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Thread on #GDP, the environment and happiness. As I have already repeatedly pointed out here, GDP is often charged with all the evils of the world, but that is mostly because both the people who use it and those who criticize think it measures things it doesni't measure /
First of all: most of the things I will write here are discussed at length in the excellent "GDP: A Brief but Affectionate History" by @DianeCoyle1859 , a book that I consider a masterpiece of economics explained to a general public.
As was said about Hannibal Lecter, if you want to understand evil (or GDP 😉) you need to go back to its origins. Rudimentary attempts to measure national income have existed for centuries. Some of them were actually really valiant attempts, given the state of data at the time
Over the course of the 19th century, an increasing number of countries produced statistics on industrial production. It took a while for people to acknowledge that production can also include things you cannot drop on your feet (what we now call "services") and that you /
also need to develop methodologies to measure those. It was only in the 1930s/1940s that a systematic methodology was developed to measure GDP. If you remember what happened in those decades, you will understand why there was an urgent need to do so: /
Indeed, with the Great Depression, governments started to understand the need to have systematic data on economic activity (as a tool to understand fluctuations in employment). Moreover, with a new war looming, measuring production was also essential for the management of /
the War Economy. Now, one the things everybody needs to understand is that the development of this methodology entailed some choices that were always controversial. For instance, if you had a course in economics at university, you may remember that, in national accounting /
the value added of the services provided by the government is measured by the *inputs* in the production of those services (the wages of the civil servants and the goods purchased by the government). Which leads to the somewhat paradoxical situation that a less efficient /
government will have a greater value added. It is thus important to realise that this is an accounting convention, and that no one suggests that this means that inefficient governments are more sustainable than efficient ones. That' simply not measured. /
And, to be sure, there was a lot of discussion about this convention. Some economists thought at the time that GDP should only measure what was going on in the private sector, and you may understand from the previous tweet why they thought like that. /
Anyway, for the best or the worst, that is the convention that was adopted. There are other issues you may remember from introductory courses (I certainly covered them when I taught a intro to econ course). For instance, because GDP only covers market exchanges, if you marry/
your house maid or your gardener, their work in the household is no longer a market exchange and disappears from GDP (I always thought it was funny when non-economists would tell me that as if this is something that this was an issue that never occurred to an economist)/
Also, with comparisons through time and in space, there are a lot of problems. When you compare between countries, exchange rates do not reflect differences in prices. And measuring price indices is also fraught with challenges /
One problem that is becoming increasingly important is that of measuring services in a digital world: how do you measure the "value added" of services like social media for which, as a consumer, you don't pay? A full treatment would take us to far here. If you're interested /
a good discussion can be found in "Capitalism Without Capital" by @haskelecon & @stianwestlake goodreads.com/review/show/21…
Also, if you are technically inclined, you may be interested in the work by Erik Brynjolfsson @erikbryn on redesigning GDP for the 21st century qz.com/1582202/mits-e…
OK. So I have listed limitations of the indicator that every economist worth his salt is aware of. That doesn't mean it shouldn't be used, though: even conventional GDP is well correlated over time and space with subjective indicators of well-being - I will come back to that./
But now a first fundamental issue. I have already used the word "sustainable" above, and that was on purpose. Indeed, if there's one thing GDP doesn't measure, it's sustainability, not even in the strict economic sense. /
After all, the demand side of GDP is composed of: (a) private consumption (b) investment (c) government consumption (d) net export. Whether investment makes 1 or 20 or 40% of the demand side doesn't matter, even though /
the long term consequences of such differences are likely to be important. As I have pointed out above, the quality of government expenditure doesn't matter either when you calculate GDP. More fundamentally, "investment" in GDP is measured as "gross investment": /
GDP doesn't tell you whether this gross investment suffices to maintain your existing capital stock. In other words, GDP measures your current income, it doesn't measure wealth. At all. This is one of the key sources of misunderstanding /
You would often hear people say "Well, when a hurricane (or a war) destroys a country, and that you need to build up the country again, there will be full employment and high GDP growth, and economists think that's great, look how stupid they are". Well, right. /
As everybody who's capable of some minimum introspection knows, wealth matters. Earning 2000 EURO per month is not the same when you know you will inherit a big house and some investment funds from you grandparents one day than when there's no inheritance waiting for you/
(by the way, to the extent that a war destroys the capital base of a country, it is even debatable that war is good for GDP, but that's a different question) Anyway, this discussion about wealth brings me to what I really wanted to talk about: the environment /
The key step is to understand that, just as physical capital (machines, infrastructure) provide services, natural resources do as well. They include the raw materials we extract from the earth, the biomass we use for our food, the air we breathe and the water we drink etc
What they all have in common is that we don't pay a market prices when we extract them from nature: nature provides it freely. So it's not included in any conventional indicator of economic activity. /
And that's a problem of course, because this also means that GDP doesn't measure when we deplete natural resource. Now, if we come back to conventional GDP, remember that it doesn't even measure whether we deplete our "conventional" capital /
That's why, from a sustainability point of view, it would be more informative to use net domestic product, this is after depreciation of capital. Maybe surprisingly, there are issues with measuring depreciation, and that is one of the reasons why GDP is used more often than GNP.
