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Measuring Sustainability

• Problems with GDP and GNP as development indicators• Alternative indicators addressing sustainability▫ Net or ‘Genuine’ Saving▫ Human Development Index (HDI)▫ Environmental Performance Index (HPI)▫ Gross National Happiness (GNH)• Issues, concepts, measurement• Precautionary principle

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Indicator Gross Domestic Product Gross National Product

Definition An estimated value of the total worth of a country’s production and services, within its boundary, by its nationals and foreigners, calculated over the course on one year.

An estimated value of the total worth of production and services, by citizens of a country, on its land or on foreign land, calculated over the course on one year.

Formula for Calculation GDP = consumption + investment + (government spending) + (exports − imports).

GNP = GDP + NR (Net income inflow from assets abroad or Net Income Receipts) - NP (Net payment outflow to foreign assets).

Layman Usage Total value of Goods and Services produced within the territorial boundary of a country.

Total value of Goods and Services produced by all nationals of a country (whether within or outside the country).

Country with Highest Per Capita (US$)

Qatar ($102,785) Luxembourg ($45,360).

Country with Lowest Per Capita (US$)

Malawi ($242). Mozambique ($80).

Country with Highest (Total) USA ($17.42 Trillion in 2014). USA (~ $11.5 Trillion in 2005).

GDP/GNP

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Problems with using GDP/GNP• Distribution of income▫ How is the income distributed – does a small proportion of

the population earn a high percentage of the income or is income more evenly spread?

• Quality of life▫ Can changes in economic growth measure changes in the

quality of life?▫ Does additional earnings power bring with it additional stress,

increases in working hours, increased health and family problems?

• Impact of exchange rate▫ Difference in exchange rates can distort the comparisons –

need to express in one currency, but which one and at what value?

Problems with using GDP/GNP• Informal economy▫ Some economic activity not recorded – subsistence farming

and barter activity, for example▫ Some economic activity is carried out illegally – ‘cash in hand’,

drug dealing, etc. ▫ Work of the non-paid may not be considered but may

contribute to welfare – charity work, housework, etc.

• Indiscriminate▫ Makes no distinction between beneficial and harmful economic

activity. ▫ Gun sales, oil spills, and demolitions all generate economic

activity and all count as additions to GDP. ▫ Accelerating the depletion of precious nonrenewable resources

like oil and coal accelerates GDP growth even as it destroys the essential resource on which that growth depends.

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Desirable characteristics for sustainable development indicator

• Sound underlying framework

• Numeraire / aggregation rules

• Clear interpretation regarding sustainability

• Linkage to policy levers through aggregates or sub-aggregates

• Internationally comparable, available for many countries

Alternative indicators• Net or ‘Genuine’ Saving

• Human Development Index (HDI)

• Environmental Performance Index (HPI)

• Gross National Happiness (GNH)

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Net (Genuine) Saving• Rate of savings after taking into account investment

in human capital, depletion of natural resources and damage caused by pollution.

Principles of Net (Genuine) Saving• Asset accounts in monetary units provide a consistent

framework and yardstick for measuring development prospects.• The components of net saving (gross saving, depletion,

damage) can be affected by policy, permitting tradeoffs in the pursuit of sustainability.• The saving measure is related to a loose definition of

sustainability: non-decreasing present value of social welfare.• Positive genuine saving indicates rising social welfare;

negative genuine saving suggests that social welfare will fall in the future.• Negative net saving implies unsustainability.

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Representative Composition of Net Saving

Gross domestic savings

Consump- tion of fixedcapital

Energy depletion

Mineral depletion

Net forest depletion

Carbondioxidedamage

Education expenditure

Adjusted net savings

Low income 20.3 8.3 3.8 0.3 1.5 1.4 2.9 7.8 Middle income 26.1 9.6 4.2 0.3 0.1 1.1 3.5 14.3 Low & middle income 25.2 9.4 4.1 0.3 0.4 1.2 3.4 13.3 High income 22.7 13.1 0.5 0.0 0.0 0.3 4.8 13.5 East Asia & Pacific 36.1 9.0 1.3 0.2 0.4 1.7 1.7 25.2 Europe & Central Asia 24.6 9.1 6.0 0.0 0.0 1.7 4.1 11.9 Latin America & Carib. 19.2 10.0 2.8 0.4 0.0 0.4 4.1 9.6 Middle East & N. Africa 24.2 9.3 19.7 0.1 0.0 1.1 4.7 -1.3 South Asia 18.3 8.8 1.0 0.2 1.8 1.3 3.1 8.3 Sub-Saharan Africa 15.3 9.3 4.2 0.6 1.1 0.9 4.7 3.9

