Measuring Welfare beyond Economics

The genuine progress of Hong Kong and Singapore

Claudio O. Delang, Yi Hang Yu

• Publisher: Routledge
• Year: 2015
• ISBN:
  9781135080723
• Edition: 1
• Topic: Economics
• Subtopic: Development Economics
• Index: Economics

Dissatisfaction with the Gross Domestic Product (GDP) as an indicator of a country's development or a population's wellbeing led to the development of the Genuine Progress Indicator (GPI). The GPI is an aggregate index of over 20 economic, social and environmental indicators, and accounts for both the welfare benefits of economic growth, and the social and environmental costs which accompany that economic growth. The result is better information about the level of welfare or well-being of a country's population.

This book measures the GPI of Hong Kong and Singapore from 1968 to 2010. It finds that for both countries, economic output (as measured by the GDP) has grown more than welfare (as measured by the GPI), but important differences are also found. In Hong Kong, the GPI has grown for the whole period under consideration, while in Singapore the GPI has stalled from 1993. This is in line with most countries and is explained by the "threshold hypothesis" which states that beyond a certain level of economic development the benefits of further economic growth are outweighed by even higher environmental and social costs. The book argues that the growth of Hong Kong's GPI is due to its favourable relationship with China and in particular its ability to export low-wage jobs and polluting industries, rather than successful domestic policies. A stalling or shrinking GPI calls for alternative policies than the growth economy promoted by neoclassical economists, and the book explores an alternative model, that of the Steady State Economy (SSE).

1 Problems with the Gross Domestic Product

Introduction

The Gross Domestic Product (GDP) was developed by Simon Kuznets, an economist at the National Bureau of Economic Research (US), in the 1930s, as an indicator of national economic output. The creation of the GDP was prompted by the need for a standard measure that would be able to quantify the extent of the economic collapse under way, and could be used to devise policies to improve the economy. Following the establishment of international financial institutions, such as the World Bank and the International Monetary Fund at the Bretton Woods Conference in 1944, the GDP was adopted globally as the standard tool to measure the size of a country’s economy.

The GDP is calculated as the sum of all final goods and services produced in an economy in a given period of time (Anielski and Soskolne, 2002; Stiglitz, Sen and Fitoussi, 2009). It thus offers an easy method to capture the total consumption of goods and services in a country, and does so in a way that allows for comparisons to be made with the amounts of previous years. The aggregate value can help economists, researchers and the like to assess the level of production across industries, as well as the magnitudes of consumption of a range of goods and services, from baked goods to television units to clinical check-ups. The use of market prices as the unit of measurement also reflects the relative changes in real prices of the different goods and services consumed throughout different time periods (Stiglitz et al., 2009). The GDP, therefore, is an easy to use single number to assess how ‘well-off’ a society is at a particular moment in time. As a clear and one-dimensional economic indicator, it can also help economists and policy-makers plan the economy and set economic policies to achieve further growth (Hamilton, 1997; Anielski, 2001; Stigliz et al., 2009; Berik and Gaddis, 2011).

For over 70 years the GDP has been used by governments of different countries to assess the success of their monetary and fiscal policies and to draft their national budgets (McCulla and Smith, 2007). International institutions such as the International Monetary Fund (IMF) and the World Bank also use changes in a nation’s GDP as an important criterion to fund projects around the world. A recent report by the World Bank stated that high rates of GDP growth are indeed the solution for the world’s poverty problem (Commission on Growth and Development, 2008). Today, the GDP is regularly referred to by politicians, economists, policy-makers and the media as the ultimate metric of a country’s welfare and well-being. However, we will argue in this chapter that the GDP is not a suitable indicator, neither of economic development, nor of welfare or well-being, and that it should be abandoned. This chapter brings together and summarizes criticism raised against the use of the GDP, while providing the necessary basis for the discussions on the Genuine Progress Indicator (GPI) that will take place in the following chapters.

The chapter is organized as follows: first, we discuss how the GDP is calculated; second, we discuss the problems with the GDP as an indicator of economic welfare or progress, from a social and environmental perspective. This section addresses the question of why the GPI is a better indicator of welfare than the GDP. In section three we examine the influence that focusing on the GDP has had on economic policies. We also discuss the advantages of abandoning the GDP.

The methodology of the GDP

The GDP accounts for the total value of goods and services produced in an economy during the accounting period. It can be measured in three ways, all of which, in principle, should give the same results: the production (or output) approach, the income approach, and the expenditure approach (Vu, 2009; Geostat, 2011).

