The Index of Economic Well-Being - 1984 - 2006

Lars OsbergDepartment of Economics, Dalhousie University Halifax, Nova Scotia

Conference: “Les Indicateurs Locaux de Progrès Sociétal"

Rennes, France, November 17, 2006.

Origin – a seemingly simple question:"Are you better off today than you were four years ago?"

1980 Ronald Reagan 1976-80 actual increase in per capita disposable

income in USA = 8.8% Audiences answered “NO!” – WHY ?

1984 - Osberg Paper for MacDonald Commission emphasized: Widespread dissatisfaction with GDP as a measure

of Economic Well-Being and: Alternative aggregate measures also sum to a

single index, burying value judgments

Components of:Index of Economic Well-Being (IEWB)

Consumption flows

Stocks of wealth

Economic equality

Economic security

EconomicWell-Being

Index of Economic Well-being, Equal Weighting, OECD, 2004

0.4405 0.4477 0.46100.4934

0.54290.5709

0.60390.6305

0.6565 0.6576 0.6716 0.6748 0.67860.7081

0.0000

0.1000

0.2000

0.3000

0.4000

0.5000

0.6000

0.7000

0.8000

UnitedKingdom

Australia Spain United States Canada Italy Sweden Finland Germany Netherlands France Belgium Denmark Norway

Source: Table 1

2006: ‘Are “you” better off ?’

Who is “you” ? Individual or Citizen ?

Personal well-being – no statistics needed Statistics on ‘well-being’ are only

needed if the issue is social decision-making “Well-being” as “citizen” requires

information on collectivity “Indicateurs Locaux de Progres Societal”

2006: Real Issue in Social Indicators‘Is the community “better off” ?’

As voters or bureaucrats, individuals make decisions re: collectivity Voting example: I will vote for policy X if Ix = 1 (own utilityx) + 2 (society’s well-beingx) > other alternatives Indicators of “Society’s Well-being”

Needed for individual policy & voting decisions Statistics = feedback loop of public policy

Economic Well-Being - multi-dimensional Index should respect heterogeneity

Values / Preferences Life Circumstances

What is the point of Index construction?

Policy choices must be made With multiple outcomes of differing dimensionality Affecting many dissimilar individuals

Objective of index construction: To assist democratic discourse by disentangling

When values differ When factual judgments differ

To enable individuals to make better summative subjective judgments on social choices

Dimensions of Economic Well Being

Concept Present

Representative Agent / “Typical Citizen”

Average Flow of Current Income

Per Capita GDP or “Adjusted” Average Income Flow

Issues: Market transactions only, heterogeneity, stocks

Dimensions of Economic Well BeingConcept Present

Representative Agent / “Typical Citizen”

Average Flow of Current Income

Diversity of Population Experiences

Distribution of Current Income- Poverty and Inequality

Social Welfare Function literature SWF = f ( , )

Dimensions of Economic Well Being

Concept Present Future

Representative Agent / “Typical Citizen”

Average Flow of Effective Current Consumption

Aggregate Accumulation of Productive Stocks (broadly defined)

Issues: Average Income does not reveal savings rate- assets include environment, Human Capital, R&D, etc.

Aggregate Savings – not automatically optimal, sustainable–preferences for social saving differ among individuals

Dimensions of Economic Well BeingConcept Present Future

Representative Agent/“Typical Citizen”

Average Flow of Effective Current Consumption

Aggregate Accumulation of Productive Stocks

Diversity of Population Experiences

Distribution of Current Income:- Poverty and Inequality

Insecurity of Future Income

Heterogeneity in Values ECONOMIC WELL-BEING=

1 CONSUMPTION + 2 SUSTAINABILITY / INTERGENERATIONAL BEQUEST+ 3 INCOME DISTRIBUTION / POVERTY+ 4 SECURITY

DIFFERENT VALUES WILL IMPLY DIFFERENT WEIGHTS Useful to know whether (& how much) perceived trend in

aggregate well-being depends on weighting

= 0 is a (strong) value choice

GDP per capita sets 3 = 4 = 0 assumes 1 AND 2 optimal always

What is Well-Being ?What is Economic Well-Being?

Economic Well-Being < Well-Being Economic Well-Being > GDP Economic output > Marketed $ output

GDP omits many sources utility value household labor value of leisure length of life, etc.