Negative terms Positive term

Net (Genuine) Saving Comparisons

GNI is the GDP along with the income obtained from other countries (dividends, interests).

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Adjusted Net Saving vs GDP/cap

-30.0

-20.0

-10.0

0.0

10.0

20.0

30.0

40.0

50.0

100 1000 10000 100000

GDP per capita

Ad

just

ed n

et s

avin

g, %

of

GD

P

Net (Genuine) Saving

• Looking at an extended but incomplete range of assets may produce a result further from the truth

• What’s Missing?▫ Health▫ Literacy ▫ Education

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Human Development Index (HDI)• Summary measure of three basic dimensions of

human development:

• A long and healthy life, as measured by life expectancy at birth

• Knowledge, as measured by adult literacy rate (2/3) and combined primary, secondary & tertiary gross enrollment ratio (1/3)

• A reasonable standard of living (GDP/capita)

Human Development Index (HDI)• The HDI is “an index just as vulgar as GDP but

it stands for better things” (Amartya Sen)

• Human-centered vs. commodity-centered

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Goalposts for calculating HDI**UNDP(2005): Human Development Report

Indicator Max. value Min. Value

Life expectancy at birth 85 25

Adult literacy rate (%) 100 0

Combined gross enrollment ratio(%)

100 0

GDP per capita (PPP US$)

40,000 100

HDI Calculation

• HDI = 1/3 (D1+D2+D3)where: D1=longevity index; D2= knowledge index D3= standard of living index.

• Individual indices are calculated as:D1 = (actual – min) / (max – min)D2 = 2/3 adult literacy index + 1/3 gross enrollment indexD3 = (log actual – log min) / (log max– log min)

▫ HDI>0.8 represents “high”▫ 0.5<HDI<0.8 represents “medium”▫ HDI<0.5 represents “low”

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HDI Trends by Region

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HDI Rankings (2006)

1 Iceland (.968) 11 Finland (.951)

2 Norway (.968) 12 United States (.951)

3 Australia (961) 13 Spain (.949)

4 Canada (.960) 14 Denmark (.949)

5 Ireland (.959) 15 Austria (.948)

6 Sweden (.956) 16 United Kingdom (.946)

7 Switzerland (.955) 17 Belgium (.946)

8 Japan (.953) 18 Luxembourg (.944)

9 Netherlands (.953) 19 New Zealand (.943)

10 France (.952) 20 Italy (.941)

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GDP Rankings (2006)

1 Luxembourg ($80,471) 11 United Kingdom ($35,051)

2 Ireland ($44,087) 12 Finland ($34,819)

3 Norway ($43,574) 13 Belgium ($34,478)

4 United States ($43,444) 14 Sweden ($34,409)

5 Iceland ($40,277) 15 Qatar ($33,049)

6 Switzerland ($37,369) 16 Australia ($32,938)

7 Denmark ($36,549) 17 Singapore ($32,867)

8 Austria ($36,031) 18 Japan ($32,647)

9 Canada ($35,494) 19 Germany ($31,095)

10 Netherlands ($35,078) 20 Italy ($30,732)

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GDP per capita HDI

Comparison of IndicatorsNet Saving

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Is the HDI Enough to Measure a Country’s Level of Development?• According to the UNDP, the answer is: “Not at all.”

• “The concept of human development is much broader than what can be captured in the HDI, or any other composite indices…”

• “The HDI and the other composite indices can only offer a broad proxy on some of the key the issues of human development…”

• “A fuller picture of a country's level of human development requires analysis of other human development indicators and information.”

