One of the main uses of national income data is in measuring the economic well being of the population through the concept of the standard of living. The basic standard for this is to use GDP per person (per capita). But GDP per capita does have some limitations when assessing the standard of living.
Firstly GDP does not take into account for the natural inflation; if inflation is not taken out of the equation then the GDP will overestimate the living standards of a countries population. This is the case because for example if a piece of machinery breaks down after use and a company buys a new one, inflation would have increased the price. So using GDP this would view this as an increase in the standard of living for the population which quite obviously is not the case. A better way to measure living standards would be to use real GDP which removes the factor of inflation and so give out a more realistic figure.
Also GDP figures on their own do not show the distribution of income and the uneven spread of financial wealth but show an average. Incomes and earnings may be very unequally distributed among the population and rising national prosperity can still be accompanied by rising relative poverty. So by using GDP you may be hiding the differing extremes in a country.
There are certain things that are difficult to measure using any statistical approach to living standards; these are also not reflected in GDP statistic. The GDP does not take into account social problems in the community, and even though the statistics may be showing an increase in income, the social problems may be reducing the quality of life and living standards of the people. For example, we can see divorce rates have increase significantly over the past 4 decades. Also there may be increased stress, alcoholism and suicide rates, and all these have negative effects on living standards. Also increases in GDP and so “living standards” may also be accompanied by an increase in pollution and other negative externalities which have a negative effect on living standards which the GDP does not take into account.
GDP figures also tell us little about the quality of goods and services produced, which has a major effect on living standards. For example say you purchased a laptop 2 years ago for ï¿½1000, and another person purchased a ï¿½1000 laptop today. GDP would say that both of the people had the same quality of life, but as we know that the two goods are not homogenous and that the quality differs, which affects standards of living.
Also Investment. Capital Investment into a firm or an economy provides the opportunity for development, expansion, research, and possible higher levels of Productivity. This ties in with the second, Technological Advances. These lead to the availability of better equipment, which improve the manufacturing of goods or services, or help to create better ways of managing jobs and people. Investment can also be stretched to link with the third factor, Education and training. Education and training work to make people more productive and effectively, act as investments into what is known as ‘Human Capital’. These three interlinked factors have significant effects on GDP but may not affect living standards for a few years and so my over estimate the living standards of a population.
Rising national output might have been achieved at the expense of leisure time if workers are working longer hours
A report released in August 1999, entitled Six Days a Week, claimed that more than a million managers and 656,000 professionals in the UK worked at least 48 hours a week. The study showed that the number of people working more than 48 hours a week has risen from 2.7 million to four million over the past 15 years.
British workers have the longest working week in Europe, with full-time workers putting in an average of 44 hours – three and a half hours longer than the European average. All of these factors will have increased the GDP number but may lower the living standards of the population and so will not be a true reflection of what it is trying to show.
GDP figures might understate the true living standards because of the existence and growth of the black economy. The black economy includes economic activity that goes unrecorded by the Inland Revenue and Customs & Excise. This includes output that is not sold at market prices but involves barter trade, and self-consumed products. The Economist’s latest estimates for the total value of the black economy throughout the world is $9 trillion. The scale of the underground economy is estimated to average 15% of national output for rich economies and 33% of national output for emerging economies. According to their survey, Nigeria and Thailand have the world’s largest black economies, both accounting for more than 70% of official GDP.
Another subtle criticism of GDP is that some of the goods valued in GDP do not really increase living standards, for example military expenditures, and also consider this model. Locks and keys, goods that have no use except to provide protection from burglars. If the population was perfectly honest and there were no burglars, the protection would not be needed. Suppose in two countries with equal populations and GDP. The first country has the need for locks and keys and so pay for the manufacturing of locks and keys, this will increase the GDP and show that their living standard has increased. Now country 2 has a perfectly honest population and there is no need for lock or keys and they are blessed with very favourable living conditions. Now if everything else in the country was cet. par then GDP would indicate that the living standard of country 1 was higher.
Now in looking for alternatives to GDP as a measure of living standards, I have found a theory called Amartya Sen’s capabilities approach, where living standards is seen as the maximization of the five instrumental freedoms: political freedom, economic facilities, social opportunities, transparency guarantees, and protective security. However, this approach suffers because of the lack of a simple way to compare compare and measure these 5 freedoms across countries and time periods. Moreover, some of Sen’s freedoms can at times conflict, and without the benefit of numbers, it is difficult to know how to weigh the importance of each variable. A solution to such problems comes in the form of the Human Development Index (HDI) and other composite indexes.
Which assigns numeric indicators of development to countries that allow for easy comparison, but these numeric values incorporate more than just GDP per capita. For instance, the HDI “is a simple average of three indexes reflecting a country’s achievements in health and longevity (as measured by life expectancy at birth), education (measured by adult literacy and combined primary, secondary, and tertiary enrollments), and living standard (measured by GDP per capita in purchasing power parity terms. In this way, you still are provided with a single number for easy comparison between countries but include more information than simple GDP per capita.
I have attempted to show that GDP is problematic as a measure of living standards. Ultimately, using GDP as a measure for living standards because GDP is a potential means to living standards and is not an end in itself. Therefore, it makes sense to examine living standards by composite measures of the ends themselves: life expectancy, infant mortality rates, literacy, education, happiness rates, etc. Specifically, alternative development indicators such as the HDI or the GPI are steps toward a more accurate and balanced approach to measuring development.