GDP AS A MEASURE OF THE STANDARD OF LIVING

Every nation has a different economic status and therefore the

population in each country has its own unique standard of living.

For academic and economic purposes it is necessary to measure the

standard of living. This helps to form a comparison basis and also

to evaluate the progress in the standard of living of the people.

The standard of living is directly linked to the economic growth of

the nation as a whole. By traditional definitions, economic growth

is an increase in national income over a period of time. Although

national income does rise every year the rate at which it grows is

different for different years and is affected by a variety of factors

natural and man made. The most common of measure of the

standard of living is ‘gross domestic product’ (hereto referred to as

GDP). However a growth in national income does not necessarily

mean a better standard of living. The argument for this can be

substantiated by observing the fact that economic growth does not

always mean economic development for the people.

The purpose of this essay is to evaluate the shortcomings of using

GDP as a measure of standard of living. First the concept of GDP

is explained and then the limitations and alternative measures are

discussed.

1

GDP – FACTORS CONSIDERED

GDP is an indicator of the economic activity which includes

production and exports of a nation. The most popular view on GDP

was put forward by J.M Keynes. The economist has suggested two

approaches which are the Demand and Supply Approaches.

THE DEMAND APPROACH

Keynes argued that national income is the sum effect of the

expenditure totals in certain areas by governments. The formula

put forward by Keynes is:

GDP = C + I + G + (x – m)

(Source: www.bos.frb.org)

In the above formula ‘C’ stands for increase in consumer

expenditure, ‘I’ stands for an increase in investment expenditure

and ‘G’ stands for an increase in government expenditure and ‘X’

for export expenditure, ‘M’ stands for import figures. The excess

of exports over imports is often seen as a general indicator of

economic growth.

2

Consumer expenditure is the amount the people spend on goods

and services. Two important considerations in the calculation of

the consumer expenditure are the marginal propensity to consume

(MPC) and the marginal propensity to save (MPS). As a matter of

national policy it has been suggested by various economists that

increasing the propensity to consume will decrease the propensity

to save and will therefore increase consumer expenditure.

Investment expenditure consists of mainly three factors- private

investment, public investment and household investment. The rates

of private and public investment depends on subsidies given to

businesses and interest rates etc. household investment depends on

interest rates on mortgage payments and tax policy. This has a

direct impact on the disposable income available to both the

individual and also businesses.

Government expenditure is mainly composed of spending by

central and local authorities on employment and government

services. A good example for this in the United Kingdom is the

expenditure pattern adopted for the National Health Service- NHS.

Expenditure on roads, public transport, defence, police etc are all

major factors in this direction.

3

Export expenditure is influenced by how competitive and modern

the industries and companies that are in the export sector are. This

is in turn affected by the overall infrastructure in a nation such as

reliable goods delivery channels and power supply and political

situations. Research and development spending and innovations in

goods and services all affect the export arena in the modern

business place.

THE SUPPLY APPROACH

The three main components of the supple approach are Increased

Productivity, Technological Progress and Employment patterns.

Increased productivity can be related to increase in labour due to

decrease in wage rates, capital investment etc. Also prevalent is the

increase in land supply. This does not mean a literal increase in the

volume of land. The increase in land means a decrease in land

prices due to factors such as government subsidies which would

allow investment in manufacturing concerns.

Technological progress has the effect of increasing the output for a

given industry for a given amount of investment. The rate of

technological progress and innovations has a direct impact on the

4

rate at which output is generated. Advanced machinery helps to

produce better products at a faster and more economic rate. This

increases the supply figures for the industry.

Employment patterns also affect the supply curve. Unemployment

benefits along with direct tax policies may increase the incentive of

the population to work. This means an increased use of the

resources. Also important is the mobility of the work force. Skilled

labour may not always be available on site or near the company.

Therefore factors such as transport methods such as motorways

and fast train services are directly linked to the employment

patterns effect on the supply curve.

GDP does have advantages in that many nations use it to gauge

standard of living and therefore there exists a comparison platform.

Also an inherent advantage is the GDP can be measured at basic

prices or market prices.

The sum total of all the above factors was traditionally used to

gauge GDP. The problem with the above factors is that the world

ahs changed dramatically and certain new factors such as pollution,

natural resource depletion etc has been lately proven to be

important in the calculation of a more realistic measure of standard

of living.

5

GDP – INADEQUACIES AS A TRUE MEASURE

Accurate reflection of the standard of living is often attained due to

the variety of factors involved in the calculation of the standard of

living. Through the following points we shall analyse the factors

which GDP do not take into account and why it is important to

include them to accurately calculate the standard of living.

