GDP as a measure of economic

growth and standard of living

AS Macro – 2014
 GDP
• GDP is Gross Domestic
Product
• GDP is the total value
of output of goods and
services produced
within an economy in a
given period of time
Economic Growth
• Economic growth is the increase in
value of the goods and services
produced by an economy over a
period of time
• It is conventionally measured as the
per cent rate of increase in real GDP
• Growth is usually calculated in real
terms, i.e. inflation-adjusted terms, in
order to net out the effect of inflation
on the price of the goods and services
produced
• In economics, "economic growth"
typically refers to growth of potential
output i.e., production at full
employment, which is caused by
growth in aggregate demand or
observed output (GDP).
 GDP as a measure of living standards
• Ceteris paribus, the standard of living tends to increase
when GDP per capita increases
• This makes GDP a proxy (equivalent) for standard of
living, rather than a direct measure of it
• GDP has the key attraction of internationally agreed
standards for calculation
 Gross National Product or Income
• GNP is the total value of all
final goods and services
produced within a nation in
a particular year plus net
income from overseas
investments and remittances
• Remittance money transfers
are hugely important for
some countries

Remittance flows to the developing world exceeded $406 billion in 2012

 Remittance Incomes in 2012
• 2012 are India ($70
billion), China ($66
billion), the Philippines
and Mexico ($24
billion each), and
Nigeria ($21 billion).
• Other large recipients
include
Egypt, Pakistan, Bangla
desh, Vietnam, and
Lebanon.
 Remittance Incomes in 2012
• As a percentage of
GDP, the top
recipients of
remittances, in 2011,
were
– Tajikistan (47 percent)
– Liberia (31 percent)
– Lesotho (27 percent)
– Moldova (23 percent)
– Nepal (22 percent)
– Samoa (21 percent)
 Real GNI per capita ($)
• Real
– Adjusts for
the effects
of price
changes /
inflation
• Per capita
– Divides by
the
published
resident
population
to give a
figure for
output per
person
Real GNI per capita, PPP
• PPP stands for
purchasing power
parity
• PPP measures how
many units of one
country’s currency
are needed to buy
exactly the same
basket of goods and
services as can be
bought with a given
amount of another
country’s currency
 Real GDP Per Capita
Country 2012 GDP per capita (at
constant 2005 prices, PPP,
US $)
Singapore 64,309
United Kingdom 38,969
South Korea 33,049
Malaysia 16,406
China 8,902
India 3,844
Vietnam 3,616
Ghana 1,982
Bangladesh 1,882
Problems with using real GDP per capita as
an indicator of standard of living

