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Measures of social welfare

Dr. Simon Moss

Overview

Many indices have been developed to measure the social welfare or wellbeing of a nation, roughly equivalent to standard of living. These measures are intended to compare nations across time or with each other on facets of societal health and progress. The most common measure--although not specifically developed to assess social welfare--is growth in Gross Domestic Product or GDP. Many of the alternative measures are intended to override the drawbacks of GDP.

Gross domestic product

Gross domestic product or GDP is the market value of all the goods and services that are produced by a nation in one year. GDP per capita, and corrected for inflation, is often utilized as an index to company the social welfare or standing of living across nations or time.

Calculations of GDP

Three techniques can be applied to calculate GDP, called the products, income, and expenditure approach, all of which should yield the same answer.

GDP differs from gross national product. GDP represents the value of goods and services that are produced within the nation. Gross national product represents the value of goods and services that are produced by organizations or operations that are owned by the citizens of the nation.

Limitations of the GDP index

In 2008, van den Bergh summarized some of the key criticisms that have been directed to GDP. First, GDP merely focuses on the costs of goods and services instead of the benefits of these economic activities. This emphasis on costs, instead of a balance between costs and benefits, violates a key principle of bookkeeping.

Second, GDP is independent of the types of goods and services that are produced. For example, a nation might generate goods and services that enhance status but do not fulfill fundamental human needs, like shelter, food, and health. Indeed, this problem often arises when individuals purchase goods that increase their prestige, such as expensive TVs, while not sustaining the health of their family. Wellbeing will be undermined despite sizeable economic activity.

Third, despite increases in GDP between 1950 and 1970, reported levels of happiness and wellbeing have not increased and have arguably decreased, as many studies indicate. Hence, over time, no obvious association between GDP and wellbeing has been observed. According to the threshold hypothesis (e.g., Max-Neef 1995), once income levels exceed a specific level, happiness no longer tends to increase with growth. Indeed, the costs of growth might arguably outweigh the benefits.

Similar complications highlight that GDP is unlikely to be associated with wellbeing. The income of people relative to other similar citizens significantly affects wellbeing: An overall rise in GDP may not affect the relative income of people and, thus, not be especially consequential. Similarly, any effects of increases in income might be transient: Individuals adapt rapidly to material change (see also set point theory).

Fourth, GDP per capita disregards the distribution of income (see Sen, 1976, 1979). To illustrate, at higher levels of income, further increases do not greatly affect wellbeing, called the diminishing marginal utility of income. Therefore, an increase in GDP, if primarily ascribed to increases in the income of affluent people, is unlikely to enhance wellbeing. In contrast, the same increase in GDP, but primarily underpinned by increased income to deprived people, is more likely to enhance wellbeing.

Fifth, GDP disregarded transactions outside markets, such as informal exchanges of goods including voluntary work and childcare. Sometimes, these informal activities are then transferred to the formal market, artificially inflating GDP. The benefits of these exchanges, that is, were already enjoyed but were not reflected in the GDP until later.

Finally, GDP disregards many other issues, such as pollution of air, water, or natural resources or depletion of resources. Such damage is not included in GDP. Furthermore, subsequent attempts to rectify these problems will increase GDP. Hence, factors that compromise social welfare do not often reduce GDP. GDP will tend to overestimate wealth.

Rejoinders to the criticisms of GDP

Even economists who are aware of the challenges of GDP per capita still promulgate the use of this index. Specifically, they argue these problems are trivial (for a discussion, see van den Bergh, 2008). That is, they maintain that GDP per capita does not shape or influence many important decisions anyway: The limitations of this index are not consequential. Alternatively, they maintain the limitations of this index are minor in magnitude& GDP is thus perceived as informative even if imperfect.

These rejoinders can be challenged. GDP growth is often reported and is a key source of decisions by politicians. According to van den Bergh (2008), the number of internet hits for GDP can be five times the number of hits for social welfare. Limited growth is regarded by the public, investors, and even regulators as an adverse sign to the economic climate. Indeed, Bush did not ratify the Kyoto agreement, partly because of the purported effects of this policy on growth. Indeed, information about GDP can evoke inexorable cycles: A reported decline can reduce consumer confidence and thus further stifle growth.

Furthermore, the extent to which GDP is informative seems to be overrated. For example, many important indices of social welfare do not correlate with growth, at least after income exceeds a certain level (for a meta-analysis, see Easterly, 1999). One meta-analysis examined whether GDP growth is associated with democracy, individual rights, education, health, transport, communications, injustice, and so forth. Only about 10 out of 80 correlations were significant.

In addition, GDP growth is assumed to foster consumer confidence. Nevertheless, such growth also creates expectations of further growth. If these expectations are not fulfilled, a precipitous decline in consumer confidence can unfold.