Now, by analogy, we could add depreciation of natural capital to depreciation of human made capital to obtain "green" net national product. And, as the table of contents of this handbooks show, economists have been doing this for decades e-elgar.com/shop/green-nat…
(personal note: it was reading the paper by Repetto et al that you can find in this book that got me interested in natural resource economics in the first place) /
So you heard this well people: economists have been working on green national accounting for decades, long before you ever saw it mentioned in the newspapers. But, we have to add, it's not an easy task /
How do you measure physical depreciation of natural resources to start with? For raw materials, you probably have reasonably good data in developed countries, but what about open access resources such as fisheries? What about the destruction of rain forests and peat grounds/
in developing countries where legislation is poorly enforced? What about losses in biodiversity? A lot of the key elements are simply not monitored systematically /
And then there's the question of the price. Per definition, these are goods and services without a market price. Conceptually, the solution is to use "shadow prices", the prices that we would observe if there was a well functioning market for them.
Here as well, a full discussion would take us too far. I will just point out that the World Bank has been working on the concept of "genuine savings" (including depreciation of natural resources) as an indicator for sustainable development since the early 1990s. On a personal /
note, once again, I have had the privilege to attend a seminar where the first research results were presented. (unfortunately, the website of the World Bank discussing this concept is down for maintenance for the moment)
This approach can be extended to other topics. For instance, if the markets would be left completely alone, polluters would not have to pay for the cost of the pollution they cause, and the market prices don't reflect correctly the value they add to society /
One could thus argue that the costs of pollution should also be considered as intermediate consumption by firms and should be substracted from GDP. Again, while this is conceptually consistent with the idea that GDP should substract intermediate inputs from the value of output /
the practical implementation is fraught with difficulties. You need not just to monitor pollution closely - you also need to measure the pathway from the sources to ambient concentrations, you need to measure how they affect variables that are relevant for human welfare /
(such as health) and then you need to impute the relevant "shadow prices" to calculate the monetary costs. And these really raises a new question. We know that "conventional" GDP is not without its problems, but at least it is based on data that are routinely collected /
and the methodology is well-established (even if it is far from perfect). Is there really a value added to aggregate "conventional" GDP with indicators of "green depreciation"? Or should we leave "conventional GDP" as the imperfect indicator that it is, and complement it /
with other indicators, without putting them all on the same monetary denominator? I don't have an answer to that myself, and I guess our insights on these matters will continue to evolve in the coming years.
Besides the question "is GDP an indicator for sustainability", there is another thorny question: is it an indicator for human well being? The question was first raised by Easterlin in the early 1970s en.wikipedia.org/wiki/Easterlin… /
after he found that, once a certain threshold of income has been exceeded, higher incomes do not longer correlate with higher happiness. Several explanations have been put forward to explain this paradox. For instance, it could be that people adapt their expectations /
to their existing income levels, creating a "hedonic threadmill" were people pursue always increasing levels of material welfare, just to become increasingly demanding. Or, there is the explanation (which actually makes sense from an evolutionary perspective) /
that happiness is largely related to status, while status is zero-sum game: your gain in status is a loss in mine, even if both our incomes have increased. But this research is not uncontroversial. A first problem has been pointed out by Nobel Prize Winner Daniel Kahneman /
and Angus Deaton (who has gained some public fame with his work on the US opioid epidemic) have shown that, while money only buys "happiness" until a given threshold, it does buy you "life satisfaction" without thresholds - see e.g. vox.com/2015/6/20/8815…
By the way, both Kahneman and Deaton have written excellent books for a general public ("Thinking fast and slow" and "The great escape", respectively). Deaton's work especially is a perfect antidote to any thinking that GDP doesn't matter for human welfare. /
A completely different approach has been proposed by another Nobel prize winner, Amartya Sen, who has argued that what matters for welfare, is what people are *capable* of doing, rather than what they ear - see en.wikipedia.org/wiki/Capabilit…
(the obvious example being that most people would rather be middle class in good health than rich in poor health). Again, discussing that would lead us too far, but I certainly would encourage anyone who got this far in the thread to read Sen.
And now I am going offline to read Mas Hasting's history of the Vietnam war.
