Updated: Oct 30, 2022
Image Graphics by Team Geostrata
Every human being strives to achieve a better quality of life and prosperity. In our modern society, economic theory has created a correlation between economic growth, which is measured by Gross Domestic Product(GDP), and welfare and prosperity. This has tremendous significance because the policymakers who work towards the welfare of the society focus on enhancing wealth and ipso facto increasing the GDP, often at the expense of the environment and certain sections of the society. This raises a very crucial question. In a world which is battling the consequences of climate change, is GDP a sustainable measure of economic growth?
History of human growth and GDP
In order to explore this question in proper depth, it is very important for us to understand how GDP came into the picture in the first place. Ever since the dawn of their existence, human beings have strived for growth and prosperity. It is in the very nature of humans to be unsatisfied with their surrounding environment and it is this dissatisfaction that has pushed mankind to grow from hunter-gatherers to the modern structured society. However, this growth did not occur at the same pace throughout human history. In fact, it was around the 18th century, with the onset of capitalism, that the world saw a huge surge in the creation of wealth. It was at this point that Economics, as we know it today, was born.
The concept of GDP, however, did not begin to be used for measuring economic growth until the 1930s. During the Great Depression, the British economist John Maynard Keynes opposed the ideas of the invisible hand and self-regulating markets and instead suggested that the government should increase its spending to tackle the depression. In 1937, US economist Simon Kuznets came up with the idea of GDP, a single nominal value to represent the sum total of the economic activity being undertaken in the economy during a particular time period, which was then presented in front of the US Congress for approval. The purpose of GDP was to assess the economic situation of a nation during war and to prepare the resources of the country for financing the war.
But after the end of World War II, countries began to realize the advantages of measuring their productive capacity and the concept of calculating the GDP became an international standard for measuring economic growth, with every country including China (which adopted GDP in 1993) measuring their GDP periodically. International institutions such as the IMF and World Bank use GDP as an indicator of growth and development, which emphasizes politicians and global leaders to work towards increasing the GDP of their country to ensure the welfare of their citizens.
Is GDP the perfect measure of welfare?
Although the creation of the concept of GDP was a very significant advancement in economic theory, it did not come without its share of flaws. GDP is not a perfect measure of welfare for several reasons.
Firstly, GDP measured only the transactions that were monetary in nature and in doing so, it ignored a significant portion of activities that contribute towards welfare in the society but do not involve any financial transaction. The household activities and childcare services provided by a woman for her own family, for example, were not included while calculating the GDP despite contributing to the welfare of the household.
Secondly, GDP does not take into account the activities of the informal sector, which constitutes a significant portion of the economy for developing economies. This not only omits a critical sector of the economy from the GDP but also paints an incomplete picture of the country’s economy. The result is that policy decisions which are based on this indicator of economic growth are untargeted and ill-informed.
Thirdly, GDP only looks at the monetary value generated by the production of a commodity irrespective of its impact on human health. For example, assuming that the price of milk and cigarettes are equal, both commodities contribute equally towards the GDP despite having a starkly different impact on human health and welfare.
Moreover, GDP does not indicate how the output and income being generated in the economy are distributed amongst the society. There exists an unequal distribution of wealth and income in many countries including India, where the top 10% of the population holds 77% of the country’s national wealth. What is even more concerning is that in 2017, 73% of the wealth generated went to the richest 1%, while the poorest half of the population experienced just a 1% increase in their wealth. Similarly, an increase in GDP does not indicate that both men and women receive equal benefits from the “growth” in the economy. According to the Global Gender Gap Report 2022, at the current rate, it will take 132 years to achieve full parity between men and women. In such a scenario, an increase in GDP is clearly not an appropriate indicator of the increase in welfare.
