Rethinking GNP: From welfare to cost

Gross National Product is a blunt tool that largely fails to take into account environmental and human well-being.

Riz Khan - Prediction markets
Gross National Product was developed in the 1930s and 1940s as a measure of economic actvity [GALLO/GETTY]

Aside from the nation of Bhutan, which strives to maximise Gross National Happiness, virtually all countries in the world single-mindedly pursue endless increases in Gross National Product (GNP), which measures the market value of final goods and services produced by a country in a given year. Economists and politicians alike treat GNP as the best measure of economic welfare. In the United States, GNP growth has averaged about 2.5 per cent per year since the recession ended in 2009. At this rate, GNP will double in a generation, and quadruple in two. Nonetheless, numerous surveys suggest that most Americans believe their economic welfare is declining. Something is clearly wrong.

In fact, most serious economists recognise that GNP is a fairly poor measure of economic welfare. Economist Simon Kuznets first developed the indicator during the 1930s and 40s as a measure of economic activity, and explicitly warned that it should not be confused with economic welfare. Although there have been numerous efforts to transform GNP into a more accurate measure of welfare by adding costs and benefits that are currently ignored, most economists and policymakers stick to GNP as the most useful indicator available. Indeed, GNP is a useful indicator, but has been greatly misunderstood. One must be very clear about precisely what it measures: It does not measure welfare, and is only a poor measurement of activity. GNP is, however, quite useful as a measure of monetary costs.

At first glance, such a statement appears preposterous. Nations with higher GNP are obviously better-off than nations with lower GNP, on average. However, GNP is by definition a measure of what we pay for the final goods and services purchased in a year, and is therefore explicitly a measure of costs. True, costs often correlate with benefits. More expensive products are often better than less expensive ones – but not always, and only a fool would try to maximise what he pays for something. It is also true that GNP is a measure of income from the perspective of those who receive those payments. To determine whether GNP is something we should strive to increase or decrease requires closer analysis.

Health and wealth

Health care offers an excellent starting point. If GNP is a measure of economic welfare, then it follows that the US, which spends 17 per cent of its GNP on health care – almost 50 per cent more per capita than any other country in the world – must have the planet’s best health care system.

occupy Stockholm  protest economy
Protesters take part in the “Occupy central” protest in Stockholm October 15, 2011. Protesters worldwide geared up for a cry of rage on Saturday against bankers, financiers and politicians they accuse of ruining global economies and condemning millions to poverty and hardship through greed. REUTERS/Maja Suslin/Scanpix
‘Occupy’ protesters around the world have been fighting for a different economic system [REUTERS]

However, by virtually any indicator of health outcomes – including life expectancy, infant mortality, maternal mortality, and physician visits per capita – the US has among the worst health care outcomes of any developed nation. The rapid growth in health care expenditures is widely recognised as one of the most serious economic problems in America today. Yet no one is cheering. Every sensible person realises that our goal should be to maximise health outcomes, and to do so at the lowest possible cost. Shouldn’t exactly the same logic apply to every sector of the economy, and hence to the economy as a whole? Shouldn’t our goal be to increase human welfare at the lowest possible cost?

Appropriate measures of economic welfare are particularly important for those sectors of the economy that provide essential resources for which substitution is difficult or impossible. In addition to healthcare, food, energy and water quickly spring to mind. As all economists know, and virtually anyone else understands after a moment’s reflection, people try to consume approximately the same amount of such commodities, regardless of their price. For example, if the price of food falls by half or doubles, the quantity consumed changes only slightly for those who can afford it. A demand curve tells us the amount of a resource demanded for any price. The figure below depicts the demand curve for such essential resources.

The contribution of any resource to GNP is given by price multiplied by quantity. As we can see in the figure, price multiplied by quantity (the area inscribed by the green and red rectangles) moves in the opposite direction from quantity. If we treat GNP as a measure of economic welfare, then society becomes better off the less we produce of such resources. This is clearly a nonsensical result, whether we consider GNP a measure of economic welfare or economic activity.

Pricing problems

Unfortunately, this result holds true not only in theory but also in practice. In 2006-7, for example, the price of grain tripled in response to a combination of poor global harvests, the diversion of some grain stocks to biofuels, and speculation. The result was that grains contributed several times as much to GNP as the previous year, when harvests were much better. This did not have much impact in the wealthier nations, where food accounts for only a small share of our expenditures; but was catastrophic among the poorest nations, where many of the poorest individuals spend up to half their income on food. A better harvest the following year sent the contribution of grains to GNP crashing.