Inflation – Over the years the prices of goods and services have

increased and while the increase in production is considered in

GDP calculation, prices rises are not incorporated. The effect of

inflation is that while the figures go up the actual purchasing

power of the individual goes down. In other words national income

may seem to rise but the actual standard of living actually is

declining or staying still. What a product costed two years ago is

not necessarily what it costs today. There are two sides to this

coin, for example while transportations costs and consumerables

such as food may incur price rises, electronic goods may see price

falls depending on level of technological progress in the industry

e.g.;- laptops and computer technology.

6

Distribution of income - Not every region in a country has an

even spread of economic prosperity. GDP figures do not represent

the distribution of income in a nation and only show an average of

the whole nation. In effect this conceals problems such as regional

poverty. A good example for this is China. While the GDP of

China shows a very good rate of increase, it does not reveal the

fact that a vast majority of the rural areas still suffer from poverty

and lack of development.

Black Economy – The existence of black economies in countries

are never revealed through GDP figures. GDP is the representation

of the figures that have been reported by the various agencies and

government departments. Therefore GDP is often underestimated

because of the existence of the black economy and the percentage

of the value of transactions that are not officially reported. A Black

Economy is the portion of the economy where tax evasion exists.

When individuals evade tax the actual value of goods or services

rendered are not taken into calculation for GDP purposes. This

portion includes product not sold at market prices, barter trade and

even self consumption. Black economy in many nations is a very

serious fact. For example a recent report by The Economist

revealed that countries like Nigeria and Thailand have a black

economy worth more than 70% of the official economy. In the

7

United Kingdom Blackpool in Hull is considered to be the main

hub of the black economy.

Population Increase – GDP figures can never include the

population rise over the years. For example if ten years ago a GDP

of 100 GBP was spread over 10 people, now a GDP of 200 GBP

would have to be spread over 15 people. This shows a remarkable

decline in the amount available to each individual. Factors that

affect this are immigration patterns. For example asylum seekers

may have to be provided for but do not always contribute to the

economy.

Quality of Goods and Services – the technology and performance

of the products available in the market also has an impact on the

standard of living of the people. The best example of this is the rate

at which information technology in the form of computers have

increased. Every household is now able to access technology

which was not available ten years ago, although at that time the

GDP figures might have suggested a better standard of living. This

misleads the reader of the GDP figures. The quality of the goods

and services add to the individual’s quality of life although the

figures may not represent these attributes.

8

Social Welfare – measures undertaken by the government to

provide for safer and healthier communities also are a key

consideration not included in GDP calculations. For example one

of the reasons that the United Kingdom is seen as one of the best

countries in terms of standard of living is that it is primarily a

welfare state. The government allocates enormous amounts of

money towards provisions for clean streets, better healthcare

facilities and lately the recycling revolution also has become

embedded in the minds of the citizens.

In this regard the expenditure on education and public transport is

also not fully integrated into the GDP calculations. These are

aspects of everyday life that make a remarkable difference in the

quality of life in the short as well as long term. The combination of

the welfare measures is perhaps equally as important as disposable

income because citizens need to feel enriched, secure and

committed to the society to have an excellent standard of living.

A key factor in the above argument is that the amount spent on

welfare measures does not guarantee a higher standard of living.

Let us consider two countries A and B. Let us assume that country

A has higher GDP than country B and also that country A has a

significantly bigger budget for the police department. This,

although it adds to the GDP figures, does mean that it is necessary

9

for country A to have a greater police presence than country B. In

such a case it means that the people do not feel as safe in country

A as they do in country B. This is a purely qualitative aspect of

standard of living that GDP figures cannot reveal.

Pollution levels – A factor ignored in the calculation of the

standard of living of a people is the environment they live in and

the impact of modernisation and economic development. Natural

resources are being depleted at a rapid pace and many developing

nations have opted for rapid industrial growth at the cost of the

natural environment. Clean cities and preserved natural areas

contribute significantly to the individual’s well being. Many of the

modern day diseases are the result of man made pollution. The

biggest cities in the world such as London, New York etc have

emphasised the need for green spaces and spend millions on public

parks within cities.

10

ALTERNATIVE MEASURES OF STANDARD OF LIVING

So far we have discussed the major shortcomings of using GDP as

an accurate representation of the standard of living. From the turn

of the century up until the 1970’s GDP would have sufficed

because of the relatively lower number of factors that has an effect

on the well being of the people. Since the increases in world

population, advances in science and globalisation the number of

factors have almost quadrupled. Ideally an alternative measure of

standard of living would take into account the maximum number

of factors that have an economic as well as qualitative impact on

the individual standard of living.

