Does GDP capture everything we care about in an economy?

Key points

  • GDP is an indicator of a society’s standard of living, but it is only a rough indicator because it does not directly account for leisure, environmental quality, levels of health and education, activities conducted outside the market, changes in inequality of income, increases in variety, increases in technology, or the—positive or negative—value that society may place on certain types of output.
  • The standard of living is all elements that affect people’s happiness, whether these elements are bought and sold in the market or not.

Introduction

You might have heard the term standard of living before—it means all of the elements that contribute to a person's happiness.
Standard of living is a broad term that encompasses many factors—including some that are not bought and sold in the market and some that are. The level of GDP per capita, for instance, captures some of what we mean by the term standard of living, as illustrated by the fact that most of the migration in the world involves people who are moving from countries with relatively low GDP per capita to countries with relatively high GDP per capita.
To understand the limitations of using GDP to measure the standard of living, it is useful to spell out some things that GDP does not cover that are relevant to standard of living.

Limitations of GDP as a measure of standard of living

Because many factors that contribute to people's happiness are not bought and sold, GDP is a limited tool for measuring standard of living. To understand it's limitations better, let's take a look at several factors that are not accounted for in GDP.
GDP does not account for leisure time. The US GDP per capita is larger than the GDP per capita of Germany, but does this prove that the standard of living in the United States is higher? Not necessarily since it is also true that the average US worker works several hundred hours more per year more than the average German worker. The calculation of GDP does not take German workers extra weeks of vacation into account.
GDP includes what is spent on environmental protection, healthcare, and education, but it does not include actual levels of environmental cleanliness, health, and learning. GDP includes the cost of buying pollution-control equipment, but it does not address whether the air and water are actually cleaner or dirtier. GDP includes spending on medical care, but it does not address whether life expectancy or infant mortality have risen or fallen. Similarly, GDP counts spending on education, but it does not address directly how much of the population can read, write, or do basic mathematics.
GDP includes production that is exchanged in the market, but it does not cover production that is not exchanged in the market. For example, hiring someone to mow your lawn or clean your house is part of GDP, but doing these tasks yourself is not part of GDP.
One remarkable change in the US.economy in recent decades is that, as of 1970, only about 42% of women participated in the paid labor force. By the second decade of the 2000s, nearly 60% of women participated in the paid labor force, according to the Bureau of Labor Statistics.
As women are now in the labor force, many of the services they used to produce in the nonmarket economy—like food preparation and child care—have shifted to some extent into the market economy, which makes the GDP appear larger even if more services are not actually being consumed.
GDP has nothing to say about the level of inequality in society. GDP per capita is only an average. When GDP per capita rises by 5%, it could mean that GDP for everyone in the society has risen by 5% or that the GDP of some groups has risen by more while the GDP of others has risen by less—or even declined.
GDP also has nothing in particular to say about the amount of variety available. If a family buys 100 loaves of bread in a year, GDP does not care whether they are all white bread or whether the family can choose from wheat, rye, pumpernickel, and many others—GDP just looks at whether the total amount spent on bread is the same.
Likewise, GDP has nothing much to say about which technology and products are available. The standard of living in, for example, 1950 or 1900 was not affected only by how much money people had—it was also affected by what they could buy. No matter how much money you had in 1950, you could not buy an iPhone or a personal computer.
In certain cases, it is not clear that a rise in GDP is even a good thing. If a city is wrecked by a hurricane and then experiences a surge of rebuilding construction activity, it would be peculiar to claim that the hurricane was therefore economically beneficial. If people are led by a rising fear of crime to pay for installation of bars and burglar alarms on all their windows, it is hard to believe that this increase in GDP has made them better off. In that same vein, some people would argue that sales of certain goods, like pornography or extremely violent movies, do not represent a gain to society’s standard of living.

Does a rise in GDP overstate or understate the rise in the standard of living?

The fact that GDP per capita does not fully capture the broader idea of standard of living has led to a concern that the increases in GDP over time are illusory. It is theoretically possible that while GDP is rising, the standard of living could be falling if human health, environmental cleanliness, and other factors that are not included in GDP are worsening. Fortunately, this fear appears to be overstated.
In some ways, the rise in GDP actually understates the actual rise in the standard of living. For example, the typical workweek for a US worker has fallen over the last century from about 60 hours per week to less than 40 hours per week. Life expectancy and health have risen dramatically, and so has the average level of education.
Since 1970, the air and water in the United States have generally been getting cleaner. New technologies have been developed for entertainment, travel, information, and health. A much wider variety of basic products like food and clothing is available today than several decades ago. GDP does not capture leisure, health, a cleaner environment, the possibilities created by new technology, or an increase in variety.
On the other side, rates of crime, levels of traffic congestion, and inequality of incomes are higher in the United States now than they were in the 1960s. Moreover, a substantial number of services that used to be provided, primarily by women, in the nonmarket economy are now part of the market economy that is counted by GDP. By ignoring these factors, GDP would tend to overstate the true rise in the standard of living.

GDP is rough, but useful

A high level of GDP should not be the only goal of macroeconomic policy—or broader government policy. But, even though GDP does not measure the broader standard of living with any precision, it does measure production well, and it does indicate when a country is materially better or worse off in terms of jobs and incomes. In most countries, a significantly higher GDP per capita occurs hand in hand with other improvements in everyday life along many dimensions, like education, health, and environmental protection.
No single number can capture all the elements of a concept as broad as standard of living. Nonetheless, GDP per capita is a reasonable, rough-and-ready measure of the standard of living.
To determine the state of the economy, we need to examine economic indicators, such as GDP. Calculating GDP is quite an undertaking. It is the broadest measure of a nation’s economic activity, and we owe a debt to Simon Kuznets, the creator of the measurement, for that.
The sheer size of the US economy as measured by GDP is huge—as of the third quarter of 2013, $16.6 trillion worth of goods and services were produced annually. Real GDP informs us that the recession of 2008 to 2009 was a severe one and that the recovery from that has been slow but is improving. GDP per capita gives a rough estimate of a nation’s standard of living.

Summary

  • GDP is an indicator of a society’s standard of living, but it is only a rough indicator because it does not directly account for leisure, environmental quality, levels of health and education, activities conducted outside the market, changes in inequality of income, increases in variety, increases in technology, or the—positive or negative—value that society may place on certain types of output.
  • The standard of living is all elements that affect people’s happiness, whether these elements are bought and sold in the market or not.

Self-check question

Explain briefly whether each of the following would cause GDP to overstate or understate the degree of change in the broad standard of living.
  • The environment becomes dirtier.
  • The crime rate declines.
  • A greater variety of goods become available to consumer.s
  • Infant mortality declines.
A dirtier environment would reduce the broad standard of living, but it would not be counted in GDP, so a rise in GDP would overstate the standard of living.
A lower crime rate would raise the broad standard of living, but it would not be counted directly in GDP, so a rise in GDP would understate the standard of living.
A greater variety of goods would raise the broad standard of living, but it would not be counted directly in GDP, so a rise in GDP would understate the rise in the standard of living.
A decline in infant mortality would raise the broad standard of living, but it would not be counted directly in GDP, so a rise in GDP would understate the rise in the standard of living.

Review question

List some of the reasons why GDP should not be considered an effective measure of the standard of living in a country.

Critical thinking questions

How might a “green” GDP be measured?

Attribution

This article is a modified derivative of "How Well GDP Measures the Well-Being of Society" by OpenStaxCollege, CC BY 4.0.
The modified article is licensed under a CC BY-NC-SA 4.0 license.