When measuring GDP, none of the approaches give the same value. Also no method does wholly cover all of the products that should technically constitute the final value. However, by using different methods, one approach can be checked against the other. The inconsistency between the methods is known as the Initial Residual Difference (IRD). This is used to adjust the values to make them equal. The IRD has been used as an indicator of the underground economy which will be explained later.
GDP is most probably the best measure of the quality of life. Then why is it not used as the only indicator? This is because it has many limitations. Many aspects are not included in the calculation of GDP. For example, many productive household activities such as DIY are not included as they do not involve market transactions, whereas if someone was hired to do the housework, this would be included. If there has been a general increase in DIY over the years, this would not be reflected in the GDP level. It may even give a possibly incorrect indication that the level of GDP is falling.
In order to compare the GDP of one year with another, the level of inflation also must be taken into account. If the GDP rises in line with the price level, then it must be assumed that there has not really been any increase in the level of GDP even if the figures indicate otherwise.
Nominal GDP is the GDP at the current prices whereas real GDP is GDP at a constant price in terms of a base year having taken inflation into account. So, real GDP will show us the actual rise in GDP and not the rise in the level of prices. Therefore it is important to take the real GDP into account when calculating. Also, when using GDP figures to measure the quality of life, it is wise to take the ‘GDP per capita’. This takes into account the population. A small country like Luxembourg will have less total national income than the UK due to its relatively small population. However, its GDP per capita, i.e. their GDP per head is greater than that of the UK.
If GDP increases, it may be due to an increase in income but possibly only for a very small number of people in a country with unequal distribution of income. This is symbolised by the Lorenz curve. A perfectly straight Lorenz curve represents perfect income equality. The more bowed the curve is, the more unequally the income is distributed. The Gini co-efficient shows the degree of inequality. It is defined as the ratio of area A and area B. Let us take the example of Nigeria, using Nepal as a comparison. The GDP level in Nigeria for example, in 1996 was $31,995. In Nepal in the same year, it was only $4,456. This would suggest that each and every resident of Nigeria had relatively more income than a resident in Nepal. However, this is not the case as indicated by the Gini co-efficients. The Gini co-efficient was 51 for Nigeria and 37 for Nepal in 1996. This shows that the income distribution in Nigeria is comparatively highly unequal. The benefits of high income are only enjoyed by a few which obviously means that the quality of life is not generally great for many.
Residents of two countries could have the same income and therefore the same level of GDP. However, this does not mean that these countries have the same quality of life as countries have different price levels. When comparing the GDP of two countries, the value should be assessed in terms of a common currency, preferably dollars or euros. However, this can cause a problem. If for example, 50 Cyprus Pounds can be exchanged for $105, then as it is highly unlikely that 50 Cyprus Pounds can buy the same amount of goods in Cyprus that $105 can buy in the United States. To overcome this problem, GDP is converted into a common currency at the purchasing power parity (PPP) exchange rate. This exchange rate allows a certain sum of money in one country to buy the same amount of goods in another after being exchanged into that country’s currency. For example the nominal GDP per capita in the UK in 2002 was $1,552,437 (US dollars) whereas the GDP per capita at PPP exchange rates was $1,510,997 (international dollars). An international dollar is assumed to be the common currency which has the same purchasing power as a US dollar in the United States.
Different countries compute GDP differently. For example, a country with a similar lifestyle to another may spend more on heating than the other due to climatic differences. This does not necessarily mean that it has a higher standard of living. In the same way, countries spend varying amounts on health and national defence. Working out the value of the health and defence can cause problems as these services do not have market prices. It is assumed that the cost of providing these services is the value. However, this could be an under estimate or over estimate.
Those who produce illegal goods or wish to avoid taxes and regulations are considered part of a possible underground economy. The underground economy does not by and large pose a problem as long as it is a reasonably constant proportion of the total economy. It would become a problem if, for example, regulations become more restrictive, in which case the underground economy would expand. Not all economies account for informal underground markets, e.g. the black market. The figures from such markets can distort the value of the economy. Even if the government wanted to include the underground economy, it would be very difficult to give it a value. As suggested earlier, the IRD can be considered as an appropriate approximate value.