Human Happiness Beyond Markets Externalities

Quality of Life Non Market Activities Environmental Factors

Black Market Sustainability Make up of GDP

Informal Economy The Long Run View Balance of spending
Happiness and Well-Being
• Human happiness determined by many other things Human Happiness
than physical goods and services
Quality of Life
– Changes in the number of hours worked
• Rising national output might have been achieved at the expense
of leisure time if workers are working longer hours
• Greek workers put in longer hours than anyone else in Europe —
42.2 per week, compared to just 35.6 in Germany (ONS data)
• In the UK, in 1992 we used to work 38.1 hours, in 2011 it had
fallen to 36.3 hours.
– A reduction in working week hours or number of annual
days’ holiday will adversely affect GDP… but positively
affect welfare…
– So a good measure of the standard of living should
include a measure of the increased value of leisure that
society gets
– Key issue is how we go about valuing life expectancy
Happiness and Well-Being
Human Happiness
Quality of Life
Non Market Activities
• Not all activities have a market price attached to them Beyond Markets
• Services of housewives/house-husbands Non Market Activities
• Value of home schooling / caring for a relative
• 2008 survey estimated that the average stay-at-home-
parent’s salary would be around £30,000 (if you were
to use market prices for the
ironing, washing, cooking, cleaning, school run they
do every day).
• It ignores volunteer, unpaid work. For example, Linux
contributes nothing to GDP, but it was estimated that
it would have cost more than a billion US dollars for a
commercial company to develop.
• It ignores such things as going for a walk in the
mountains or a cycle ride, if no price is paid to do such
activities
Environmental Factors
• Environmental costs such as pollution, worsening air Externalities
quality would reduce the true value of GNP
Environmental Factors
• GDP counts work that produces no net change or that
results from repairing harm. For example, rebuilding
after a natural disaster or war may produce a
considerable amount of economic activity and thus
boost GDP, but it would have been far better if the
disaster had never occurred in the first place.
• The current system counts oil spills and wars as
contributors to economic growth
• Calculating green GDP requires that net natural
capital consumption, including resource
depletion, environmental degradation, and protective
and restorative environmental initiatives, be
subtracted from traditional GDP
The Shadow Economy
• Official GDP estimates may not take into account the
Black Market
black market, where the money spent is not
Informal Economy
registered resulting in inaccurate or abnormally low
GDP figures
• The size of the black/informal economy differs
between countries – particularly bigger in LEDC’s,
with poor tax collection services
• Some think tanks put estimates of Britain's shadow
economy being now worth £150bn a year (2013),
around 10% of total GDP
• 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
• Some countries adjust figures for the shadow
economy (for example, Italy) and others do not
The Shadow Economy
Black Market
Informal Economy
Sustainability of Growth (1)
• GDP does not measure the sustainability of growth
• A country may achieve a temporarily high GDP by over-
exploiting natural resources or by misallocating
investment Sustainability
• Many countries rich with natural resources remain The Long Run View
poor – this is known as the natural resource curse
• Other countries have successfully invested incomes
from their endowment of natural resources to build a
more sustainable growth model
– Norway – one of the biggest sovereign wealth funds in the world
- estimated to be worth $1tr (£0.6tr) by 2020
– Uganda - The 2008 National Oil and Gas Policy required that
an appropriate framework be put in place to aid the
sustainable management of oil and gas revenues.
Ecological Footprint
Carbon Productivity and HDI
 Sustainability of Growth (2)
• Economies experiencing an economic bubble, such
as a housing bubble or stock bubble, or a low
private-saving rate tend to appear to grow faster
due to higher consumption, having higher current
Sustainability
growth
The Long Run View
• But the cost of this will be lower future growth
• Japan for example in the 1980s experienced a
spectacular property bubble and then bust and
stagnation for two decades (‘the Lost Decades’).
(Between 1985-1991, commercial land prices rose
302.9%; and by 1986, the average for 1 square
metre of land in Tokyo’s commercial districts cost
$25,000).
The Make Up of GDP (1)
• The composition of GDP may be very different Make up of GDP
• E.g. defence versus consumer goods Balance of spending
• A country that produces all military gods and services
may have a high GDP…
• But it will have a lower level of welfare if society
doesn’t value that military expenditure, and would
prefer some consumer goods
• Defence expenditure as a % of GDP
– Japan 1%
– Lebanon 4.4%
– Saudi Arabia 8.4%
– UK 2.6%
– USA 4.7% (World Bank, 2011).
Military Spend as % of GDP
Make up of GDP
Balance of spending
Military Spend and HDI
Make up of GDP
Balance of spending
 The Make Up of GDP (2)
• Short term versus long term – Standard of living effects Make up of GDP
(capital versus consumer goods)
Balance of spending
• The balance between consumption and investment
• If an economy devotes too many resources to satisfying
the short run needs & wants of consumers, there may be
insufficient resources for investment needed for long term
economic development.
• China investment reached a high of c.47% of GDP in the
last few years, whilst it’s consumption was around c.20%;
whilst in UK consumption is around c.65%
• Faster economic growth might improve living standards
today but lead to an over-exploitation of scarce finite
economic resources thereby limiting future growth
prospects for next generations
A key issue – who gains from growth?
Rising per capita incomes may go hand
in hand with an increase in the scale of
income inequality