The same thing has happened several times with oil prices. When OPEC produced less oil in 1973 and 1979, the contribution of oil to global GNP skyrocketed. Following a century and a half of continually rising production (with the exception of the OPEC reductions), oil production virtually stagnated after 2005. By 2008, oil prices, and with them the contribution of oil to global GNP, had tripled. For any essential resource with limited possibilities for substitution – whose importance demands accurate treatment in any indicator of economic welfare – treating GNP as a benefit perversely shows a decrease in production as a gain in welfare, and an increase in production as a loss. In contrast, treating GNP as a cost sends a far more accurate signal of welfare or of economic activity.

Oil prices have a major impact on GNP [GALLO/GETTY]

GNP also fails when technological advances lower prices. I am writing this on a computer that cost $500 three years ago. A computer of similar capabilities would have contributed millions to GNP a few decades ago, and would contribute only about $500 today. Again, GNP is perverse as a measure of welfare, but effective as a measure of cost.

Most economists claim that adjusting GNP for inflation (or deflation) addresses these problems, but inflation implies an increase in overall price levels independent of supply and demand, not the response of individual prices to changes in supply or demand. Furthermore, any decent indicator of economic welfare should be amenable to disaggregation – it should measure the contribution to welfare for each sector of the economy as well as for the economy as a whole. GNP clearly fails this litmus test, and this failure leads economists to absurd conclusions. Several famous economists, including Nobel Laureate Thomas Schelling, have stated that global climate change will have minimal economic impacts, because it primarily affects agriculture, which is less than three per cent of GNP. Such beliefs are actually quite stupid, whether we consider GNP a cost or a benefit, but are presumably less likely if we treat it as a cost.

After careful reflection on the role of GNP, it appears that it would be far more effective as an indicator of costs rather than benefits, but simply treating it as a cost will do little to guide our society if we continue to focus blindly on GNP alone. As David Korten has pointed out, flying an airplane through stormy weather with poor visibility requires a sophisticated instrument panel measuring several different indicators: speed, direction, altitude and so on. Basing all decisions on the single indicator of airspeed would be suicidal. The economy is far more complex than an airplane, and we are currently entering an era of unprecedented storminess and poor visibility. A singular goal of striving to reduce GNP would be as suicidal as striving to increase it.

Ecological issues

The economy must be guided by at least three separate goals: ecological balance, human solidarity, and quality of life. Each of these goals requires several different indicators.

Ecological balance requires measures of renewable resource extraction relative to renewal rates, extinction rates relative to speciation rates, and waste emission flows relative to waste absorption capacity. By any of these indicators, we are currently experiencing the worst ecological recession in human history. GNP perversely measures resource extraction as a benefit while largely ignoring extinction rates and waste emissions. GNP may actually be one of the best existing measures of ecological imbalance.

Indicators of human solidarity might include a just distribution of the wealth created by nature and society as a whole, the absence of poverty, and the availability of fulfilling employment. Until we redefine economic recession as the existence of poverty, misery and unemployment, we will fail to solve these problems. GNP fails to distinguish between one hedge fund manager earning $5bn a year and 100,000 families earning $50,000; it provides no signal of human solidarity.

Quality-of-life indicators might include years of healthy life, access to culture (e.g. music, literature, arts) and education; networks of social connections and mutual trust; access to clean air, water, nature and life sustaining ecosystem services; and the buildings and infrastructure that provide us with shelter, transportation, gathering places, and human-produced means of production; as well as more subjective measures of happiness and satisfaction with life as whole.

As ecological economist Robert Costanza points out, we are in the midst of a 30-year-long quality-of-life recession. Quality-of-life indicators belong in the numerator of any measure of economic welfare, while GNP (plus the non-monetary costs it ignores) measures economic costs, and belongs in the denominator. Economic development is an improvement in human solidarity or quality of life, while economic growth in an increase in costs. The ratio of quality of life to GNP is a measure of efficiency.

There frequently are real costs to achieving our goals, and many developing countries will need to increase GNP in order to increase quality of life, but are only likely to achieve the latter if they also focus on ecological balance and human solidarity. The wealthy nations in contrast are likely to find that the costs of continued economic growth currently overwhelm the benefits, and the path to sustainable, just and efficient prosperity requires dramatic reductions in GNP.

Joshua Farley is an ecological economist and Associate Professor in Community Development & Applied Economics and Public Administration. He holds degrees in biology, international affairs and economics.

The views expressed in this article are the author’s own and do not necessarily reflect Al Jazeera’s editorial policy.