GDP as a measure of economic growth and standard of living

AS Macro – 2014

GDP

• GDP is Gross Domestic Product

• GDP is the total value of output of goods and services produced within an economy in a given period of time

Economic Growth• Economic growth is the increase in value

of the goods and services produced by an economy over a period of time

• It is conventionally measured as the per cent rate of increase in real GDP

• Growth is usually calculated in real terms, i.e. inflation-adjusted terms, in order to net out the effect of inflation on the price of the goods and services produced

• In economics, "economic growth" typically refers to growth of potential output i.e., production at full employment, which is caused by growth in aggregate demand or observed output (GDP).

GDP as a measure of living standards

• Ceteris paribus, the standard of living tends to increase when GDP per capita increases

• This makes GDP a proxy (equivalent) for standard of living, rather than a direct measure of it

• GDP has the key attraction of internationally agreed standards for calculation

Gross National Product or Income

• GNP is the total value of all final goods and services produced within a nation in a particular year plus net income from overseas investments and remittances

• Remittance money transfers are hugely important for some countriesRemittance flows to the developing world exceeded $406 billion in 2012

Remittance Incomes in 2012

• 2012 are India ($70 billion), China ($66 billion), the Philippines and Mexico ($24 billion each), and Nigeria ($21 billion).

• Other large recipients include Egypt, Pakistan, Bangladesh, Vietnam, and Lebanon.

Remittance Incomes in 2012

• As a percentage of GDP, the top recipients of remittances, in 2011, were – Tajikistan (47 percent)– Liberia (31 percent)– Lesotho (27 percent)– Moldova (23 percent)– Nepal (22 percent)– Samoa (21 percent)

Real GNI per capita ($)• Real

– Adjusts for the effects of price changes / inflation

• Per capita– Divides by

the published resident population to give a figure for output per person

Real GNI per capita, PPP

• PPP stands for purchasing power parity

• PPP measures how many units of one country’s currency are needed to buy exactly the same basket of goods and services as can be bought with a given amount of another country’s currency

Real GDP Per CapitaCountry 2012 GDP per capita (at

constant 2005 prices, PPP, US $)

Singapore 64,309United Kingdom 38,969South Korea 33,049Malaysia 16,406China 8,902India 3,844Vietnam 3,616Ghana 1,982Bangladesh 1,882

Problems with using real GDP per capita as an indicator of standard of living

Quality of Life

Human Happiness

Non Market Activities

Beyond Markets

Environmental Factors

Externalities

Informal Economy

Black Market

The Long Run View

Sustainability

Balance of spending

Make up of GDP

Happiness and Well-Being• Human happiness determined by many other things

than physical goods and services– Changes in the number of hours worked

• Rising national output might have been achieved at the expense of leisure time if workers are working longer hours

• Greek workers put in longer hours than anyone else in Europe — 42.2 per week, compared to just 35.6 in Germany (ONS data)

• In the UK, in 1992 we used to work 38.1 hours, in 2011 it had fallen to 36.3 hours.

– A reduction in working week hours or number of annual days’ holiday will adversely affect GDP… but positively affect welfare…

– So a good measure of the standard of living should include a measure of the increased value of leisure that society gets

– Key issue is how we go about valuing life expectancy

Quality of Life

Human Happiness

Happiness and Well-Being

Quality of Life

Human Happiness

Non Market Activities• Not all activities have a market price attached to them• Services of housewives/house-husbands • Value of home schooling / caring for a relative• 2008 survey estimated that the average stay-at-home-

parent’s salary would be around £30,000 (if you were to use market prices for the ironing, washing, cooking, cleaning, school run they do every day).

• It ignores volunteer, unpaid work. For example, Linux contributes nothing to GDP, but it was estimated that it would have cost more than a billion US dollars for a commercial company to develop.

• It ignores such things as going for a walk in the mountains or a cycle ride, if no price is paid to do such activities

Non Market Activities

Beyond Markets

Environmental Factors• Environmental costs such as pollution, worsening air

quality would reduce the true value of GNP• GDP counts work that produces no net change or that

results from repairing harm. For example, rebuilding after a natural disaster or war may produce a considerable amount of economic activity and thus boost GDP, but it would have been far better if the disaster had never occurred in the first place.

• The current system counts oil spills and wars as contributors to economic growth

• Calculating green GDP requires that net natural capital consumption, including resource depletion, environmental degradation, and protective and restorative environmental initiatives, be subtracted from traditional GDP

Environmental Factors

Externalities

The Shadow Economy• Official GDP estimates may not take into account the

black market, where the money spent is not registered resulting in inaccurate or abnormally low GDP figures

• The size of the black/informal economy differs between countries – particularly bigger in LEDC’s, with poor tax collection services

• Some think tanks put estimates of Britain's shadow economy being now worth £150bn a year (2013), around 10% of total GDP

• The scale of the underground economy is estimated to average 15% of national output for rich economies and 33% of national output for emerging economies

• Some countries adjust figures for the shadow economy (for example, Italy) and others do not

Informal Economy

Black Market

The Shadow Economy

Informal Economy

Black Market

Sustainability of Growth (1)• GDP does not measure the sustainability of growth• A country may achieve a temporarily high GDP by over-

exploiting natural resources or by misallocating investment

• Many countries rich with natural resources remain poor – this is known as the natural resource curse

• Other countries have successfully invested incomes from their endowment of natural resources to build a more sustainable growth model– Norway – one of the biggest sovereign wealth funds in the world

- estimated to be worth $1tr (£0.6tr) by 2020– Uganda - The 2008 National Oil and Gas Policy required that

an appropriate framework be put in place to aid the sustainable management of oil and gas revenues.

