Selvin Thanacoody – Doctoral Student, School of Economics, University of East Anglia
Gross Domestic Product (GDP) has only started to be used as a measure of economic progress after World War II and it is now applied as a proxy of economic wellbeing by politicians, the public and economists alike. Easily quantifiable, GDP is an indicator that improves policymakers and businesses’ ability to analyse the impact of fiscal and monetary policies on the economy, but also on social issues like poverty.
Yet, GDP growth, like most aggregate measures, cannot capture the complex and sometimes contradictory processes behind well-being. Well-being is a multidimensional notion comprising three core components: material living conditions, quality of life and sustainability of socio-economic and natural systems. Hence, GDP growth, which merely measures the value of goods and services in the economy, cannot be considered a measure of sustainable progress per se.
Inequality, for example, which entails substantial social costs such as corruption, nepotism, conflicts, and the erosion of social cohesion, is not captured in the measure of GDP. In most OECD countries, larger income gaps between richer and poorer households have been associated with positive GDP growth for the past decades. In Mauritius, despite sustained average growth of 4.3% over the past 20 years, rising inequalities have been noted in some sectors.
Any measure of economic wellbeing should capture, for instance, any damage to the environment. Yet, deforestation is valued more under the GDP measure than the benefits an uncut forest can provide – biodiversity habitat, reducing flooding, improving water quality, absorbing carbon dioxide, and producing oxygen. In fact, wood exports in Ivory Coast and Mexico have led to extinction of fauna and flora whereas some Chinese provinces which abandoned GDP growth as an indicator for public policy have seen wetlands and lakes reappearing.
Considering these shortcomings, what are the alternatives?
The adoption of the inclusive growth approach has been considered as an alternative to address, for instance, the distributive concerns of growth. Inclusive growth relates to a growth that is sustainable over time and fair: one that reduces poverty and incorporates the macroeconomic and microeconomic aspects of growth. This can be achieved by ensuring equal access to markets and resources, and unbiased regulation of businesses and individuals.
However, Gromling and Klos (2019) identify two main drawbacks related to inclusive growth. First, since growth is the result of macroeconomic activity, the concept of inclusive growth abstracts from a normative framework that would determine what wealth distribution level is considered as fair or not. Second, the causal relationship between the various indicators of inclusive growth and growth itself is not clear. For instance, education or investment can be growth drivers as well as outcomes of growth. They argue that the central economic markets – the labour market, the capital market and the education system, along with the institutions that regulate them can determine the path of growth and its outcomes. For instance, an employment protection regulation can provide job security for existing employees but will increase firms’ labour costs and thus limit the earnings growth of these employees as well as the employment of job seekers. Finally, since inclusive growth focuses on the sustained growth of GDP and its distribution across the economy, it does not account for environmental degradation. Hence, one cannot expect the environmental problem be solved by focusing only on inclusive growth.
Inclusive wealth as an indicator of economic wellbeing
The amount of wealth a country possesses stands as a more robust indicator of wellbeing and sustainable development. Wealth consists of the amount of produced, human and natural capital stocks a country owns, but importantly also includes the institutions (markets, legal system, government agencies, norms) that guide the allocation of resources.
Time horizon: Framed within modern macroeconomic theory and welfare economics, wellbeing is derived from an intertemporal normative approach. Thus, one can ask what the optimal consumption of society at any given point in time is. As defined by Arrow et al. (2012), wellbeing ‘(… )is the dynamic counterpart of real income’. Put differently, when the population of a country consumes a certain amount of this wealth at any given point in time, it has an impact on the amount of wealth the next generation can consume in the future. Thus, the level and intertemporal changes in the stock of the different assets are indications of the extent of sustainability of consumption.
Since sustainable development refers to the development that meets the needs of current and future generations, proxying a nation’s total wealth as an indicator of economic wellbeing enables any policymaker to appreciate whether policies impact on assets and thus on sustainable development.
Human Capital Stock: the causality relationship between market outcomes and institutions and wealth appears to be clear. For instance, an increasingly market-oriented economy since the 1990s and higher school attainments have led China’s urban human capital stock to increase significantly, which in turn was conducive to productivity growth and poverty and inequality reductions.
In Morocco, the increase in total assets was constrained by a slow growth in human capital but according to the World Bank reforms aiming at matching demand and supply such as training programs upgrades and changes in hiring and laying-off regulations can reverse the trend. Furthermore, better access to healthcare increases the supply of female labour and can thus reduce gender inequality.
Natural Capital Stock: Adopting the wealth approach to marine fisheries indicates a depletion of natural capital due to overfishing, which resulted in foregone rents of $83 million in 2012. This trend was caused by subsidies in the sector that not only incentivised the industry to catch an amount of fish higher than the profit maximising amount, but also increased fishing efforts to a point where negative impact on the stock’s ability to replenish itself.
Wealth creation is upwardly biased when GDP growth alone is used. As such, inclusive wealth grew less than GDP between 1990 and 2014, with advanced economies having a positive inclusive wealth growth whereas the developing world saw a reduction of the indicator. This comparison highlights the important trade-offs between the different assets. Indeed, produced and human capital were expanded at the expense of natural capital.
Because the inclusive wealth approach is based on capital stocks, it is possible to attain a balanced portfolio of assets by setting up the institutional structure capable of, for example, correcting the rent variation that businesses can earn from exploiting natural assets. This also includes providing effective education and health services as well as facilitating a business environment favourable to competition and contestability – when ease of entry into a market induces incumbents to behave competitively.
A way forward
The broad wellbeing notion conveyed by the GDP measure casts a shadow on the real sustainability path a country takes and brings forward a compelling need to adopt alternative economic welfare indicator(s). Mauritius’ newly acquired high-income status is meaningless unless we think differently about the economy and recognise that well-functioning markets and institutions are essential to ensure that citizens’ life standard is maintained and enhanced.
Adopting the inclusive wealth approach can guide policymaking to reach this objective by enabling decision-makers to detect which type of wealth need to be expanded, and thus intervening in the concerned markets by designing appropriate institutions. The establishment of a competition authority or an environmental agency are good examples of public intervention to tackle market power or pollution. In practice, however, the lack of data and the inability to measure some aspects of wellbeing in monetary values makes the derivation of a single indicator challenging. Furthermore, there is no consensus among economists and other stakeholders on using valuation techniques to measure certain wellbeing components. For instance, life is considered as priceless.
A semi-inclusive wealth indicator, such as the UN inclusive wealth index, could be a more practical approach for policymakers to shape sustainability strategies. A semi-inclusive wealth indicator is a version of inclusive wealth that is restricted to forms of capital that can be easily measured in monetary terms. Monetary aggregation can be restricted to produced capital, human capital and fossil resources. This measure could be complemented by wellbeing indicators that cannot be easily monetised like biophysical metrics. Other wellbeing measures include housing, political governance, sense of community, crime rates, access to public facilities and green areas. For instance, the UK Airports Commission strengthened its assessment of the impact of a new runway on citizens’ well-being by using the national wellbeing measures. In the pandemic context, the recent application of a wellbeing indicator to daily aspects of life shows that less commuting per day can increase life satisfaction.
Adding these wellbeing indices to a semi-inclusive wealth indicator resembles a benefit-cost analysis where a monetary value is assigned to monetary quantifiable benefit and cost items, while non-economic indicators are used as such. Such an approach goes beyond the concept of GDP.
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