The welfare perspective - GDP vs GPI

Gross Domestic Product is the crossing point of three sides of the economy: demand, production and income. Most misconceptions concerning GDP stem from its overt abuse as an indicator of welfare.

An aggregation of individual welfare functions is implicitly done in all aggregate measures. There is a wide
consensus that aggregation of information always leads to information loss.

Even if accepting a certain type of measure for individual welfare, the aggregation to a societal welfare function may be too ambitious. There has been a long debate in economics whether a social welfare function can be meaningfully constructed in the real world, and the widely recognized Arrow’s Impossibility Theorem teaches that this cannot be done. Thus GDP as a social welfare function is on shaky ground from the very beginning.

As in terms of welfare we are interested in welfare enhancing elements of GDP, how can good elements in
GDP be separated from bad elements?

Basically, GDP (or any other relative aggregate) can be broken down to its different parts. For example, decomposing GDP from the income side to wages and profits will already give an idea about the purpose of the transaction. Similarly, decomposing it from the expenditure side to consumption and investment can also yield interesting welfare-relevant insights.

However in general all transactions in GDP are monetary income for someone, whether it is the fireman cleaning up the havoc of a hurricane, or the divorce lawyer making money out of a human relationship
tragedy. Given that everything is income on some level, this implies that further criteria need to be introduced before being able to assess the good and the bad elements in GDP.

Cost-benefi t analysis (CBA) provides some tools in this regard. The basic yardstick used in this analysis is the marginal benefit vs. cost. Essentially, the marginal social benefit of a certain GDP component should be higher or equal to its marginal social costs. As an important element, this implies taking adequate account of the all externalities included in these GDP components, not measured by market transactions.

Taking a related perspective, one important principle of good bookkeeping is violated in GDP: the division between assets (benefi ts) and liabilities (costs). Joseph Stiglitz (2005) wrote in comparing a country to a firm that “no one would look just at a firm’s revenues to assess how well it was doing. Far more relevant is the balance sheet, which shows assets and liabilities. That is also true for a country.”

Jeroen van den Bergh (2007) argued that “Economists are happy to argue in favour of cost-benefi t analysis as a general method for policy evaluation and support. When it comes to direction of the economy as a whole, many of them suddenly are satisfied with only information about costs, that is, GDP information.”

SWOT Analysis for ISEW and GPI

GPI (Genuine Progress Indicator) and ISEW – (Index of Sustainable Economic Welfare)

The ISEW was developed in the 1980s by Herman Daly and John Cobb and takes into account the links between environment, economy and society. The Genuine Progress Indicator, as developed by Clifford Cobb, is similar to the ISEW, but incorporates additional elements such as crime, divorce, unemployment and changes in leisure time. Furthermore, it is considered as less complex and more accessible to all people. It balances the costs and benefits of economic activity and growth.

Strengths

As a single, monetary measure similar to the GDP, it is comprehensible to the general public, and can easily be related to and compared with traditional GDP data. The GPI provides a more robust measure for assessing Genuine Progress by addressing a series of shortcomings of traditional GDP calculation, although monetarisation is a debated method towards aggregating data into a single indicator. The GPI methodology offers a flexible framework that can and has been extended to incorporate additional aspects over time, reflecting growing data availability or new societal concerns. The GPI has been calculated backwards based on existing data for significant time spans, allowing to track long term trends. Comparability across nations is generally possible, but depends heavily on the selection of issues factored into the GPI, and the quality of the basic data.

Weaknesses/Limitations

The selection of criteria and the methods of assigning monetary values to them show a certain degree of arbitrariness, and have indeed varied over time and across studies. Other authors have questioned the mere possibility and merits of quantifying sustainability factors in a single (monetary) unit. Additionally, calculations of GPI rest on estimates and interpolations. This limits the validity of GPI, its comparability across studies and ultimately its policy relevance.

While the GPI has successfully been used in civil society campaigns, its usefulness for evaluating policy decisions is debated. Its arbitrariness might make the GPI methodology vulnerable for political intervention and biased selection of factors to be included.

Opportunities and threats for successfully going beyond GDP

So far, no systematic attempt has been made for measuring GPI across European countries or on the European level. The GPI addresses several of the key objectives of the EU Sustainable Development Strategy (EU SDS), with a potential to support ‘policy coherence’ and ‘policy integration’. By providing an integrated measure of economic progress and ‘social equity and a healthy environment’, it could also promote synergies between the EU SDS and the EU Lisbon Strategy.

Developing a measurement methodology for GPI at the European level based on a broad scoping and expert consultation process, potentially including sample calculations, could help to reduce the arbitrariness of the indicator and increase its policy relevance. The structural similarity to the GDP would offer the opportunity to create public awareness for the indicator, especially when linked to policy agendas like the Lisbon Strategy or the EU SDS. The GPI could complement both the Structural Indicators as well as the Sustainable Development Indicators as a single, integrative, top-level indicator

Documents

Adopted and shortened from Philipp Schepelmann, Yanne Goossens , Arttu Makipaa (eds.) 2014. Towards Sustainable Development. Alternatives to GDP for measuring progress. (2014). Wuppertal Spezial 42.

Discussion

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