Policymakers around the world have used Gross Domestic Product as the main gauge of economic performance – and have often adopted policies that aim to maximise its rate of growth. Generation after generation of economists have committed significant time and effort to thinking about the factors that influence GDP growth, on the premise that an expanding and healthy economy is one that sees its GDP increasing every year at a sufficient rate.
But is economic output a good enough indicator of national economic wellbeing? Costanza et al (2014) (see link below) argue that, despite its merits, GDP can be a ‘misleading measure of national success’:
GDP measures mainly market transactions. It ignores social costs, environmental impacts and income inequality. If a business used GDP-style accounting, it would aim to maximize gross revenue — even at the expense of profitability, efficiency, sustainability or flexibility. That is hardly smart or sustainable (think Enron). Yet since the end of the Second World War, promoting GDP growth has remained the primary national policy goal in almost every country. Meanwhile, researchers have become much better at measuring what actually does make life worthwhile. The environmental and social effects of GDP growth is a misleading measure of national success. Countries should act now to embrace new metrics.
The limitations of GDP growth as a measure of economic wellbeing and national strength are becoming increasingly clear in today’s world. Some of the world’s wealthiest countries are plagued by discontent, with a growth in populism and social discontent – attitudes which are often fuelled by high rates of poverty and economic hardship. In a recent report titled ‘The Living Standards Audit 2018’ published by the Resolution Foundation, a UK economic thinktank (see link below), the authors found that child poverty rose in 2016–17 as a result of declining incomes of the poorest third of UK households:
While the economic profile of UK households has changed, living standards – with the exception of pensioner households – have mostly stagnated since the mid-2000s. Typical household incomes are not much higher than they were in 2003–04. This stagnation in living standards for many has brought with it a rise in poverty rates for low to middle income families. Over a third of low to middle income families with children are in poverty, up from a quarter in the mid-2000s, and nearly two-fifths say that they can’t afford a holiday away for their children once a year. On the other hand, the share of non-working families in poverty has fallen, though not by enough to prevent an overall rise in poverty since 2010.
Their projections also show that this rise in poverty was likely to have continued in 2017–18:
Although the increase in broad measures of inequality were relatively muted last year, our nowcast suggests that there was a pronounced rise in poverty (measured after housing costs[…]. The increase in overall poverty (from 22.1 to 23.2 per cent) was the largest since 1988. But this was dwarfed by the increase in child poverty, which rose from 30.3 per cent to 33.4 per cent. […]The fortunes of middle-income households diverged from those towards the bottom of the distribution and so a greater share of households, and children, found themselves below the poverty threshold.
A simple literature search on Scope (or even Google Scholar) shows that there has been a significant increase in the number of journal articles and reports in the last 10 years on this topic. We do talk more about the limitations of GDP, but we are still using it as the main measure of national economic performance.
Is it then time to stop focusing our attention on GDP growth exclusively and start considering broader metrics of social development? And what would such metrics look like? Both interesting questions that we will try to address in coming blogs.
- What are the main strengths and weakness of using GDP as measure of economic performance?
- Is high GDP growth alone enough to foster economic and social wellbeing? Explain your answer using examples.
- Write a list of alternative measures that could be used alongside GDP-based metrics to measure economic and social progress. Explain your answer.
Economists were generally in favour of the UK remaining in the EU and highly critical of the policy proposals of Donald Trump. And yet the UK voted to leave the EU and Donald Trump was elected.
People rejected the advice of most economists. Many blamed the failure of most economists to predict the 2007/8 financial crisis and to find solutions to the growing gulf between rich and poor, with the majority stuck on low incomes.
So to what extent are economists to blame for the rise in populism – a wave that could lead to electoral upsets in various European countries? The podcast below brings together economists and politicians from across the political spectrum. It is over an hour long and provides an in-depth discussion of many of the issues and the extent to which economists can provide answers.
Should economists share the blame for populism? Guardian Politics Weekly podcast, Heather Stewart, joined by Andrew Lilico, Ann Pettifor, Jonathan Portes, Rachel Reeves and Vince Cable (23/2/17)
- Why has globalisation become a dirty word?
- Assess the arguments for and against an open policy towards immigration?
- In what positive ways may economists contribute to populism?
- Do economists concentrate too much on growth in GDP rather than on its distribution?
- Give some examples of ways in which various popular interpretations of economic phenomena may confuse correlation with causality.
- Why did the proportions of people who voted for and against Brexit differ considerably from one part of the country to another, from one age group to another and from one social group to another?
- In what ways have economists and the subject of economics contributed towards a growth in human welfare?
