The standard of living measures our material welfare
“Equity, dignity, happiness, sustainability – these are all fundamental to our lives but absent in the GDP. Progress needs to be defined and measured in a way which accounts for the broader picture of human development and its context"
Source: Helen Clarke, UNDP
The baseline measure is real national output per head of population or real GDP per capita
Real income per capita is an inaccurate and insufficient indicator of living standards
For many economists, there is a growing disconnect between GDP and wellbeing
National income data can be used to make cross-country comparisons. This requires
Converting GDP data into a common currency
Making an adjustment to reflect differences in the cost of products in each country to produce data expressed at purchasing power parity standard
The PPP dollar takes into account the fact that it is cheaper to live in some countries than others
Problems in using national income statistics to measure living standards
Official data on GDP understates the growth of real national income per capita over time due to the shadow economy and the value of unpaid work by volunteers and people caring for their family
The "shadow economy" includes illegal activities such as drug production and distribution, prostitution, theft, fraud and concealed legal activities such as tax evasion on otherwise-legitimate business activities such as un-reported self-employment income
Often official GDP data is inaccurate, e.g. many countries in sub-Saharan Africa do not update their reporting often enough, and so their GDP numbers may miss large and fast-growing sectors, like cell phones. In 2014 Nigeria became the largest economy in Africa (over-taking South Africa) after a fundamental reassessment of their GDP calculation. GDP data may become a target for political manipulation.
Reasons why GDP data may give a distorted picture of living standards in a country:
Bill Gates on Alternative Measures of the Standard of Living
The Human Development Index uses health and education statistics in addition to GDP.
The UN's Multidimensional Poverty Index uses 10 indicators; including nutrition, sanitation, and access to cooking fuel and water.
By using purchasing power parity, which measures the cost of the same basket of goods and services in different countries, economists can adjust GDP to gain better insight into living standards.
Regional variations in income and spending: National data can hide regional variations in output, employment and income per head of the population
Inequalities in income and wealth: Average (mean) incomes might rise but inequality could grow
Leisure and working hours and working conditions: An increase in real GDP might have been achieved at the expense of leisure time if workers are working longer hours or if working conditions have deteriorated
Imbalances between consumption and investment: High levels of investment as a share of GDP might be superb for creating extra capacity to produce but at the expense of consumer goods and services for the current generation
Changes in life expectancy: Improvements in life expectancy don't always show through in GDP accounts. Putting a monetary value on the benefits of increased longevity is difficult
The value of non-marketed output: Much useful and valuable work is not sold in markets at market prices. The value of the output of people working for charities, self-help groups and of housework might reasonably be added to national income statistics
Innovation and the development of new products: New goods and services become available because of invention and innovation that simply would not have been available to the richest person on earth less than fifty years ago. About half of what we spend our money on now was not invented in 1870. Examples include air travel, cars, computers, antibiotics, hip replacements, insulin and many other life-enhancing and life-saving drugs
Environmental considerations: Rising output might have been accompanied by an increase in air and noise pollution and other externality effects that have a negative effect on our social welfare
Defensive expenditures: Much spending is to protect against an economic or social bad e.g. crime, or spending to clean up the effects of pollution and waste
Imperfect measures of GDP should not be the only criteria by which economies are judged. India’s Amartya Sen, a Nobel Prize-winning economist, has correctly said that achieving other factors — he calls them capabilities — should play a prominent role in determining government policy. Some of these can be boiled down to outcomes in health, literacy and welfare
Moving away from GDP per capita – the case for median household incomes
There is widespread agreement that changes a nation's GDP per capita are an inadequate measure of human wellbeing.
Instead of tracking changes in mean per capita incomes, some economists are now pushing for an extra indicator – namely changes in median per capita household incomes. Household income measures the flow of income that finds its way to households each year.
The median is better than the mean since it is reflective of progress in the middle of the income distribution. For example, increases in GDP that go solely to the rich would not increase this measure. Looking at median income would create more focus on inclusive growth that generates wider benefits.
In the United Kingdom, median income growth has lagged behind GDP per capita since the early 1980s, in part because of the growth of income inequality reflected in an increase in the Gini coefficient.
Geoff Riley FRSA has been teaching Economics for nearly thirty years. He has twenty years experience as Head of Economics at leading schools. He writes extensively and is a contributor and presenter on CPD conferences in the UK and overseas.
Our AQA A Level Economics Year 1 (AS) Course Companion is the designed as a high quality and cost-effective replacement for expensive and overly complicated textbooks. The Course Companion maps precisely against the AQA specification and teaching content for Year 1 (AS) and provides students with comprehensive and concise coverage of what students really need to know and understand.