GDP includes “regrettable expenditures” Costs of pollution, crime, commuting, etc

Human Well-being- includes well-being from much more than economics

(e.g. personal freedoms, relationships, spiritual & intellectual discovery)

Economic Well-being < Well-being- but some aspects of well-being depend on

tradeoffs in scarce resources – ‘economic’

Economic Well-being

Chart 2: Growth in the Index of Economic Well-being, OECD, 1980-2004 (percentage points)

0.0000

0.1000

0.2000

0.3000

0.4000

0.5000

0.6000

0.7000Level of the Index of Economic Well-being, EqualWeighting, 1980Percentage Point Change, 1980-2004

Source: Table 1.

Economic Well-being and GDPmarketed $ output < total goods & services

GDP

Economic Well-being

GDP

“Social regrettables” – part of GDP, but not well-being

GDP

Economic Well-being

GDP

“Social regrettables”- Costs of crime, pollution, commuting

GDP per capita

GDP rigorously standardized across countries (SNA) – the clear point of comparison Can one do better? Does it make any difference ?

But - Strong Implicit assumptions when used as measure of economic well-being aggregate share of income devoted to accumulation (including

value of unpriced environmental assets) automatically optimal poverty, inequality & economic insecurity do not matter changes in leisure time, length of life, family size, costs of

commuting, pollution & crime - all irrelevant + poor match to popular perceptions of trends in economic

well-being

Payoff to per capita GDP growth in self-reported happiness ≈ nil

Chart 3: Average Annual Growth of the Overall Index of Economic Well-being and GDP per Capita, OECD, 1980-2004 (per cent)

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50Overall Index of Economic Well-beingGDP per Capita (2000 US dollars)

Source: Tables 1 and 2.

Average Consumption Flows $

Marketed real consumption per capita Adjustments

value of increased longevity of life reduced economies of scale in household consumption changes in working hours – leisure

Government services provision of non-marketed or heavily subsidized

services includes defense and capital consumption allowances excludes debt service charges and transfer payments

Chart 4: Total Consumption Flows per Capita, OECD, 2004 (2000 constant US dollars)

19,362

21,29122,154 22,481 22,709

23,70725,033 25,175 25,397 25,568 25,632 26,287 26,422

31,971

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

Finland Spain Sweden Germany Denmark Canada Belgium Australia Italy Netherlands UnitedKingdom

France Norway United States

Source: Table 3.

Wealth Stocks, Sustainability and Intergenerational Bequest $

Physical capital stock from SNA State of environment and national heritage

(degradation -) cost of CO2 emissions @ $ 85 per tonne

Value of natural resource stocks price + quantity change

Stocks of human capital Evaluated at cost of schooling

Research and development capital stock Net foreign indebtedness (-)

NOTE: Real productive assets only

Chart 5: Total per Capita Wealth, OECD, 2004 (2000 constant US dollars)

79,52482,324

87,723

95,23899,006

101,945 101,997107,528

113,762 114,307 115,484118,598

122,909127,524

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

Source: Table 4

Income Distribution Index

How to summarize “Distribution”? Simplicity desirable if index to be used Poverty & Inequality differ, but both matter

Inequality Gini coefficient

After-tax & transfer household income Equivalence scale =

Poverty Sen-Shorrocks-Thon measure

Rate Average poverty gap ratio Intensity = rate x gap

Index = 0.75*Poverty + 0.25*Inequality

familysize

Chart 6: Index of Equality, OECD, 2004

0.1783

0.2636

0.36160.3965 0.4056

0.4903

0.61530.6344

0.66650.6894 0.7027 0.7186 0.7231

0.8287

0.0000

0.1000

0.2000

0.3000

0.4000

0.5000

0.6000

0.7000

0.8000

0.9000

Source: Table 5.

Universal Declaration of Human Rights - 1948

[25] “Everyone has the right to a standard of living adequate for the health and well being of himself and of his family, including food, clothing, housing and medical care and necessary social services, and the right to security in the event of unemployment, sickness, disability, widowhood, old age or other lack of livelihood in circumstances beyond his control.”