- What are the advantages and disadvantages of the trend for undergraduate economics curricula to become more mathematical (at least until relatively recently)?
How much does the UK spend on welfare? This is a highly charged political question, with some arguing that benefit claimants are putting great demands on ‘hard-working tax payers’. According to information being sent by the government to all 24 million income tax payers in the UK, the figure of £168bn being spent on welfare is around 24.5% of public spending. But what is included in the total? Before you read on, try writing down the categories of government expenditure included under the heading ‘welfare’.
The heading does not include spending on certain parts of the ‘welfare state’, such as health and education. These are services, the production of which contributes to GDP. The category ‘welfare’ does not include expenditure on produced services, but rather transfer payments. The way the government is using the term, it does not include state pensions either, which account for 11.6% of public expenditure. So does the 24.5% largely consist of payments to the unemployed? The answer is no.
The category ‘welfare’ as used by the government includes the following elements. The percentages are of total managed expenditure (i.e. government spending).
||Public service pensions, paid to retired public-sector employees, such as teachers, police officers, doctors and nurses
||Other support for the elderly, including pension credit, winter fuel allowance, bus passes, etc.
||Sickness and disability benefits, including long-term care for the elderly, sick and disabled
||Support for families and children, such as child benefit and child tax credits
||Social exclusion, including income support and housing benefit
||Unemployment benefits, including Job Seekers Allowance
Lumping all these together under a single heading ‘welfare’ can be highly misleading, as many people have strongly held preconceptions about who gets welfare. In fact the term is used pejoratively by many who resent their taxes being given to those who do not work.
But, as you can see from the figures, only a small proportion goes to the unemployed, the majority of whom (around 65%) are unemployed for less than a year as they move between jobs (see). The bulk of benefits goes to children, the retired and the working poor.
Another preconception is that much of welfare spending goes to fraudulent claimants. But, as the article by Professor Hills states:
Just 0.7% of all benefits was over-paid as the result of fraud, less than the amount underpaid as a result of official error. For the main benefit for unemployed people, Jobseeker’s Allowance, estimated fraud was 2.9%, or an annual total of £150million.
It is also important to consider people’s life cycle. The same people receive benefits (via their parents or guardians) as children, pay taxes when they work and receive benefits when they retire or fall sick. Thus you might be a net contributor to public finances at one time and a net beneficiary at another. For example, the majority of pensioners were net contributors when they were younger and are now mainly net beneficiaries. Many unemployed people who rely on benefits now were net contributors when they had a job.
The message is that you should be careful when interpreting statistics, even if these statistics are factually accurate. How figures are grouped together and the labels put on them can give a totally misleading impression. And politicians are always keen to ‘spin’ statistics to their advantage – whether in government or opposition.
Annual Tax Summary: TUC and MPs on spending information BBC Daily Politics, Jo Coburn (3/11/14)
Osborne’s tax summary dismissed as propaganda by the TU BBC News (3/11/14)
The truth about welfare spending: Facts or propaganda? BBC News, Brian Milligan (4/11/14)
Its Cost Is Just One of the Myths Around ‘Welfare’ Huffington Post, John Hills (12/11/14)
Welfare spending summary criticised Express & Star (4/11/14)
Data and Reports
Public Expenditure: Statistical Analyses (PESA) 2014 HM Treasury (see Table 5.2)
DWP annual report and accounts 2013 to 2014 Department of Work and Pensions (see Table 2)
Welfare trends report – October 2014 Office for Budget Responsibility
What is welfare spending? Institute for Fiscal Studies (4/11/14)
- What benefits do you receive? How would you expect this to change over your lifetime?
- What are the arguments for (a) reducing and (b) increasing welfare payments. In each case, under which categories of welfare would you decrease or increase the level of benefits?
- Referring to Table 5.2 in the PESA data below (the table used for the government’s calculations), which of the categories would be classified as expenditure on goods and services and which as transfer payments?
- Assess the arguments of the IFS for the reclassification of the categories of ‘welfare’ payments.
- Referring to the pie chart above, also in the BBC video and articles and Table 5.2 in the PESA data, assess the arguments about the size of the UK’s contributions to the EU budget.
The most commonly used measure of economic performance is GDP and while there is agreement that it is an important and useful measure, there is also agreement that there are some big problems with it. Does it measure welfare or quality of life? What is and isn’t included? Do some things add to GDP which actually make us worse off?