▫ Environmental impacts on health▫ Depletion of water resources▫ Depletion of biodiversity▫ Depletion of stocks of fish▫ Climate change▫ ...

What’s Missing?

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Environmental Performance Index (EPI)• Based on 20 variables

• 9 issues

• 2 objectives: Reduce environmental stress on human health and promote ecosystem vitality and sound natural resources management

• EPI measures proximity-to target for each indicator (established by international agreements, national standards or scientific consensus with a range of 0-100), which does not vary by country.

• Scores are calculated as average of the score of the 2 objectives

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▫ Psychological well-being▫ Community vitality▫ Cultural diversity▫ Good governance▫ ...

What’s Missing?

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Gross National Happiness (GNH)

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Gross National Happiness (GNH)

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Three Issues to Consider When Evaluating Indexes

1) Validity

2) Reliability

3) Parsimony

Validity

• What is the index supposed to measure?

• What indicators make up the index?

• Are these the best indicators for this index?

• How are the indicators calculated?

• Are there better ways to calculate these indicators?

• In short, how well does the index actually measure what it is supposed to be measuring?

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Reliability

• Who or what organization collected the data?

• How were the data collected?

• In short, if you or someone else were to try to replicate the index would you end up with more or less the same results?

Parsimony

• The whole point of an index is to simplify the measurement of a particular phenomenon.

• In short, does the index rely upon as few indicators as reasonably possible without undermining its validity?

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Break

35

Decisions under Ignorance

Choice Good chef Bad chef

LobsterGood

lobsterTerrible Lobster

HamburgerEdible

hamburgerEdible

hamburger

Nothing Hungry Hungry

I am eating at a new restaurant, for which I don’t have any information about the chef.

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HungryHungryNothing

Edible hamburger

Edible hamburger

Hamburger

Terrible Lobster

Good

lobsterLobster

Bad chefGood chefChoice

HungryHungryNothing

Edible hamburger

Edible hamburger

Hamburger

Terrible Lobster

Good

lobsterLobster


22Nothing

33Hamburger

14Lobster


22Nothing

33Hamburger

14Lobster


Having a Hamburger dominates Nothing.

So there is no reason to choose Nothing.

Weak Dominance:

Strong Dominance:

).,(),(such that s state some is and there

stateevery for ),(),( ifonly and if

n njni

mmjmiji

savsav

ssavsavaa

. stateevery for ),(),( ifonly and if ssavsavaa jiji

Decisions under Ignorance

Dominance

Probabilities are not required to assess dominance.

However, dominance often fails to single out a particular decision alternative.

So, it is not an entirely sufficient decision criterion.

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Maximin

HungryHungryNothing

Edible hamburger

Edible hamburger

Hamburger

Terrible Lobster

Good

lobsterLobster


HungryHungryNothing

Edible hamburger

Edible hamburger

Hamburger

Terrible Lobster

Good

lobsterLobster


22Nothing

33Hamburger

14Lobster


22Nothing

33Hamburger

14Lobster


If we are pessimistic, we might want to maximize the worst possible outcome.

Maximin criterion:

So what should we order?

Again, probabilities are not required.

. states allover )min()min( ifonly and if saaaa jiji

Precautionary Principle The precautionary principle states that if an action has a

suspected risk of causing harm to the public or to the environment, then the burden of proof that it is not harmful falls on those taking an action.

The principle implies that there is a social responsibility to protect the public from exposure to harm, when scientific investigation has found a plausible risk.

In some legal systems, as in the law of the European Union, the application of the precautionary principle has been made a statutory requirement in some areas of law.

Practically, the precautionary principle implies a maximindecision criterion.

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Maximax

HungryHungryNothing

Edible hamburger

Edible hamburger

Hamburger

Terrible Lobster

Good

lobsterLobster


HungryHungryNothing

Edible hamburger

Edible hamburger

Hamburger

Terrible Lobster

Good

lobsterLobster


22Nothing

33Hamburger

14Lobster


22Nothing

33Hamburger

14Lobster


If we are optimistic, we might want to maximize the best possible outcome.