GDP is not the most reliable measure of the quality of life. For example, if there is an increase in profit due to an increase in production (output), the extra profit is quite often recycled back into the business (as labourers always have fixed wages). Therefore, this will not show as an increase on GDP and therefore will not reflect on the standard of living. Also, if there is a rise in investment, it will reflect as a rise in the level of GDP. However, this does not necessarily mean an increase in the current quality of life as it aids in future consumption. If the quality of a good improves, then it is most likely that its price will also rise. This price rise is considered as inflation in the economy not as an increase in real GDP. When calculating GDP, using the expenditure approach, in order to take into account inflation, the GDP-Deflator is referred to, which covers consumer and government expenditure as well as expenditure on investment unlike the Consumer Price Index which only considers consumer expenditure.
The quality of life cannot be measured just using the level of GDP. There are many other factors that it depends on. General good health and a higher life expectancy are not directly indicated by the level of GDP. It can be said that as GDP has risen, our life expectancy has also lengthened but there are many new health risks discovered each year. In recent years, it has become the case that the number of single parent families, amongst many other households, living below the official poverty line has risen. Such negative influences show that the GDP level exaggerates the improvement in the standard of living.
Although leisure time is not valued as part of GDP, it is a crucial economic good that adds to our economic welfare. If more holidays are taken or fewer hours worked, income and output may fall, but life may be enjoyed more. Resources used to protect the environment, such as catalytic converters are valued as part of GDP. However, pollution for example, is not counted as an economic ‘bad’ when calculating GDP. Tougher restrictions on such negative externalities might reduce output but once again will increase the quality of life. There are also economic ‘bads’ that actually increase the level of GDP. For example, street crime is an economic bad. However, this will lead to an increase in expenditure on protective measures such as CCTV cameras etc. Such expenditures add to GDP.
GDP statistics are very useful at judging the performance of the economy. However, when it comes to measuring the quality of life, it is not the most perfect measure. As an environmental economist, Robert Repetoo, said, “a country can exhaust its mineral resources, cut down its forests, erode its soils…hunt its wildlife to extinction, but its GDP would not be affected”. Economists have come up with many other measures to include GDP such as EDP, the environmentally adjusted domestic product which subtracts depreciation of natural capital and defensive expenditures from GDP. However, the same valuation problem arises once more. How can one give an accurate value to the depreciation of natural capital? The United Nation’s Human Development Index (HDI) is another measure that takes into account life expectancy, adult literacy, schooling and PPP real GDP per capita. This includes many other factors that affect the quality of life. There are many others such as doctors per person, number of paved roads, amount of crime etc. However, a country which excels in all those features may not always have a high GDP. That cannot necessarily mean that the standard of living in that country is low. GDP measures the national output and should be considered in that perspective only. It is obvious that it is not the best and most reliable measure of the quality of life.
All these measures allow economists to acquire a fuller picture of the economy and the welfare of the country. GDP is one extremely important instrument out of many used in the examination of the economy.
BIBLIOGRAPHY
Books
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J. Sloman, Economics, fifth edition, Pearson Education
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M. Parkin, M. Powell, K. Matthews, Economics, third edition, Addison-Wesley
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B. Atkinson, Economics Study Guide, fourth edition, Addison-Wesley
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Beardshaw, Brewster, Cormack, Ross, Economics – A Student’s Guide, fifth edition, Pearson Education
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P. Maunder, D. Myers, N. Wall, R. L. Miller, Economics Explained, revised third edition, Collins
Websites
http://www.worldbank.org/data/archive/cdrom/gdp.pdf
http://www.worldbank.org/data/databytopic/gdp.pdf
http://www.worldbank.org/data/databytopic/gdp_ppp.pdf
http://math.wustl.edu/~rr/128/gini.doc
http://www.money.cnn.com
http://devdata.worldbank.org/external/CPProfile.asp?SelectedCoun try=BRA&CC ODE=BRA&CNAME=Brazil&PTYPE=CP
