The world has been using gross domestic product (GDP) for decades as the standard for measuring the health of an economy. But as many economists are now concluding, it’s a pretty good measure of the value of goods and services produced during a particular period, but it’s a fairly lousy measure of economic progress.
As Australian economist Ross Gittins once noted, GDP measures ignore all the work that doesn’t involve the exchange of money. Which means that work at home is not included or valued, nor is voluntary work, and nor is the value of what we now refer to as natural capital, the input from eco-systems, and the impact that is caused by depletion, destruction, pollution and emissions. Even the measure of production is one-sided, because it may include the cost of repairing a car after an accident, or a city after an earthquake, but it doesn’t take into account the damage, pain and the disruption of those events.
So how should we be measuring economic progress?
Harvard Business School professor Michael Porter has come up with an alternative that he has dubbed the Social Progress Index, and it is designed to connect the dots between economic value and social challenges, and to incorporate the social and environmental needs of citizens into the calculation
His index includes 52 indicators in three dimensions: Basic human needs (looking at nutrition, air, water and sanitation, shelter, personal safety), foundations of well-being (access to basic knowledge, health and wellness, ecosystem sustainability), and opportunity (personal rights, access to higher education, equity and inclusion).
Each of these dimensions is calculated as the sum of its components and is weighted equally in the overall index. The result is an aggregate score that measures its social progress, which Porter describes as “the capacity of a society to meet the basic human needs of its citizens, establish the building blocks that allow citizens and communities to enhance and sustain the quality of their lives, and create the conditions for all individuals to reach their full potential.”
Analysts say that the main value of the SPI seems to be its ability to provide both policymakers and the private sector better assessment of countries’ success in improving their overall well-being. But it could go so far as to turn current thinking on its head.
If the information gathered by other agencies, such as the UN-sponsored TEEB (The Economics of Ecosystems and Bio-diversity), then that thinking needs to be challenged. Take this graphic for instance, it shows the total damage as a percentage of revenue from various common industrial activities. The income from these activities is measured by GDP, but not the environmental damage. How much support would those activities enjoy if the damage was properly accounted for?
The prominent economist Joseph Stiglitz came to a similar view to Porter, arguing that the situation is perfectly illustrated with the problem around climate change. “If we have poor measures, what we strive to do (say, increase GDP) may actually contribute to a worsening of living standards,” he wrote. “We may also be confronted with false choices, seeing trade-offs between output and environmental protection that don’t exist. By contrast, a better measure of economic performance might show that steps taken to improve the environment are good for the economy.”
The problems are highlighted in other areas such as the growth in inequality. Another marked change in most societies is an increase in inequality. “If a few bankers get much richer, average income can go up, even as most individuals’ incomes are declining,” he wrote. “So GDP per capita statistics may not reflect what is happening to most citizens.”
Stiglitz argued that if statistical frameworks are intended to summarise what is going on in the world’s complex society in a few easily interpretable numbers, then it should have been obvious that it couldn’t be reduce to a single number, GDP. And it was a number that could be easily abused, as it was by bankers ahead of the global financial crisis.
“Our banks were very creative in deceptive accounting. They were creative in moving things off balance sheets so they could get their profit up and have the risk off those balance sheets. It worked well, especially for CEOs,” he said.
“Our GDP was bloated by fictitious numbers and our European counterparts believed these. It affected the way we thought about policies. Market prices didn’t affect what was really going on in the economy. This led to not only distorted incentives, but was a distorted investment in how companies were doing.”
Time to measure things differently then.
Giles Parkinson founded and edits the website RenewEconomy, Australia’s most widely read website focusing on cleantech and climate issues. He is an award-winning journalist, and former business editor and deputy editor of the Australian Financial Review. You can follow him on Twitter at @renew_economy.
