GDP is a seriously flawed indicator of human wellbeing. We have been conditioned to mistake dollar value for things that really matter
This may seem like a silly question, but it’s a deadly serious one. Economic growth is the dominant policy position of every government and has an enormous impact on our lives and wellbeing. But it may not work the way we think it does.
How can economic growth be “uneconomic”? Let’s unpack this question.
Economic growth is understood to mean ever increasing GDP. But increases in GDP can create more costs than benefits. Such a net loss must certainly be considered “uneconomic”.
Research data show this is now the case in New Zealand and globally.
If the goal of our economy is to support human wellbeing in a way that does not irreparably damage the web of life, then a major problem with our main index of national wellbeing, GDP growth, is that it includes things that cost more than they contribute to that goal.
Economic growth is almost universally considered our best measure of how well a national economy is doing. Politicians of all stripes support economic growth as the answer to everything from maintaining a high standard of living, to alleviating poverty and restoring the environment. All businesses want to grow their sales and profits. Many of our key institutions are designed to support the growth paradigm, our central and private banks being key examples. Indeed, our debt-based money system could not function unless the economy grows.
When a business wants to assess how it is doing, it generally produces a profit and loss statement, which indicates whether its total income exceeds its total costs. GDP calculations don’t do this, they only count activity and don’t subtract costs associated with those activities.
Governments often make policy decisions on the basis of whether the programme and related expenditures are “economic”, which is understood to mean the benefits outweigh the costs. But counting dollars only is problematic.
GDP counts all economic expenditures as positive, even if they are costs to individuals or society. For example, GDP counts the dollar costs associated with the following as benefits to society: defensive private expenditures on health and education; crime; commuting; personal pollution control; auto accidents; water, air and noise pollution; loss of wetlands to development; farmland and soil loss; the depletion of non-renewable resources; long-term environmental damage such as climate change and biodiversity loss, etc.
The entire list of such expenditures that detract from human welfare is much longer, and should logically include all externalised costs that society in general pays for. Even this would be an underestimate as many such costs are unknown and don’t become evident until they cause obvious problems. But currently all known costs to human welfare are added in as contributing to GDP; they are considered benefits because they increase GDP.
Counting such environmental and social costs as positive contributions to GDP and human wellbeing is a bit like an alcoholic counting his daily bottle of Jack Daniel’s as a nutritional supplement.
If one were to add up all these negative expenditures, ones that should be avoided if possible because they detract from human wellbeing, we get a very large number. If we then subtract this amount from the total expenditures, we find that our “economic activity” is in fact uneconomic. Total costs are greater than the total benefits counted by GDP; there is a net loss to society.
And this sort of analysis only focuses on dollar costs and benefits, and excludes non-monetary values, many of which are even more relevant to human wellbeing.
A variety of alternative measures of human wellbeing or human welfare have been devised to overcome these inadequacies of GDP. All these measures include economic activity as an important index, but attempt to compensate for GDP’s distortions by combining it with a range of other social and environmental indicators.
These alternative measures of human wellbeing/welfare include the Index of Sustainable Economic Welfare (ISEW), the Genuine Progress Indictor (GPI), and the Human Development Index (HDI). Each of these are composites and include many environmental and social indices, as well as financial ones, all of which contribute positively to human wellbeing.
All of them indicate a divergence from GDP. For example, using both standard economic measures and the Index of Sustainable Economic Welfare (ISEW), some US research found that while the economic measure increased, the ISEW actually declined. The study states:
“… the ISEW includes a long term trend from the mid 1970s to the present  that is indeed bleak. Economic welfare has been deteriorating for a decade, largely as a result of growing income inequality, the exhaustion of resources, and unsustainable reliance on capital from overseas to pay for domestic consumption and investment … the most fundamental problem in terms of sustainable economic welfare is the decline in quality of energy resources as measured by the ratio of energy output to energy input.”
Such a comment applies even more so today, despite the continued growth of GDP.
Using the GPI, another study found the same gap between GDP and human wellbeing. While GDP grows, the GPI is flat or declining from about 1975.
Yet another study using the HDI and Life Satisfaction measures found the same divergence evident in the NZ economy.
If our dominant assumption that GDP is the best measure of human wellbeing and therefore a worthy national goal was correct, then other measures such as GPI, HDI, and Life Satisfaction should all trend in unison with GDP. The data, however, tell a different story. The results show GDP increasing from 1950 up to 2010, but other measures of wellbeing are either flat or declining. GDP clearly does not represent wellbeing.
Additional details of the actual dollar costs associated with undesired social and environmental expenditures are included in this more recent NZ study of GPI.
The point of all these studies is that GDP is a seriously flawed indicator of human wellbeing. Yet we continue to place GDP on a policy pedestal. Given the serious divergence of GDP growth from these major indicators of social and environmental wellbeing, why do we continue to support policies and politicians that promote GDP growth, and ignore the net losses?
Putting aside for the moment the enormous hardships and social fragility caused by growing economic inequality, the environmental data alone point to ever increasing risks of social collapse as a result of global ecosystems breakdown. Not only is GDP miscounting these costs, increasing GDP is actually causing many of these serious costs which threaten our wellbeing.
Yet GDP growth remains our dominant goal.
The reasons for this disconnect between the biophysical realities that will determine our future and our dominant policy goal are many and complex. In part it is due to the prominence of economists in policy planning, and the complete disconnect between economic theory and practice, and the real physical world.
Economics should be a life science based on how human activities take raw materials from nature and transform them into useful goods, and the impact these activities have on natural systems.
But economics doesn’t operate this way. Economics seriously ignores the role of natural materials and systems and focuses on their dollar value. Because dollars are just numbers they can grow for ever. But the use of natural materials cannot. This distinction is close to the heart of the disconnect between GDP and human wellbeing. We have been conditioned to mistake dollar value for things that really matter.
All economic activity requires energy and materials, and the more GDP grows the more energy and materials we use. The data from ecological overshoot studies make it clear that globally we have already greatly exceeded natural systems’ capacity to continue providing raw materials for the lifestyles we have developed, and the wastes it produces. Climate change is only one of the waste management challenges we face.
When our next national budget is presented, check out how well GDP is balanced with other wellbeing measures.
How do we get our politicians and policy makers to pay heed to the natural sciences that show us where our biophysical limits are, and establish national goals compatible with the science? How do we encourage our fellow citizens to see these connections? Why are we not only accepting net losses from economic activity, but also promoting them?
We will have a national election before too long. Let’s get some reality checks into the discussions.