In the following paragraphs we shall look at the alternative

measures put forward by academics in the field. Although the

different methods do take additional and/or different factors into

its’ calculation we should not forget that when it comes to

comparison between countries, cultural differences and religious

and political beliefs will always exist and there is no way to

homogenise all the people. Also the below list is in no way a

conclusive list. For instance a very widely acknowledged concept

is that of the Purchasing Power Parity – PPP. The PPP suggests

that a dollar should buy the same amount of product everywhere in

the world and this would make country wide comparisons easier

11

and possible. But the PPP again only takes into account the

monetary factors and leave no space for inclusion of the qualitative

factors of a person’s life. For the purposes of this essay we shall

look at the measures which do take into account more than

economic aspects.

Human Development Index (HDI) – The United Nations

Development Program 1999 came up with a new annual report

named the HDI. The HDI took into account GDP, life expectancy

at birth, education etc. The inclusion of these social factors meant

that the HDI gave a better measure of the standard of living.

Although not a complete indicator of the true standard of living the

HDI is perceived to be better than the GDP. (www.undp.ord)

Genuine Progress Indicator (GPI) – A North American public

policy organisation based in California called ‘Redefining

Progress’ put forward the Genuine Progress Indicator – GPI in

1995. The GPI laid more importance to the qualitative situations in

societies. For example where the GDP treated public expenditure

on crime prevention as an addition to the standard of living the GPI

subtracted these costs in the logic that such costs added to

breakdown of the social fabric. A key characteristic of the GPI is

that the income disparities in the society are more aptly adjusted

for when measuring standard of living in a country. The GPI rises

12

for a nation when the poorer sections of the society receive a larger

section of the national income thus presenting a more accurate and

all round picture of the true standard of living conditions. Further

advantages of using the GPI is that, where GDP counts pollution as

a double gain, once when it is created and then again when it is

cleaned up, GPI subtracts the costs of air and water pollution as

measured by actual damage to the human well being and also to

the natural environment. (www.undp.ord)

Index of Social Health – In 1987 Marc Miringoff and Prof.

Marque-Luisa Miringoff together developed the Index of Social

Health. The Index is published annually using government data for

16 social indicators. The Index uses a scorecard where countries or

even states within a country are ranked out of 100. The factors

included in the Index shows how important the inclusion of the

qualitative factors of life are sometimes more crucial than the mere

amount of disposable income. (www.undp.ord)

The Sixteen Indicators in the Index of Social Health

1. Affordable Housing

2. Child poverty

3. Infant mortality

4. Unemployment

5. Age 65 plus poverty

6. Health care coverage

13

7. Life expectancy

8. Violent crime

9. Alcohol related traffic fatalities

10.High school completion

11.Teenage births

12.Wages

13.Child abuse

14.Inequality in family income

15.Teenage drug abuse

16.Youth suicide

Human Poverty Index (HPI) – the HPI measures the different

percentages of people that are not expected to achieve specified

target levels of different economic and quality of life indicators.

The HPI model includes three separate indicators, P1, P2 and P3.

P1 is the percentage of people not expected to survive to age 40.

P2 is the percentage of adults who are illiterate.

P3 is the percentage of people who fail to attain a decent living

standard. P3 is then separated into three separate items which are:

P31 - % of people without access to safe water, P32 - % of people

without access to health services and P33 - % of people with

underweight children, P3 is then calculated as an average of these

three items.

P3 = (p31+p32+p33)/3 (www.undp.ord)

14

CONCLUSION

In conclusion we can see that the GDP as a measure of true

standard of living is grossly inadequate and requires to be

combined with others forms of measures which include qualitative

aspects as well. With an increased number of factors which affect

the well being of the modern citizen it is not realistic to rely solely

on measures which are purely economic based. Sustainability

issues in an economy also need to be incorporated in to the

measure of standard of living. While it is not easy to formulate a

platform for this measurement there has to be some sort of

parameter where such factors are included.

The adoption of alternative measures is complicated because of the

inherent nature of changes in technology and cultural inclinations

of people in different countries. While the adoption of a combined

measure of standard of living may reflect a reasonably accurate

picture for a given nation, it is necessary from an academic point

of view for there to be a comparison base between countries.

15

Bibliography

1. Tony Buxton, Paul Chapman and Paul Temple, Britain’s

Economic Performance, 2nd edition, 2001

2. David Begg, Economics, 7th edition, 2004

3. Oxford Dictionary of Economics by John Black

4. www.undp.ord/hdr2003/faq.html21- Human Development

Report, 2003, FAQ’s on the Human development Indices

5. www.bos.frb.org/genpubs/ledger/ledger03/winter/measure.pdf-

The Ledger 2003, ‘’How do we measure standard of living’’?

16