Further, there emerged a positive correlation between rising GDP and employment. This, however, was not a true indicator of prosperity and quality of life. According to a study jointly conducted by the Bill and Melinda Gates Foundation, Omidyar Network, the Lumina Foundation, and Gallup, the majority of workers in the US were dissatisfied with their current jobs. Further, in India while the GDP has continued to rise, there has also been a rise in the unemployment rate, which clearly refutes this correlation. The notion that a rise in GDP leads to employment often results in governments pursuing perennial job growth without focusing on the quality of employment being generated.
It has been observed that in developing countries, in the early stages of development, an increase in GDP results in improved quality of life and living standards for the citizens as it improves access to commodities for the people. However, during the later stages of development, an increase in GDP does not lead to any significant increase in welfare.
Impact of GDP on the environment
Perhaps the biggest shortcoming of GDP is its treatment of environmental degradation and climate change as an externality. Being an externality, it is not included in the calculation of GDP.
GDP has four components: consumption, investment, government purchases and net exports. Hence, in order to increase the GDP of the economy, the focus is on increasing spending in the economy, whether it is private or public. This consumption-driven economic growth leads to the generation of heaps of waste in the economy.
Take the instance of a common practice adopted by producers known as planned obsolescence, in which producers manufacture products which have a limited lifespan to encourage consumers to buy their products more frequently. From the purview of Macroeconomics, this is seen as beneficial as it translates to increased consumer spending which means higher GDP growth along with increased economic activity which translates into higher employment. However, from the standpoint of the environment, this is extremely detrimental because it means that despite having the technology to produce long-lasting durable products, manufacturers deliberately produce cheaper non-durable goods which result in the generation of tonnes of waste. Even though this practice is unsustainable, it is reflected positively in the GDP and hence it is encouraged by policymakers who use GDP as the indicator of welfare. This practice is famously adopted by fast fashion brands like Zara as well as manufacturers of electronic goods.
Finally, it is very interesting to observe the consequences of environmental disasters like floods, landslides and earthquakes from an economic standpoint. Every time there is an environmental tragedy in which human lives are lost and valuable property and resources are destroyed, the government spends money on rescue operations, relief schemes and construction projects which contributes to the GDP. For instance, in 2018 Himachal Pradesh CM asked the centre for ₹200 crore in aid to meet losses incurred due to floods in that season alone. Similar to the broken window fallacy, this instance also shows that not only is there no welfare improvement for the people by such government spending, but there is also an opportunity cost incurred in the form of avoiding damage to infrastructure through schemes for mitigation of disasters.
Developing a more comprehensive measure of growth
After taking into consideration all the shortcomings of GDP, it might be puzzling to understand why it continues to be used as an indicator of welfare and growth. The reason is that there is no alternative measure of growth that can completely replace GDP.
This does not mean that alternative approaches to measuring welfare are not present. There are social progress indicators like the Human Development Index which can be taken into consideration along with GDP while taking policy decisions to make sure that the decisions are well informed and actually improve the welfare of the society. Moreover, incorporating externalities as an environmental and social cost while calculating GDP can also help encourage policymakers to consider the overall impact of any economic activity. The Social Progress Index helps navigate the challenges that our society faces and aims to achieve an equitable and inclusive society. This index can be used to supplement GDP. The Gross National Happiness Index, which gives equal importance to non-economic aspects of well-being can also be adopted. Green GDP, which has been implemented by China, can also be an important indicator as it places a monetary value on environmental degradation and reflects the trade-off between the environment and economic growth.
Gross Ecosystem Product attempts to place a monetary value on ecosystem services such as clean water, forests that act as carbon sinks, the stimulating effect of nature on our mental health along with other important aspects such as food security and healthcare. This provides a direct financial incentive for governments to preserve the cultural and natural environment. It can also create a system where the export of ecosystem services like clean drinking water can be financially rewarded, thus encouraging the conservation of the environment.
There is a need for more detailed research to refine and develop these alternative measures of well-being that incorporate social and environmental aspects while assessing the growth of the economy. In the current scenario, with countries across the globe battling extreme weather conditions due to climate change, this could make a major difference between the success and failure of our climate action plans.
BY PRANAV ANAND