The production approach measures GDP as the sum of all ‘added value’ in the economy – the figure results from subtracting the cost of the goods and services used in production from the value of the total output produced during a particular accounting period (Vu, 2009). For example, if a value of 100 is given to the total output of goods and services in an economy, and the cost of goods and services used in the process of production is 70, then the value added is 30 (Vu, 2009). Taxes on products and import (VAT, excise tax and customs duties) are added, and subsidies on products are subtracted. The equation for this approach is as follows (Geostat, 2011):

Total GDP at market prices = Total output (goods and services) by types of activities at market prices − intermediary consumption for generating goods and services + taxes on products and import − subsidies on products

The income approach requires information on the factors that are directly involved in the production of goods and services during an accounting period, presented as the sum of all types of factor incomes (returns from resources, or factors of production) generated in the production process, for example ‘wages and bonuses and other compensation payable to employees, taxes on products and production payable to the government, and operating surplus for the producers’ (Vu, 2009: 5; Geostat, 2011). The equation for this approach is as follows (Geostat, 2011):

Total GDP at market prices = Employment income in the form of wages and Social benefits (including Income tax) + Mixed income received from self-employment + Total profit received by companies from economic activities + Taxes on production and import − Subsidies on production and import

The expenditure approach calculates GDP as the total value of goods and services that are used for final consumption, gross capital formation or total value of transfer of personal savings to business through different types of investments, such as bank deposits, plus net exports (Vu, 2009). The equation of this approach is (Geostat, 2011):

Total GDP at market prices = Consumption expenditure of households + Services rendered by non-profit institutions serving households + Collective and personal services rendered by General Government + Gross capital formation + Changes in inventories + Exports of goods and services − Imports of goods and services

It is important to note that the GDP as a measure of economic activity is not inherently bad. The GDP measures what it was intended to: the size of a country’s economic output (the GDP takes into account only monetary transactions of final goods and services produced in an economy). However, it is not (and was never meant to be) a measure of welfare, even though it seems to be treated as such by economists, politicians, and the press. In the next section we discuss its weaknesses, and why it is not a measure of welfare.

Problems of the GDP as an indicator of social welfare

While the GDP is an indicator of economic output, it only includes the market values of traded products. For example, only the costs of extraction of natural resources are included. The inherent values (or existence values (Davidson, 2013)) of these natural resources are not included, nor are their non-marketed qualities (e.g. the cooling properties of urban trees), and non-marketed products (e.g. wild plants consumed by the gatherers). Its creator already acknowledged severe limitations of the GDP: after presenting an itemized list of the things measured by the GDP to Congress in 1934, Simon Kuznets discussed the uses and limitations of the GDP. Kuznets (1934) acknowledged ‘a number of other services, in addition to those [itemized goods] listed above might also be considered a proper part of the national economy’s end-product’. Kuznets named these services as ‘services of housewives and other members of the family’, ‘relief and charity’, ‘services of owned durable goods’, ‘earnings from odd jobs’, and ‘earnings from illegal pursuits’ among others (pp. 3–5). Kuznets cited various reasons for excluding these services from the GDP, the most important of which being his objective of creating an indicator designed to measure only a society’s ability to produce and consume goods.

Kuznets thought that the simplicity of a GDP value would make it vulnerable to misrepresentation and detract from its limitations. This was reflected in Kuznets’ report to the US Senate, where he stated:

The valuable capacity of the human mind to simplify a complex situation in a compact characterization becomes dangerous when not controlled in terms of definitely stated criteria. With quantitative measurements especially, the definiteness of the result suggests, often misleadingly, a precision and simplicity in the outlines of the object measured. Measurements of national income are subject to this type of illusion and resulting abuse, especially since they deal with matters that are the center of conflict of opposing social groups where the effectiveness of an argument is often contingent upon oversimplification.

(Kuznets, 1934: 5–6)

In spite of these admonitions, many people consider the GDP a measure of welfare. As such, the focus of economic policies pursued by economists and politicians has for the most part remained set on increasing the growth rates of their country’s GDP. Costanza et al. (2009) conducted the most comprehensive study on the limitations of the GDP as an indicator of social welfare, and concluded that:

the GDP ignores changes in the natural, social, and human components of community capital on which the community relies for continued existence and well-being. As a result, GDP not only fails to measure key aspects of the quality of life; in many ways, it encourages activities that are counter to long-term community well-being.

(p. 9)

According to Stockhammer et al. (1997), the critical views on the GDP have been exacerbated by the widening gap between economic growth and quality of life since the 1970s. Anielski and Soskolne (2002) argued that well-being is more than economic output and involves multiple causal pathways, which remain unaccounted for in the GDP. These unaccounted pathways include benefits such as unpaid labour, ecosystem services, costs such as crime and environmental degradation, investments in infrastructure, conservation practices and income equality, among others.

In the following pages we describe some of the shortcomings of the GDP as a measure of welfare, dividing them into two different categories: environmental and socioeconomic. These issues, ignored by the GDP, are included in the GPI, as Chapter 4 will elaborate.

