010). It thus leads to a situation where each and every of these indices presents an inaccurate picture of the economic reality in a country. Most of these indices, for example, fall short in the measurement of the economic aspect of social development.
According to Stahel (2010), considering that a proper economic analysis is a vital tool for social and economic progress, there is the need for a more precise indicator that balances between social welfare and economic growth. This tool will be useful for the current environment of escalating social tensions, financial crises, and ecological disasters. The suggested CEIU Indicator takes all these factors into consideration and promises to be the best economic indicator. It will elaborately address the flaws GDP, the most widely used economic indicator in the globe.
The proposed index will focus on the following measures: household consumption, government services, related expenditure, income inequality, and unemployment. It will be based on the principle that since there is a great difference between economic development and social growth, failure to adequately account for any of them leads to inaccurate results. The index seeks to make a clear distinction between measures and indicators. Measures should be used for economic growth while indicators will be used for social development. This distinction was necessitated by the realization that while aspects of economic growth such as income are easy to measure, aspects of social growth such as cultural awareness are primarily qualitative and difficult to measure.
To identify the metrics and measures to be used in the new CEIU Indicator, it is important first to determine the factors that are commonly covered by the conventional indices. Most economic indices currently in use focus on one or more of the following factors: economic welfare, sustainable development, human well-being, prosperity, or economic growth (Kubiszewski et al., 2013). However, no index currently considers all these factors together. CEIU seeks to overcome this shortcoming by including measures or indicators for each of these factors. It will have six metrics that will comprehensively cover the factors stated above.
The first will be human welfare expenditure which represents that portion of public spending that directly impacts the wellbeing of the people in a given economy. Second will be disposal personal income which will focus on that part of a nation’s income that trickles down to households and individuals for the purpose of promoting their welfare. Third, there will be income inequality which will enable the index to adjust per capita income to reflect adverse impacts of income inequality on the well-being of people and households.
Also, there will be a full employment indicator that will help the index identify the levels of employment or unemployment that impact the utilization of human capital. Additionally, there will be the combined educational enrolment indicator that will enable the index to consider and factor in the impact of current investments in education. Lastly, there will be an energy efficiency index that will factor in the changes in the efficiency of fossil fuel sources over time. This will be necessary for the measurement of sustainability.
One of the major strengths with this proposed index will be that it integrates social, economic, and ecological factors, thus making it a robust tool for measurement of the economic wealth of a nation. Other indices such as the GDP fail to consider one or two of these factors effectively.
The other strength of this proposed index is that it will be based purely on monetary terms and will rely on data that is readily available from international organizations and governmental institutes from more than 100 countries. As Daga (2014) states, the inadequacy of date is one of the factors that compromise the currently available indices. This will make it a more accurate and reliable index.
CEIU, just like any index, is expected to have its own share of drawbacks. Its main drawback is that just like the GDP and other economic indices discussed, it does not take into account the unwanted effects of risk, uncertainty, non-monetized activities, as well as money from the underground economy. The other drawback is that it does not accurately and perfectly measure economic sustainability. It does not take into account the social, organizational, cultural, and technological factors that contribute to the capacity of a given country to evolve and become better over time. In evaluating its effectiveness, data currently present will be used. In this world of uncertainty and risk, societal sustainability is an issue that warrants a lot of seriousness.[Need an essay writing service? Find help here.]
To wrap up, the GDP is one of the most conclusive economic indices in use currently. It measures the value of goods and services an economy generates. However, the GDP has many flaws and alternatives have been developed. The Green GDP, Human Development Index, and Genuine Progress Indicator are three of the alternatives already developed. However, these indices do not conclusively address the weaknesses of GDP, and this justifies the development of another index. The CEIU index would be a good index to be used in the future. It considers costs, expenditure, inequalities, and unemployment. It is a suitable index that balances between the emphasis on economic and social growth.
References
Daga, G. (2014). Towards a new development paradigm: Critical analysis of gross national happiness (Unpublished master’s thesis).
OECD Observer. (2004). Is GDP a satisfactory measure of growth?.
Kubiszewski, I., Costanza, R., Franco, C., Lawn, P., Talberth, J., Jackson, T., & Aylmer, C. (2013). Beyond GDP: Measuring and achieving global genuine progress. Ecological Economics, 93(C), 57-68.
McCarthy, J. (2015). U.S. Standard of Living Index Climbs to Highest in 7 Years.
Navarro, P. (2006). The Economics of the “China Price”. China Perspectives, 68, 13-27.
Stahel, W. (2010). Global change, acts of God, acts of man, acts of nature and systemic risks. Risk Management, (47)
Talberth, J., Cobb, C., & Slattery, N. (2015). The genuine progress indicator 2006: a tool for sustainable development. Oakland: Redefining Progress.
Worstall, T. (2014). The problems with using GPI rather than GDP. Forbes. Retrieved from
Gertner, J. (2010, May 13). The rise and fall of the G.D.P. The New York Times Magazine.
Hollomon, J. (2015, June 27). What are some problems with using GDP as a measure of economic development?
Schwartz, N. (2015). U.S. economy contracted 0.7% in first quarter. The New York Times.
