Answer to Question #57989 in Macroeconomics for Jessica

Question

What is the basis for the argument that GDP measures fail to include many things that are part of human welfare?

Answer 1

Gross Domestic Product or GDP is generally considered as a measure of economic activity and as such is widely used for making welfare comparisons across countries and across time on its basis. By definition GDP is a monetary measure of the value of all final goods and services produced in a period (quarterly or yearly).
From that it is clear that GDP measures primarily the economic activity and could only potentially be used as welfare indicator under some ideal conditions. Yet there are serious reasons to think that these conditions do not exist:
1. GDP is computed at market prices – which means that it ignores, in particular, the environment.
2. “Defensive expenditures” as part of GDP: a category that includes items from expenditures on the military, infrastructural projects etc. These expenditures increase the GDP, but they have got nothing to do with well-being.
3. GDP does not include a meaningful part of the economy – such as household work. Beside of its importance for the proper functioning of the economy and society, unaccounted for household work makes welfare comparisons based on GDP both across time and across countries difficult. For instance, the US is known for its culture of “outsourcing” of household work, which makes the US GDP (per capita) higher in comparison with GDP in European countries.
4. GDP does not include the “shadow” or informal economy, which is a substantial part of economy in developing countries.
5. GDP does not include changes in natural capital and ecosystem services (including renewable and nonrenewable natural resources, water purification, climate regulation, pollination, flood protection etc.) which are tremendously important for the well-being of people.
6. GDP do not account for distributional or equity effects, while those effects in many cases (particularly when basic needs of the population are satisfied, as is the case in most developed countries) may be more important than the average level of wealth.