The Long Run View

Sustainability

Ecological Footprint

Carbon Productivity and HDI

Sustainability of Growth (2)• Economies experiencing an economic bubble, such

as a housing bubble or stock bubble, or a low private-saving rate tend to appear to grow faster due to higher consumption, having higher current growth

• But the cost of this will be lower future growth• Japan for example in the 1980s experienced a

spectacular property bubble and then bust and stagnation for two decades (‘the Lost Decades’). (Between 1985-1991, commercial land prices rose 302.9%; and by 1986, the average for 1 square metre of land in Tokyo’s commercial districts cost $25,000).

The Long Run View

Sustainability

The Make Up of GDP (1)• The composition of GDP may be very different• E.g. defence versus consumer goods • A country that produces all military gods and services

may have a high GDP…• But it will have a lower level of welfare if society

doesn’t value that military expenditure, and would prefer some consumer goods

• Defence expenditure as a % of GDP– Japan 1%– Lebanon 4.4%– Saudi Arabia 8.4%– UK 2.6%– USA 4.7% (World Bank, 2011).

Balance of spending

Make up of GDP

Military Spend as % of GDP

Balance of spending

Make up of GDP

Military Spend and HDI

Balance of spending

Make up of GDP

The Make Up of GDP (2)• Short term versus long term – Standard of living effects

(capital versus consumer goods)• The balance between consumption and investment• If an economy devotes too many resources to satisfying

the short run needs & wants of consumers, there may be insufficient resources for investment needed for long term economic development.

• China investment reached a high of c.47% of GDP in the last few years, whilst it’s consumption was around c.20%; whilst in UK consumption is around c.65%

• Faster economic growth might improve living standards today but lead to an over-exploitation of scarce finite economic resources thereby limiting future growth prospects for next generations

Balance of spending

Make up of GDP

A key issue – who gains from growth?

Distribution of income & wealth

Inequality

Rising per capita incomes may go hand in hand with an increase in the scale of income inequality

This can be measured by an indicator known as the Gini co-efficient

Regional inequalities within a country may also widen

Within each region there are also areas of relative prosperity contrasting with unemployment black-spots and deep-rooted social and economic deprivation

Robert Kennedy on GDP• “The gross national product includes air pollution and

advertising for cigarettes and ambulances to clear our highways of carnage. It counts special locks for our doors and jails for the people who break them. GNP includes the destruction of the redwoods and the death of Lake Superior. It grows with the production of napalm, and missiles and nuclear warheads... it does not allow for the health of our families, the quality of their education, or the joy of their play. It is indifferent to the decency of our factories and the safety of our streets alike. 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.”

The UNDP Human Development Index

• Human Development Index (HDI): • A composite index measuring average

achievement in three basic dimensions of human development-a long and healthy life, knowledge and a decent standard of living

Composition of the HDI

1. Knowledge: First an educational component made up of two statistics – mean years of schooling and expected years of schooling

2. Long and healthy life: Second a life expectancy component is calculated using a minimum value for life expectancy of 25 years and maximum value of 85 years

3. A decent standard of living: The final element is gross national income (GNI) per capita adjusted to purchasing power parity standard (PPP)

Gross National Income per capita

HDI Progress• The UNDP classifies each

country into one of three development bins:

• Low human development for HDI scores between 0.0 and 0.5

• Medium human development for HDI scores between 0.5 and 0.8

• High human development for HDI scores between 0.8 and 1.0

Big Improvers

GDP and HDI Ranking

HDI rank < GDP rank suggests that a country is using its wealth less effectively to improve the lives of its people.

Of course, this assumes that HDI is an accurate measure of quality of life.......

Trade Integration and HDI progress

Limitations of the HDI• The HDI notably fails to take account of qualitative factors, such as cultural identity and

political freedoms (human security, gender opportunities and human rights for example) • Many argue that the HDI should become more human-centred and expanded to include more

dimensions, ranging from gender equity to environmental biodiversity• The GNP per capita figure – and consequently the HDI figure – takes no account of income

distribution. If income is unevenly distributed, then GNP per capita will be an inaccurate measure of the monetary well-being of the people. Inequitable development is not human development

• PPP values change very quickly and are likely to be inaccurate or misleading• The 2010 edition of the Human Development Report marked the launch of a new Inequality-

adjusted HDI and also a Gender Inequality Index and a Multidimensional Poverty Index• Inequality HDI - The average loss in the HDI due to inequality is about 23 per cent—that is,

adjusted for inequality, the global HDI of 0.682 in 2011 would fall to 0.525• Key point: the HDI is intended to allow economists to draw broad conclusions about which

countries enjoy relatively high standards of living, and which are, by comparison, under-developed

Multidimensional Poverty Index • First introduced in 2010 and it an attempt designed to illustrate the many deprivations

faced by the most severely disadvantaged. The MPI requires a household to be deprived in multiple indicators at the same time. A person is multi-dimensionally poor if the weighted indicators in which he or she is deprived add up to at least 33%. The MPI is closely linked to the Millennium Development Goals targets and includes ten components:

• 1. Possession of some assets• 2. Nutrition• 3. Child mortality• 4. Access to drinking water• 5. Access to sanitation• 6. Access to a safe room• 7. Access to electricity• 8. Access to an improved cooking oil• 9. Years of schooling• 10. Children enrolled in school

Multidimensional Poverty Index

More Summary Indices of Welfare

Happy Planet Index Genuine Progress Indicator

OECD Better Life Index

More great study resources from tutor2u:

Economics Blog

AS Macro Revision Notes