Economics and finance, Environment & energy | Australia

14 March 2018

A project in South Australia is showing that there is a better way to measure net positive economic activity, if not societal wellbeing, Robert Costanza, Philip Lawn, Ian Lowe, and Peter Martin write.

Gross Domestic Product (GDP) helped the allies win the Second World War by better understanding production and consumption in an economy. But it was never designed as a national policy goal. As Simon Kuznets, the main architect of GDP warned: “The welfare of a nation can scarcely be inferred from a measurement of national income as defined by GDP…Goals for ‘more’ growth should specify of what and for what.”

Despite growing recognition of the salience of Kuznets’ initial warning, most nations and states still misuse GDP growth as a major policy goal, without adequate understanding of what is growing and why they would want it to grow.

GDP counts only marketed economic activity. Some of that activity can be considered a benefit, but some should be considered a cost to be avoided. GDP conflates the two. More crime requires more police and more security devices that add to GDP, but it’s not something we want more of. Likewise for air and water pollution, serious illness, divorce, inequality, and a range of other factors.

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One measure that has been designed to separate the two is the Genuine Progress Indicator (GPI). GPI starts with Personal Consumption Expenditures (a major component of GDP indicative of discretionary spending) but weights it by income distribution (because a dollar’s worth of income to a poor person creates more welfare than a dollar’s worth of income to a rich person).

As far as GDP is concerned, inequality does not matter and the fact that most of the income gains over the last several decades have gone to the top 1 per cent is just fine. Then GPI adds a few things that are left out of GDP because they are not marketed (like household labour and volunteer work) and subtracts a bunch of things that should be considered costs rather than benefits, including the costs of crime, family breakdown, pollution, resource depletion, and ecological damage. There are 26 elements of GPI all denominated in dollars that can be summed to give an estimate of the net contribution of economic activity to wellbeing.

Mind you, GPI is still not a measure of overall societal wellbeing. It misses several things, including the positive contributions of social and natural capital to wellbeing that would need to be included to create an overall Sustainable Wellbeing Index.

But GPI does estimate net positive economic activity and that should be a more important guide to policy than the gross economic activity that GDP measures. Remember Kuznets’ warning that “goals for ‘more’ growth should specify of what and for what.”

The advantages of GPI over the many other alternatives to GDP that have been suggested include firstly that it is relatively easy to estimate using available data; secondly it can be estimated for historical periods giving time trends; and finally, since it is denominated in dollars, it is easy to compare with GDP.

GPI has been estimated for more than 17 countries and many states and territories, including a recent study of all 50 US states. The US states of Maryland and Vermont have adopted GPI as a policy tool and several other states are considering doing the same.

A recent study we’ve been involved with through the Wakefield Futures Group compared the GPI of South Australia for the period 1986-2016 with the rest of Australia. It found that while South Australia lagged the rest of the country in terms of GDP growth, it did much better in terms of the GPI.

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For example, the GPI showed that the average South Australian is $3,000 per year better off than five years ago, albeit this is less than the increase in its per capita GDP. But more importantly, they are around $2,000 per year better off than the average person living elsewhere in Australia. This superior performance was due to improvements in the state’s distribution of income, a steep rise in private-sector and public-sector consumption, an increase in the services generated by the infrastructural assets provided by governments, and the containment of environmental costs.

The purpose of the economy, economics, and policy should be the improvement of societal wellbeing.

GDP does not measure societal wellbeing and continuing to misuse it as a proxy for this at a time when the negative side effects are growing is leading us down the wrong path.

You get what you measure, and, while GPI is not the comprehensive indicator of societal wellbeing we ultimately seek, it at least accounts for the costs of economic activity. No business in its right mind would try to maximise revenues and ignore costs, or, even worse, conflate costs as revenues. GPI allows us to separate benefits and costs at the state and national level and we should be using that information to make better policy.

South Australia, with its progressive tradition, could take a national lead in instituting the GPI as a routine part of economic reporting and join the innovative vanguard of jurisdictions around the world charting this necessary new course.

If that happened, it really would be genuine progress.

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