One criticism often levelled at GDP is that there are many aspects that go unmeasured – often known as the underground economy. Some areas are typical everyday things – DIY, looking after your own children rather than paying someone to do it, or even giving yourself a haircut. But, there are other activities, often illegal, which go unrecorded, such as the selling and distribution of drugs and prostitution. In countries like the Netherlands, their GDP figures get a boost, as some drugs and prostitution are legal. In other countries, such data is not recorded and as such, the contribution of these markets is under-estimated or even completely omitted.
However, this aspect of the calculation of GDP statistics is changing across Europe, which will allow much easier and more meaningful comparisons of relative GDP across countries. This extra production will therefore offer a positive contribution towards our GDP and perhaps suggest to the untrained eye that the British economy is growing, which can only be good news. But, for the trained economist, we are looking at extra data being added, which will boost total output and the question will be does it really indicate that the economy is better off? The following articles consider this change to GDP.
Small data: The way drugs and prostitution boost the economy BBC News (4/4/14)
Small data: Calculating the sex and drugs economy BBC News (2/6/14)
UK economic output to be revised up after ONS updates BBC News, Anthony Reuben (10/6/14)
UK economic output will get near 5 percent boost from data changes Reuters (10/6/14)
Accounting for drugs and prostitution to help push UK economy up by £65bn The Guardian, Katie Allen (10/6/14)
- What does GDP measure? Is it good at measuring it?
- Explain the pros and cons of using GDP to measure the welfare of an economy.
- Why are there problems using GDP to compare output between countries?
- Is it a good idea to include markets such as sex and drugs in calculating a nation’s output?
- What other measures of welfare do we have?
What lies ahead for economic growth in 2013 and beyond? And what policies should governments adopt to aid recovery? These are questions examined in four very different articles from The Guardian.
The first is by Nouriel Roubini, Professor of Economics at New York University’s Stern School of Business. He was one of the few economists to predict the collapse of the housing market in the USA in 2007 and the credit crunch and global recession that followed. He argues that continuing attempts by banks, governments and individuals to reduce debt and leverage will mean that the advanced economies will struggle to achieve an average rate of economic growth of 1%. He also identifies a number of other risks to the global economy.
In contrast to Roubini, who predicts that ‘stagnation and outright recession – exacerbated by front-loaded fiscal austerity, a strong euro and an ongoing credit crunch – remain Europe’s norm’, Christine Lagarde, head of the IMF and former French Finance Minister, predicts that the eurozone will return to growth. ‘It’s clearly the case’, she says, ‘that investors are returning to the eurozone, and resuming confidence in that market.’ Her views are echoed by world leaders meeting at the World Economic Forum in Davos, Switzerland, who are generally optimistic about prospects for economic recovery in the eurozone.
The third article, by Aditya Chakrabortty, economics leader writer for The Guardian, looks at the policies advocated at the end of World War II by the Polish economist, Michael Kalecki and argues that such policies are relevant today. Rather than responding to high deficits and debt by adopting tough fiscal austerity measures, governments should adopt expansionary fiscal policy, targeted at expanding infrastructure and increasing capacity in the economy. That would have an expansionary effect on both aggregate demand and aggregate supply. Sticking with austerity will result in continuing recession and the ‘the transfer of wealth and power into ever fewer hands.’
But while in the UK and the eurozone austerity policies are taking hold, the new government in Japan is adopting a sharply expansionary mix of fiscal and monetary policies – much as Kalecki would have advocated. The Bank of Japan will engage in large-scale quantitative easing, which will become an open-ended commitment in 2014, and is raising its inflation target from 1% to 2%. Meanwhile the Japanese government has decided to raise government spending on infrastructure and other government projects.
So – a range of analyses and policies for you to think about!
Risks lie ahead for the global economy The Guardian, Nouriel Roubini (21/1/13)
Eurozone showing signs of recovery, says IMF chief The Guardian, Graeme Wearden (14/1/13)
Austerity? Call it class war – and heed this 1944 warning from a Polish economist The Guardian, Aditya Chakrabortty (14/1/13)
Bank of Japan bows to pressure with ‘epoch-making’ financial stimulus The Guardian, Phillip Inman (22/1/13)
- What are the dangers facing the global economy in 2013?
- Make out a case for sticking with fiscal austerity measures.
- Make out a case for adopting expansionary fiscal policies alongside even more expansionary monetary policies.
- Is is possible for banks to increase their capital-asset and liquidity ratios, while at the same time increasing lending to business and individuals? Explain.
- What are the implications of attempts to reduce public-sector deficits and debt on the distribution of income? Would it be possible to devise austerity policies that did not have the effect you have identified?
- What will be the effect of the Japanese policies on the exchange rate of the yen with other currencies? Will this be beneficial for the Japanese economy?