Finally, growth is often assumed to promote or maintain employment. However, the association between growth and employment is complex. Unemployment rate depends on many other features of the economy, unrelated to growth, such as misalignment between education and work (see Pissarides, 2000) as well as the capacity to search for suitable jobs and employees. Growth in GDP does not always curb unemployment: growth may coincide with the disruption of traditional economic activities, increasing temporary unemployment. Similarly, jobs may be outsourced to other nations, while retaining GDP. Employment will enhance GDP but not always vice versa.

Corrected measures of GDP

Other measures of social welfare have been developed. Many of these measures, including the Index of Sustainable Economic Welfare, are corrections to GDP. Interestingly, between the 1960s and 1980s, this index has declined in many nations, even while GDP has increased. Unlike GDP, the Index of Sustainable Economic Welfare does depend on income distribution, contamination of resources and other costs that undermine instability (Daly & Cobb, 1989& for conceptual precursors of this index, see Nordhaus & Tobin, 1972). This index, therefore, overrides some of the drawbacks that GDP presents.

Roughly, this index equals personal consumption minus various costs--comprising the costs of environmental degradation, depreciation of natural resources, and private defensive expenditures. Furthermore, several costs are added, including capital formation, services from domestic labor, and public non-defensive expenditures.

The genuine progress indicator represents an extension to the Index of Sustainable Economic Welfare (for a discussion, see Lawn, 2003). The genuine progress indicator attempts to represent whether growth in production and services actually enhance the welfare or wellbeing of residents in a nation. That is, some growth is regarded as uneconomic--depleting or contaminating resources, compromising family cohesion, damaging health, undermining culture, inciting crime, and so forth (see Lawn & Sanders, 1999). These costs, despite the rising GDP, increase the risks of curbing yields or inciting disasters. A value of 0 indicates these costs of growth offset the gains in production. In essence, this index thus represents not only current GDP but the capacity to maintain GDP in the future (cf., Hicks, 1946).

Genuine savings or investment

Measures of genuine savings or investment represent the extent to which a nation maintains or increases human capital and natural resources in addition to economic capital (e.g., Bolt, Matete, & Clemens, 2002& Hamilton & Clemens, 1999). The World Bank utilizes a similar measure, called adjusted net savings. Genuine savings is equal to national savings minus several costs--including the depletion of natural resources, pollution, net foreign borrowing, and capital depreciation Furthermore, education is regarded as an additional saving instead of a consumption. World Bank estimates indicate negative values throughout many African nations, positive values for many OECD nations, and particularly high values throughout East Asia.

Composite indices

Some measures are composites of several facets, all intended to represent various features of wellbeing. The value that emerges is not expressed as a monetary unit. One example is the Human Development Index, calculated by the United Nations. In essence, the Human Development Index represents the geometric mean of three distinct measures:

Norway, Australia, New Zealand, United States, Sweden, and Canada generated relatively high values. This index, and similar measures, do entail more facets that merely income and costs to natural resources, such as education and health. Nevertheless, features that are not as measurable have been excluded, although attempts to override these shortfalls continue (see Hicks, 1997& Noorbakhsh, 1998).

References

Bolt, K., Matete, M., & Clemens, M. (2002). Manual for calculating adjusted net savings. Environment Department, World Bank.

Daly, H. & Cobb, J., (1989). For the common good. Boston, Beacon Press.

Hamilton, K., & Clemens, M. A. (1999). Genuine savings rates in developing countries. World Bank Economic Review, 13, 333-356.

Hicks, D. A. (1997). The inequality-adjusted human development index: A constructive proposal. World Development, 25, 1283-1298.

Hicks, J., (1946). Value and capital (second ed.). London, Clarendon.

Lawn, P. A. (2003). A theoretical foundation to support the Index of Sustainable Economic Welfare (ISEW), Genuine Progress Indicator (GPI), and other related indexes. Ecological Economics, 44, 105-118.

Lawn, P., & Sanders, R. (1999). Has Australia surpassed its optimal macroeconomic scale: Finding out with the aid of benefit and cost accounts and a sustainable net benefit index. Ecological Economics, 28, 213-229.

Max-Neef, M. (1995). Economic growth and quality of life. Ecological Economics, 15, 115-118.

Nordhaus, W., & Tobin, J. (1972). Is growth obsolete? Columbia University Press, New York.

Noorbakhsh, F. (1998). A modified human development index. World Development, 26, 517-528.

Sen, A. (1976). Real national income. Review of Economic Studies, 43, 19-39.

Sen, A. (1979). The welfare basis of real income comparisons. Journal of Economic Literature, 17, 1-45.

Sen, A. (1999). Commodities and capabilities. Oxford: Oxford University Press.

Sen, A. (2000). Development as freedom. Oxford: Oxford University Press.

van den Bergh, J. C. J. M. (2008). The GDP paradox. Journal of Economic Psychology, 30, 117-135.








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Last Update: 7/17/2016