The main problem when using this figure is that the ‘league table’ of countries’ standards of living, the GDP figure is in a common currency (it has to be to make a reasonable comparison), the currency chosen being the US$. However exchange rates fluctuate, therefore if the US$ is strong against another currency it will give a distorted view of the standard of living in that country. Another problem is that the Real GDP figure does not take into account the problem of negative externalities. For example, if pollution is high in one country, it may have a high GDP and thus thought to have a high standard of living, however, obviously with high pollution, living standards cannot be high. Distribution of wealth is another problem which real GDP figures do not take into account. Countries with a high GDP may have 99% of the population having 1% of that figure, and 1% of the population having 99% of that figure; again although the country may have a high figure for GDP, clearly standards of living in this country are not all that high. An example of where this is the case is Saudi Arabia. A fourth problem with using the real GDP per capita figure to compare living standards is the problem with the figure itself. The unrecorded economy gives a warped picture of GDP and living standards. In countries such as Colombia, where a high proportion of exports is Cocaine, this activity does not get recorded in the GDP figures and neither does any other illegal activity which may take place, such as builders being paid in cash. Similarly, if parents put their children into a crèche then this would be included in the GDP figure, however if they had a babysitter to stay at home with the children, this would not be calculated in the GDP figure. An inefficient civil service along with an illiterate population, makes gathering the data required for the GDP figure difficult. Other problems with using Real GDP to compare international living standards include the hours worked to produce the output, and the quality of the goods produced.
Although there are some problems with using real GDP to compare living standards, there are a number of ways to overcome some of these difficulties. For example, to overcome the problem of exchange rate fluctuation, one could use the Purchasing Power Parity (PPP) method. One goes to America and buys $100 worth of goods. You then go to all the other countries in the world and buy exactly the same goods and see how much they would cost in local currency. If they cost £120 then to convert UK GDP into US$ for comparison of standards of living you would use the exchange rate $1 = £1.20 instead of the current exchange rate. In addition, to take into account the problem caused by the distribution of income, you could measure the skew of the distribution by using the Gini coefficient. This is a ratio between the percentage of the population and the percentage of income that they own, and is calculated using the Lorenz curve.
There are 3 alternative measures, which can be used to compare international standards of living. There is the Index of Sustainable Welfare (devised by Daly & Cobb) and this index takes into account: negative externalities, the value of household labour, and the changes in the distribution of wealth. The Human Development Index takes into account: life expectancy, infant mortality, and adult literacy. A third measure is the Measure of Economic Welfare (MEW), which takes into account that leisure is valuable, and also many of society’s ills such as crime is included in the GDP figure because high crime leads to more money being spent on fighting crime. The devisers of the MEW believe that the GDP gives an inflated figure of welfare.
Although Real GDP per capita may in some ways be a good measure for comparing international living standards, there are a number of fundamental flaws, which means that it may not be the best method of measuring standard of living. A better figure for comparing living standards is gross national income (GNY). The figure for GDP fails to include some key components of living standards, negative externalities and distribution of income being the most important two and, considering the actual collection of the data for the GDP figure contains many errors, such as the underground economy and tax evasion, this figure cannot be considered an accurate comparison of living standards. The three other methods described earlier take into account a far wider range of indicators, not just the output of a country as indicated by GDP, and therefore can be regarded as a better, although not perfect, method for comparing relative standards of living internationally.
