Thanks to economic growth, living standards around the world are rising. But in modern conditions, the fact that the standard metric of economic growth, gross domestic product (GDP), reflects only the size of the state’s economy, and not the level of well-being of its people, is not taken into account. However, politicians and economists often rely on GDP or GDP per capita as a comprehensive indicator of a country’s development, which implies its economic prosperity and social well-being. As a result, it is believed that policies aimed at economic growth are beneficial to society.
Now we know that everything is not so simple: taking into account exclusively GDP and economic benefits for measuring the country’s development, we ignore such negative consequences of economic growth for society as climate change and growing income inequality. The time has come to recognize the limitations of GDP and expand the set of instruments for measuring wealth that take into account the quality of life of society.
A number of countries have already embarked on this task. For example, India, where we both work as government consultants, is developing a living comfort index that takes into account quality of life, economic opportunities, and sustainability.
When we stop measuring the level of development of a country solely in terms of production, the policy pursued by the state will become more consistent with those aspects of life that are really important for residents, which will be better for society. However, before trying to refine the concept of GDP, it is important to understand how it came about.
The origins of GDP
Like many familiar concepts, the modern GDP model is a product of the war era. Although the invention of GDP is often attributed to Simon Kuznets (since it was he who sought to estimate the national income of the United States in 1932 in order to understand the real depth of the Great Depression), the modern definition of GDP was given by John Maynard Keynes during the Second World War.
In 1940, a year after the outbreak of war with Germany, Keynes, who served in the UK Treasury, published an essay commenting on the inadequacy of economic statistics to calculate the production capacity of the British economy based on available resources. He argued that the lack of data does not allow us to assess Britain’s willingness to mobilize and fight.
In his opinion, an estimate of national income should take into account the amount of private consumption, investment, and government spending. He rejected the version of Kuznets, who took into account government revenues, but excluded his expenses. Keynes understood that if wartime government procurements were not taken into account in demand when calculating national income, GDP would decline, despite the actual growth of the economy. His method of calculating GDP, which included government spending, which was determined by the needs of wartime, soon gained worldwide recognition and was widely used even after the war ended. This understanding of GDP prevails to this day.
Why GDP does not solve the tasks
However, the metric created to assess the country’s production capabilities in wartime is not suitable for peacetime. First, GDP, by definition, is an aggregate measure that includes the value of goods and services produced by the economy over a given period. It does not include both positive and negative consequences that appear during the production and development of the country.
For example, GDP takes into account the number of cars produced, but does not reflect their emissions; it takes into account the economic value of sugary drinks, but not the health problems they cause; it takes into account the value of building new cities, but does not evaluate the destruction of vital forests. As Robert Kennedy said in his famous election speech in 1968, GDP “GDP measures everything except what it’s worth living for.”