Is Gdp an Adequate Measure of Economic Welfare?

Gross Domestic Product (GDP) is defined as the total value of all final goods and services produced in an economy within a given period (Economics Course Notes, 2006). As is common in most economies worldwide, it is used to gauge the performance of the economy.

GDP is calculated with an assumption that all goods and services produced in the period specified have been sold, and all the income derived from the sale is spent within the same period. The expenditure method calculates GDP as follows:

GDP = consumption + investment + government spending + (exports − imports).

There are several methods of calculating GDP but they all arrive at the same end result which is deemed to be a reflection of the country's total production in a specified period, and thereby a measure of economic activity.

National welfare refers to the wellbeing of a country's people. Economic growth is one of the key macroeconomic objectives that influence national welfare. The economic growth rate must outstrip the population growth rate for living standards to increase and adequate job creation to sustain the population (Mohr et al, 2004). Favourable economic growth implies that a nation is better off, things are going well. GDP is used to measure economic growth. Hence, if GDP is used as a measure of national welfare, a rise in GDP would imply that the national welfare has improved and people are better off than they were before.

There are some serious flaws with using the GDP calculation alone to measure economic activity. GDP is merely a measure of "all money that changes hands in a country" during a specified period (Montague, 1996). Transactions in the informal sector are not taken into account, yet in South Africa this sector is a significant player in the economy. For this reason, our national GDP figures have been adjusted since 1994 to estimate and recognise informal sector contribution, but these figures are not reliable (Mohr et al, 2004). It also ignores the value of non-monetary transactions which promote national wellbeing such as volunteer work and care of the elderly (Montague, 1996).

Yet another shortfall in using GDP as a measure of national welfare is the fact that it does not recognise inequalities in the distribution of income. For example, South Africa may have a satisfactory GDP, but the income may be unevenly spread, with wealth concentrated in small pockets of the general population. Under such conditions, individuals with lower income and wealth would be dissatisfied with their quality of life, so using GDP alone would misrepresent the nation's wellbeing status (Mohr et al, 2004)

Various economists have called for new measures which take into account sustainable growth that does not harm the environment, equitable income distribution and accurately records the effects of negative social transactions. One example of such a calculation is the Genuine Progress Indicator (GPI). The GPI calculation is calculated in the same way as GDP, but it accounts for income distribution via weightings. The negative effects of destructive social transactions like natural resource depletion are subtracted to give a more accurate measure of wellbeing (Montague, 1996).

The GDP calculation is certainly useful to measure economic activity in a given period, but on its own, it is not an adequate measure of national welfare. The flaws inherent to the GDP calculation present an opportunity for new measures to be established to give a better reflection of the economic and national wellbeing.