Environmental problems with the GDP

1. The GDP acccounts for the flow, but not for stock of resources

The natural resources that are not transformed, and for which no money is invested, are not included in the GDP. For example, the value of timber found in a forest, or the services the forest provides (e.g. in absorbing carbon dioxide) are not included in the GDP, but when that forest is cut and the timber sold, the value of the timber shows up in the GDP. In reality, since a forest has values beyond the commercial value of the timber (for example the value of the carbon sequestered by the vegetation, the forest products that may be used by local populations, soil stabilization, and climate regulations), a country may as well be worse off after the forest is cut, even though the GDP has grown.

2. The GDP encourages the depletion of natural resources

It follows from the previous point that measuring a country’s wealth using GDP encourages the depletion of natural resources. When political authorities aim at maximizing GDP, the easiest way to do so is by increasing the extraction and usage of natural resources.

3. The GDP does not account for environmental degradation

By ignoring the stock of natural resources in the GDP, the GDP does not give a clear signal about the conditions of the stock of natural resources in a country. In theory prices should increase as natural resources become scarcer, and therefore more expensive to extract. However, as the technology improves, extraction costs may decrease, which may result in lower prices, even as the natural resources become scarcer. Market prices do not reflect the relative scarcity of natural resources. Hence, one cannot gauge from the GDP whether the environment is being degraded, and the extent and pace at which this is taking place.

4. Environmental degradation increases the GDP

Economic activities place stress on the environment, thereby reducing the ecosystem services that are of value to society. The value of ecosystem services, such as the sequestration of carbon dioxide, the absorption of pollution, the production of oxygen, and the preservation of biodiversity, is very large. Costanza et al. (1997) estimated the value of the world’s ecosystem services and natural capital at a staggering US$33 trillion per year, larger than the world GDP at that time.

Many natural resources perform particularly valuable non-marketed services, but are degraded to make way for marketed products. Such is the case, for example, of wetlands. Wetlands are favourite sites for housing because of the clear view they offer. They are also sites for mangrove trees, particularly sturdy trees used in many countries as construction material or for fuel. Many wetlands are dried out to build houses, or mangrove trees cut. The functions performed by natural mangrove forests (e.g. clean waste water) are not included in the GDP, but when wetlands are transformed (e.g. into housing), this increases the GDP.

Damages caused by pollution (of air and water) have a negative impact on the GDP only if it negatively impacts productivity. More often than not, the negative effects of pollution are addressed through further expenditure, which increases GDP. Similarly, when ecosystem services are degraded, they may need to be restored (for example a forest may need to be replanted to reduce the risk of landslides), or replaced by man-made infrastructure (for example, a wall may need to be built to replace the coastline protection functions that were lost when a wetland was built on, or a sewage treatment plant may need to be built to replace the water purification functions of a wetland). Both restoration and replacement add value to the GDP, but do not add to welfare.

Since environmental services are not accounted for in the GDP, it is not known how much of the growth in GDP is the result of replacing degraded environmental services. Omitting the positive contribution that a healthy environment provides to the economy and to welfare, and presenting the cost of mending environmental degradation as an improvement of the economy (or current income) violate basic accounting principles (Cobb, Halstead and Rowe, 1995). Herman Daly presented this violation of basic accounting principles as ‘the current national accounting system treats the earth as a business in liquidation’ (cited in Cobb, Halstead and Rowe, 1995: 10).

5. The GDP does not encourage the preservation of income-generating natural capital

According to Hicks (1946), income is the maximum amount that can be consumed over a specific period without undermining the capacity to produce and consume the same amount in future periods. Lawn and Clarke (2008b) illustrate this idea through the example of a timber plantation. Given 1000 m³ of timber available during the first year, a regeneration rate of 5 per cent a year would amount to the regeneration of 50 m³ of timber (1000 m³ × 0.05). However, if 100 m³ of timber were to be extracted, exceeding the rate of timber regeneration, only 950 m³ of timber would be left at the end of the first year (1000 m³ + 50 m³ − 100 m³). The amount of timber regenerated the next year would equate to 47.5 m³ (950 m³ × 0.05). If extraction continued at the same rate, the resultant amount of timber at the end of the second year would be 897.5 m³ (950 m³ + 47.5 m³ – 100 m³). According to Hicks’ definition of income, only 50 m³ of timber during the first year and 47.5 m³ during the second year could be considered income, while the additional 50 m³ and 52.5 m³ harvested, respectively, should be seen as capital depletion.

GDP violates this definition of income, as it does not subtract the costs of the depletion of natural capital that may accompany an increase in man-made capital (manufactured products). To maintain constant levels of man-made capital consumption, it is necessary to maintain the level of extraction of low-entropy raw material (such ...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• List of figures
• List of tables
• Preface
• 1 Problems with the Gross Domestic Product
• 2 Alternative indicators to the Gross Domestic Product
• 3 The Genuine Progress Indicator as an alternative indicator of welfare
• 4 Items used to calculate the Genuine Progress Indicator
• 5 The Genuine Progress Indicator of Hong Kong: results
• 6 The Genuine Progress Indicator of Singapore: results
• 7 The ‘threshold hypothesis’ and the two city-states
• 8 Towards a Steady State Economy
• Index