Friday July 19, 2024

Measuring economic wellbeing

By I Hussain
May 31, 2016

The writer is group director for business development at the Jang Group.

When Pakistan’s finance minister announces the annual budget this week one metric about the economy that is bound to figure prominently is the gross domestic product (GDP). This statistic is a measure of the monetary value of all final goods and services that are produced in a country within a given time period.

Because myriad goods and services are produced in a modern economy, the only way to combine them is to multiply each good or service by its market price (when available) and then to add each of the separate resulting values to get the country’s GDP. To avoid distortions in GDP comparisons due to price changes which could give a misleading picture about the condition of the economy, economic statisticians use a price index called the GDP deflator that removes the impact of price changes on GDP.

The resulting measure reflects changes in the actual volume of production of goods and services or what is called ‘real GDP’. It is real GDP when divided by the country’s population, or per capita GDP, that is considered a barometer of the economic health of the country.

While real GDP may be the best measure of productive activity in a country, many economists consider it a highly flawed indicator of living standards. The GDP measure has been criticised by such eminent economists as Joseph Stiglitz and Amartya Sen (both Stiglitz and Sen have been awarded the Nobel Prize for economics) who believe that a wider range of indicators is needed to measure human welfare. The ‘Commission on the Measurement of Economic Performance and Social Progress’ also known as the ‘Stiglitz-Sen-Fitoussi Commission’ that was set up by former president Sarkozy of France in 2007 deliberated on these matters and recommended that a “dashboard’ of indicators (analogous to the readings on the dashboard of a car that provide information to the driver about speed, fuel availability, distance travelled etc) should be produced by statistical agencies to assess living standards within a country instead of relying on a single figure such as per capita GDP.

The Stiglitz-Sen-Fitoussi Commission averred that for various reasons GDP per capita is a poor representation of the quality of life. One of the numerous examples cited in their report is the time people spend stuck in traffic jams. This increases spending on petrol thereby adding to GDP growth but this enhancement hardly leads to a better quality of life for those trapped in gridlocks on a daily basis. Another is that GDP excludes the value of leisure time that adds to people’s welfare while attaching the same weight to a rupee spent on education as on a rupee of ‘defensive spending’ such as on pollution abatement is tantamount to ignoring the quality of the expenditures constituting GDP.

More troubling from a resource sustainability perspective, particularly for countries dependent for their growth on exploitation of natural resources such as mineral deposits or forests, is that the GDP statistic does not account for the destruction and/or depletion of a country’s environmental and ecological capital. Indeed the most damaging environmental omission is that by emphasising maximum GDP growth as a desideratum while downplaying the effect of higher levels of production on carbon emissions, the majority of countries are exposed to a potentially severe negative economic shock as climate change upends economic activity worldwide.

Another major issue discussed in the commission’s report is the distribution of the GDP total among the population: a per capita figure is an average and averages can conceal more than they disclose since total income may be concentrated in a tiny sliver of the population – say, the top one percent. Which is why median income (the person with income in the middle of an array when persons are ranked from those having the highest down to the lowest income is the median income earner) rather than the average per capita income would be more revealing in assessing how most people are doing in terms of their ability to buy goods and services.

In periods of increasing inequality the difference between median and average income can widen considerably such that focusing on increases in the average per capita income masks the possibility that the majority have not shared in the GDP gains. Apart from using the statistical measure of the median, the report also recommends that economists focus on after-tax household incomes adjusted for social transfers (like free education) since this is a way of measuring what people actually receive from the national income and directly correlates with their living standards.

Apart from the conceptual problem areas, data collection itself is a minefield, which is why GDP data even for the most advanced economies with sophisticated data collection capabilities tend to be revised months or even years after the reporting period. One particularly glaring deficiency in GDP estimation is that the black or informal economy is perforce excluded. Given what we know about the poor governance situation in most developing countries including the extent of tax evasion, the degree of criminality (extortion, drug trafficking etc) and that some, if not the majority, of developing countries are ‘fantastically corrupt’ (in the words of British Prime Minister David Cameron) the GDP number is no doubt a gross underestimate.

For instance, Pakistan’s undocumented economy is said to be anywhere from 40 percent to 91 percent the size of the formal or documented economy. Think of all the money being secreted abroad through commercial banks, foreign exchange dealers, hawala/hundi, diplomatic bags, private aircraft, motor launches, yachts and, not least, human couriers and it is clear that the sums missed out by the official numbers are staggering. And for the technologically astute the usage of cryptocurrencies such as bitcoin, currently traded in Pakistan, provides another method for spiriting ill-gotten funds out of the reach of domestic authorities.

The problems with GDP have elicited a slew of alternative measures to assess how a country is doing in elevating its citizens’ living standards. One alternative commanding wide recognition is the United Nations’ Human Development Index (HDI) which is a composite number averaging three magnitudes: a country’s per capita gross national income, its access to knowledge that includes average years of schooling, and its people’s life expectancy.

While countries ranked higher on GDP per person generally tend to also have a higher ranking on the HDI measure, this is not always the case. For instance, several of the oil-exporting Gulf States have high international rankings on the basis of per capita GDP but slip significantly down the league table depicting countries’ level of human development when their respective HDI scores are tabulated.

On the HDI measure Pakistan is currently among the ‘low human development’ countries and is ranked at 147 out of 188 countries for which the latest HDI scores have been computed (in 2015). This is certainly not a good place to be in as we are at the bottom position among South Asian countries. In 2012 Bangladesh had been classified along with Pakistan as a ‘low human development’ country with both countries having the same HDI score. However Bangladesh has since moved up in the 2015 ranking and is now classified as a ‘medium human development’ country while Pakistan still languishes among the lowest tier countries.

One could well argue that improving Pakistan’s HDI score and its relative ranking on the HDI table is an important goal with which to judge the effectiveness of the government’s economic agenda. It should, therefore, be incorporated as an official target to be pursued – regardless of the political party in power.