This can be measured by an indicator

known as the Gini co-efficient

Regional inequalities within a country

may also widen

Inequality Within each region there are also areas

of relative prosperity contrasting with
Distribution of income & unemployment black-spots and deep-
wealth rooted social and economic deprivation
Robert Kennedy on GDP
• “The gross national product includes air pollution and advertising
for cigarettes and ambulances to clear our highways of carnage. It
counts special locks for our doors and jails for the people who break
them. GNP includes the destruction of the redwoods and the death
of Lake Superior. It grows with the production of napalm, and
missiles and nuclear warheads... it does not allow for the health of
our families, the quality of their education, or the joy of their play.
It is indifferent to the decency of our factories and the safety of our
streets alike. It does not include the beauty of our poetry or the
strength of our marriages, or the intelligence of our public debate
or the integrity of our public officials. It measures everything, in
short, except that which makes life worthwhile.”
The UNDP Human Development Index
• Human Development Index (HDI):
• A composite index measuring average
achievement in three basic dimensions of
human development-a long and healthy life,
knowledge and a decent standard of living
 Composition of the HDI
1. Knowledge: First an educational component
made up of two statistics – mean years of
schooling and expected years of schooling
2. Long and healthy life: Second a life expectancy
component is calculated using a minimum value
for life expectancy of 25 years and maximum
value of 85 years
3. A decent standard of living: The final element is
gross national income (GNI) per capita adjusted
to purchasing power parity standard (PPP)
Gross National Income per capita
 HDI Progress
• The UNDP classifies each
country into one of
three development bins:
• Low human
development for HDI
scores between 0.0 and
0.5
• Medium human
development for HDI
scores between 0.5 and
0.8
• High human
development for HDI
scores between 0.8 and
1.0
Big Improvers
 GDP and HDI Ranking

HDI rank < GDP rank suggests that a country is using its wealth less effectively
to improve the lives of its people.

Of course, this assumes that HDI is an accurate measure of quality of life.......

Trade Integration and HDI progress
 Limitations of the HDI
• The HDI notably fails to take account of qualitative factors, such as cultural identity and
political freedoms (human security, gender opportunities and human rights for example)
• Many argue that the HDI should become more human-centred and expanded to include more
dimensions, ranging from gender equity to environmental biodiversity
• The GNP per capita figure – and consequently the HDI figure – takes no account of income
distribution. If income is unevenly distributed, then GNP per capita will be an inaccurate
measure of the monetary well-being of the people. Inequitable development is not human
development
• PPP values change very quickly and are likely to be inaccurate or misleading
• The 2010 edition of the Human Development Report marked the launch of a new Inequality-
adjusted HDI and also a Gender Inequality Index and a Multidimensional Poverty Index
• Inequality HDI - The average loss in the HDI due to inequality is about 23 per cent—that
is, adjusted for inequality, the global HDI of 0.682 in 2011 would fall to 0.525
• Key point: the HDI is intended to allow economists to draw broad conclusions about which
countries enjoy relatively high standards of living, and which are, by comparison, under-
developed
 Multidimensional Poverty Index
• First introduced in 2010 and it an attempt designed to illustrate the many
deprivations faced by the most severely disadvantaged. The MPI requires a
household to be deprived in multiple indicators at the same time. A person is
multi-dimensionally poor if the weighted indicators in which he or she is deprived
add up to at least 33%. The MPI is closely linked to the Millennium Development
Goals targets and includes ten components:
• 1. Possession of some assets
• 2. Nutrition
• 3. Child mortality
• 4. Access to drinking water
• 5. Access to sanitation
• 6. Access to a safe room
• 7. Access to electricity
• 8. Access to an improved cooking oil
• 9. Years of schooling
• 10. Children enrolled in school
Multidimensional Poverty Index
More Summary Indices of Welfare

Happy Planet Index Genuine Progress Indicator

OECD Better Life Index

More great study resources from
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Economics Blog

AS Macro Revision Notes