“Economic Security”

Risk of income loss due to unemployment changes in employment rate x UI coverage x UI replacement rate

Risk of financial loss due to illness Uninsured medical expenses as % disposable income

Risk of single parent poverty poverty rate & gap for single women with children divorce rate of legally married couples

Risk of poverty in old age chance x depth of elderly poverty

“Economic Security”

Risk of loss due to unemployment Risk of Unemployment + E(financial loss|unemployment)

Financial Risk of Illness Unreimbursed private medical expenses as share of disposable

income Risk of single parent poverty

Divorce rate x poverty rate x poverty gap of single parents Risk of poverty in old age

chance x depth of elderly (>65) poverty Security risks weighted by relevant population size

Security from Unemployment

Original method – financial loss implied by compound probability =P(U)*P(B|U)*(E(B/W)

Assumes components matter equally Decline UI/EI coverage has big impact on trends

New literature on self-reported happiness Di Tella, MacCulloch, Oswald (2003) “The Macro Economics of Happiness” RESTAT

Ordered Probit life satisfaction – n= 271,224

Recover Implicit weights on Unemployment Rate and Unemployment Benefits

This paper: Unemployment rate = 4x UIBen = .8*(scaled Unemp) + .2*(scaled P(B|U)*(E(B/W))

Chart 7: Index of Economic Security, OECD, 2004

0.2030

0.3134

0.5102

0.5642

0.6146 0.61920.6523 0.6642 0.6766 0.6809 0.6950 0.7080 0.7238

0.7746

0.0000

0.1000

0.2000

0.3000

0.4000

0.5000

0.6000

0.7000

0.8000

0.9000

Source: Table 6.

Does it matter?How different is trend in IEWB & GDP?

Trend in IEWB depends partly on how heavily current consumption is weighted compared to: Sustainability / accumulation Income Distribution Security

Excel data sheet available for experimentation @ http://www.csls.ca/iwb.asp

Figure 2a: The Index of Economic Well Being and its Components in the United Kingdom, 1980-2001

00.10.20.30.40.50.60.70.80.9

Consumption Flows Wealth Stocks Equality Measures Economic Security Economic Well-being Index

Policy Implications ? Much less gain in economic well-being

than in real GDP per capita 1980-2004 Major reason has been growth in

inequality & insecurity Reducing Inequality & Insecurity was the

major objective of the welfare state BUT de-emphasized in recent years

Social Policy Design should aim at increasing Well-Being

The role of the natural environment

Natural Capital

GDPEWB

Physical Investment

Natural Capital

Produced Capital

GDPEWB

Human and Social Capabilities

Natural Capital

GDP

Human and Social Capabilities

Produced capital

EWB

The role of knowledge/skills

Natural Capital

GDP

Human and Social Capabilities

Human capital

Produced capital

EWB

A DIGRESSION

Definitions Human Capital

“The knowledge, skills, competencies and attributes embodied in individuals which facilitate the creation of personal, social and economic well-being

Social Capital “Networks together with shared norms,

values and understandings which facilitate co-operation within or among groups”

The role of networks/social norms

Natural Capital

GDP

Human and Social Capabilities

Human capital

Produced capital

EWB Social

capital

Close ties between human and social capital

Natural Capital

GDP

Human and Social Capabilities

Human capital

Produced capital

EWB Social

capital

The role of institutions

Natural Capital

GDP

Human and Social Capabilities

Human capital

Produced capital

EWB Social

capital

Political, institutional and legal arrangements

Natural Capital

GDP

Human and Social Capabilities

Human capital

Produced capital

EWB Social

capital

Political, institutional and legal arrangements

Natural Capital

GDP

Human and Social Capabilities

Human capital

Produced capital

EWB Social

capital

Political, institutional and legal arrangements

In both 1984 & 2006 – why do we care if indicator goes ‘up’ ?

Standard Indicators have ambiguous relation to Well-being GDP per capita excludes leisure,

environment & more Hourly wages ? Employment ?

Not valued directly – but indicate a more fundamental objective

Wage = price of labour; potential consumption? Market ‘power’?

Unemployment = unused labour; insecurity? Social exclusion ?

Methodology

Variables now scaled linearly Consistent with other indices (e.g. HDI) Solves “Directionality Problem”

(Max – value)/(Max – Min) OR (Value – Min)/(Max-Min)

Problems: Reporting trends as % change or % points Scaling removes base – sensitive to comparison

group “Base Case” assigns equal weight to all

dimensions Excel data sheet available for experimentation

http://www.csls.ca/iwb.asp