Measures of Wealth and Prosperity

This post was authored by Richa Gupta during an internship with Fields of View.

 

The Gross Domestic Product (GDP) has long been used to measure the prosperity and health of an economy. The GDP is defined as the market value of all final goods and services produced in a country’s economy, over a given time period (usually a year) [1]. It includes the four components of spending—spending by consumers, firms/businesses, the government, and foreigners (on exports).

 

According to the expenditure approach, GDP = Consumption + Gross Investment + Government Spending + (Exports – Imports)

 

There are other variations of GDP that are also in use, such as the NDP (Net Domestic Product), GNP (Gross National Product), and NNP (Net National Product). That said, all of them still factor in variables related to a country’s manufactured/produced output.

 

 

It is essentially the annual measure of a country’s output, but adjusted to account for depreciation (depreciation refers to reduction in the value of an asset, such as a car or house, over time).

 

  • Gross National Product = GDP + (net income inflow from abroad) – (net income outflow to foreign countries)

 

The GNP is the total value of a country’s output (final goods and services) produced by a country’s residents (domestically produced goods and services).

 

 

The NNP is the monetary value of domestically produced goods and services, minus depreciation.

 

Despite its variations, the Gross Domestic Product is largely used as a metric of a country’s prosperity and economic health. Nominal GDP (i.e. GDP evaluated at current market prices) is used to determine the economic performance of a country and to make international comparisons.

 

However, widely used as the GDP is, it has still come under criticism for not accounting for a range of factors; for example, it cannot accurately measure standards of living, such as levels of education, health, life expectancy, and quality of life. Furthermore, it does not look at negative environmental externalities caused by production, such as compromised air quality, water pollution, and land degradation. It also fails to look at the sustainability of capital stock used; capital stock is the total amount of a firm’s capital, represented by the value of its issued stock. All in all, the GDP of a country cannot give policy-makers an indication about the economy’s future; it’s all about the present. In fact, as said by Danish politician and former environmental minister, Ida Auken, “we need to move beyond GDP as soon as possible”.

 

Since GDP on its own cannot account for negative environmental externalities, a modification of the Gross Domestic Product was duly proposed, called the Green GDP. Green GDP is an index of economic growth that factors in environmental quality to the conventional GDP. It monetises the loss of biodiversity, and takes into consideration external costs caused by climate change. For example, if there is an oil spill in a country’s ocean, the money used to clean up the spill and to treat subsequent illnesses will invariably be included in the country’s GDP—thereby making it appear better off than it was before the spill. China was one of the first countries to measure its performance based on Green GDP; the first green GDP report for 2004 was consequently published in September 2006.

 

Green GDP = GDP – (value of environmental degradation) – (price of fixing environmental damage) [2]

 

However, Green GDP does not look at human capital. Moreover, as remarked by renowned economists Joseph Stiglitz, Jean-Paul Fitoussi, and Amartya Sen, “[Green GDP does not] characterize sustainability per se. Green GDP just charges GDP for the depletion of or damage to environmental resources”.

 

Another index was also decided upon—the Human Development Index, or HDI. The HDI not only takes a country’s value of output into consideration, but also looks at four important criteria: life expectancy at birth, mean years of schooling, expected years of schooling, and gross national income per capita.  So, the HDI is a much more comprehensive measure of a country’s development, since it includes a social aspect as well.

 

However, GDP, Green GDP, and HDI are insufficient when it comes to gauging environmental sustainability This observation has led to the inception of the Inclusive Wealth Index (IWI), which computes a country’s wealth by also taking the environmental and sustainability dimensions into account. It was launched by the United Nations at Rio+20 (a conference on sustainable development), in an attempt to develop a divergent way of gauging prosperity. A country’s Inclusive Wealth Index includes natural capital, in addition to produced/manufactured capital and human capital. Measuring sustainability of a country is critically important, since, as stated by the Sustainable Housing Foundation, “our global future depends on it”.

[1] Tragakes, E. (2012) Economics for the IB diploma [With CDROM]. 2nd edn. Cambridge: Cambridge University Press.

 

[2] Tragakes, E. (2012) Economics for the IB diploma [With CDROM]. 2nd edn. Cambridge: Cambridge University Press.

 

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