Maximax criterion:

So what should we order?

Again, probabilities are not required.

. states allover )max()(ax ifonly and if saamaa jiji

Minimax Regret

HungryHungryNothing

Edible hamburger

Edible hamburger

Hamburger

Terrible Lobster

Good

lobsterLobster


HungryHungryNothing

Edible hamburger

Edible hamburger

Hamburger

Terrible Lobster

Good

lobsterLobster


22Nothing

33Hamburger

14Lobster


22Nothing

33Hamburger

14Lobster


What if we order the lobster and it turns out to be terrible?

What if we order the hamburger, and we find out that the lobster is good?

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HungryHungryNothing

Edible hamburger

Edible hamburger

Hamburger

Terrible Lobster

Good

lobsterLobster


HungryHungryNothing

Edible hamburger

Edible hamburger

Hamburger

Terrible Lobster

Good

lobsterLobster


What if we order the lobster and it turns out to be terrible?

What if we order the hamburger, and we find out that the lobster is good?

Minimax regret criterion:

Will we actually learn whether the lobster was any good?

12Nothing

01Hamburger

20Lobster


12Nothing

01Hamburger

20Lobster


Regret TableMinimax Regret

What if the waiter now tells us that the special of the day is Lobster Thermidor?

HungryHungryNothing

Horrible!Outstanding!Lobster

Thermidor

Edible hamburger

Edible hamburger

Hamburger

Terrible Lobster

Good

lobsterLobster


HungryHungryNothing

Horrible!Outstanding!Lobster

Thermidor

Edible hamburger

Edible hamburger

Hamburger

Terrible Lobster

Good

lobsterLobster


Minimax Regret

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22Nothing

-1010Nothing

33Hamburger

14Lobster


22Nothing

-1010Nothing

33Hamburger

14Lobster


18Nothing

130Nothing

07Hamburger

26Lobster


18Nothing

130Nothing

07Hamburger

26Lobster


Regret Table

LobsterThermidor

LobsterThermidor

So what meal is preferred option now?

Minimax regret is sensitive to irrelevant alternatives.

Minimax Regret

Principle of Insufficient Reason If one has no reason to think that one state of the world is more

probable than another, then all states should be assigned equalprobability.

This transforms a decision problem under ignorance into a decision problem under uncertainty (or risk).

This implies that we should maximize expected utility.

22Nothing

-1010Nothing

33Hamburger

14Lobster


22Nothing

-1010Nothing

33Hamburger

14Lobster


LobsterThermidor

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Extremely sensitive to delineation of states.

What if we divided ‘Good chef’ into ‘Excellent chef’ and ‘Mediocre chef’?

Which meal is preferred now?

In general, why favor ‘equal’ probabilities over anything else?

222Nothing

0

3

0

Mediocre chef

-1020Lobster

Thermidor

33Hamburger

18Lobster

Bad chefExcellent chefChoice

222Nothing

0

3

0

Mediocre chef

-1020Lobster

Thermidor

33Hamburger

18Lobster

Bad chefExcellent chefChoice

6 2

Principle of Insufficient Reason

Ellsberg’s Paradox

I have an urn containing 90 balls:

30 are red

The remaining 60 are either black or yellow or a mix.

Which would you prefer?

Gamble 1: Receive $100 if a red ball is chosenGamble 2: Receive $100 if a black ball is chosen

Gamble 3: Receive $100 if a red or yellow ball is chosenGamble 4: Receive $100 if a black or yellow ball is chosen

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Ellsberg’s Paradox

It is inconsistent to prefer G1 and G4 (or G2 and G3), yet that is what most people state.

Rather than certainty principle, it seems that people want to avoid ambiguity.

Perhaps we should add ambiguity aversion to risk aversion.

Remainder of Term:• No class on Tuesday, June 2

• Help session on Thursday, June 4, 2:00-3:00 PM

• TA office hours (Time and Location TBA)

• Prof. Borsuk office hours (C131)▫ Thursday, June 4, 3:00-5:00 PM▫ Friday, June 5, 3:00-5:00 PM

• Final Exam: Sunday, June 7, 11:30 AM

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