The Stiglitz-Sen-Fitoussi Report stressed that progress is more than increases in income, wealth or production (Stiglitz et al 2009). Nevertheless, we continue to struggle to adopt a consistent broader focus in defining and measuring progress.
There have been a number of reports outlining the limitations of GDP as a measure of progress, and recommendations for alternative measures. Alternative indicators of progress generally fall into one of three categories (Goossens et al 2007):
- Adjusting GDP usually involves adjusting traditional measures of economic performance to include environmental and social factors.
- Replacing GDP includes indicators that attempt to assess progress more directly. For example, by assessing the achievement of basic human functions (like the Human Development Index) or average satisfaction (like the Happy Planet Index).
- Supplementing GDP includes approaches designed to complement GDP with additional environmental and/or social information (such as dashboards).
While it is beyond the scope of this paper to discuss all the various measures, a few alternate measures of progress are worth mentioning.5
3.1 Adjusting GDP
A number of adjustments to GDP can be made to provide some, albeit limited, insights. In particular, being a measure of market production, GDP misses a significant amount of household activity as it excludes home production of goods and services (other than imputed rents). It does not measure appropriately the goods and services of the public sector. In fact, this was highlighted by Pigou who noted that 'if a man marries his housekeeper or his cook, the national dividend is diminished' (Pigou 1920, p.26).
Importantly, household income and consumption are more relevant measures of living standards than is real GDP. Real GDP ignores the income changes that arise from changes in the terms of trade which can be significant particularly for commodity exporting countries. In addition to terms of trade effects, divergences between production and domestic income may also arise where there are net foreign transfers - for example, the repatriation of profits to foreign investors. Thus, while higher foreign investment may increase profits and therefore GDP, profits repatriated by foreigners do not enhance the purchasing power of domestic residents. Adjusting for these effects would result in a more comprehensive measure of (material) progress.
GDP is also a gross measure, and therefore does not take into account the depletion of the capital stock; a cost associated with the production of output due to the erosion of an asset. Depreciation effectively means a proportion of output needs to be set aside to renew or replenish asset stocks. Removing depreciation of the physical capital stock converts GDP into Net Domestic Product (NDP). The theoretical foundation for NDP in terms of welfare was outlined by Hicks (1939) who argued that 'the purpose of income calculations in practical affairs is to give people an indication of the amount which they can consume without impoverishing themselves in the future'. While real NDP is a better measure of what the economy is producing, and is often calculated by statistical agencies, GDP is more typically used because of the difficulties in measuring economic depreciation.
While NDP makes allowance for the depreciation of physical capital, the depreciation, or degradation, of environmental capital and resource depletion is often overlooked. Take for example the treatment of natural resources. The value of extracted natural resources is treated as production, an increase in GDP. However, natural resources are assets already owned by the community. Their extraction and sale represents the transformation of an asset (the natural resource) into another asset (cash). By not counting the depletion of the natural resource asset, production or valued added, as measured by GDP, is overstated, possibly at the expense of the wellbeing of future generations. Measures such as Green GDP, the Index of Sustainable Economic Welfare, the Genuine Progress Indicator and Adjusted Net National Income, all adjust GDP for environmental degradation, resource depletion or both.
As GDP can be adjusted to incorporate depreciation of physical capital, resource depletion and environmental degradation, so too can measures of wealth (and savings). Gross National Savings measures how much the country is saving for future consumption. Adjusted net savings (or Genuine Savings) measures the true rate of savings in an economy after taking into account depreciation, investment in human capital, depletion of natural resources and damage caused by pollution. Accounting for resource depletion and environmental degradation can provide interesting insights into whether countries are developing sustainably. A country that raises current consumption by running down its capital stocks, or by borrowing, may increase current wellbeing, but possibly at the expense of its future wellbeing.
3.2 Replacing GDP
Addressing the issues with GDP outlined above will get us somewhat closer to better understanding material wellbeing. However, there are arguably a number of other dimensions which are also important for wellbeing. These include health, education, personal activities including work, political voice and governance, social connections and relationships, the environment and insecurity. Many of these non material dimensions of wellbeing are reflected in Treasury's wellbeing framework. These non material dimensions raise significant measurement difficulties for economists and statisticians. For example, a key dilemma for the 'capabilities approach' has been how to measure what people could do, as opposed to what they actually do. Non-material dimensions of wellbeing, both objective and subjective, have driven the development of measures that either replace GDP or supplement it.
One the most widely known measures of progress that attempts to incorporate some of these non material dimensions is the Human Development Index (HDI), developed by Mahbub ul Haq and Amartya Sen for the first Human Development Report in 1990. The HDI is a summary measure based on three aspects of human development: health (life expectancy at birth), education (mean years of schooling) and income (GNI per capita). Environmental issues are not considered.
Two prominent indicators that take into account environmental considerations are the Ecological Footprint (EF) and the related Ecological Balance (EB). The EF measures the area of land required to sustain a given population at present levels of consumption, technological development and resource efficiency. The EB measures the extent to which the ecological demand of an economy stays within or exceeds the capacity of the biosphere to supply goods and services.
The Environmental Sustainability Index (ESI) expands on traditional environmental measures of progress by incorporating institutions, in particular an economy's capacity to improve its environmental performance over time. This is done by measuring social and institutional capacity and global stewardship.
Incorporating and considering subjective measures of wellbeing has proven significantly more difficult. The Happy Planet Index (HPI), introduced in 2006 by the New Economics Foundation (nef), is an index of human wellbeing and environmental impact. The indicator is based on two objective indicators, life expectancy and ecological footprint, and one subjective indicator 'life satisfaction'.
3.3 Supplementing GDP
Given
the difficulty of constructing single indexes, of estimating monetary equivalents for environmental and social indicators of progress, and of ensuring indicators are based on a common framework, a number of measures have also been developed to supplement GDP.
One approach used by a number of agencies, and also recommended by Stiglitz et al (2009), is the presentation of a select set or 'dashboard' of indicators to complement traditional economic measures. One example of this is the ABS Measures of Australia's Progress (MAP) publication. MAP presents approximately 80 headline and supplementary indicators which are split into three pillars of society, economy and environment. The ABS has long been acknowledged as a leader in the development of national account statistics, and has been influential in looking at new ways of measuring wellbeing and progress. The ABS started developing MAP in the late 1990s, and released the first MAP report in 2002, in response to the growing understanding that GDP should be assessed in conjunction with other measures spanning society and the environment as well as the economy.
Another measure supplementary to GDP is the United Nations' System of Integrated Environmental and Economic Accounting (SEEA). The SEEA is a satellite system of the System of National Accounts, which means that accounts produced under this standard bring environmental and economic information together within a common framework.