Thursday, October 11, 2012

Why GDP Growth is Good

Most teachers of economics at some point have to address the existential question from students: Is more output always good? Nicholas Oulton does has a nice punchy essay called "Hooray for GDP!", written as an "Occasional paper" for the Centre for Economic Performance at the London School of Economics and Political Science. Oulton summarizes the main arguments against focusing on GDP in this way:
  1.  GDP is hopelessly flawed as a measure of welfare. It ignores leisure and women’s
    work in the home. It takes no account of pollution and carbon emissions.
  2. GDP ignores distribution. In the richest country in the world, the United States, the
    typical person or family has seen little or no benefit from economic growth since the
    1970s. But over the same period inequality has risen sharply.
  3. Happiness should be the grand aim of policy. But the evidence is that, above a certain level, a higher material standard of living does not make people any happier. ...
  4. Even if higher GDP were a good idea on other grounds, it’s not feasible because the
    environmental damage would be too great.
Oulton then addresses each question, not attempting any kind of exhaustive review, but by providing a selective sampling of the arguments and evidence. Here are some of  his answers, mixed with my own.

1. GDP is flawed as a measure of welfare. 

 Yes, GDP leaves out a lot that matters, and a lot that should matter. There's no surprise in this: Every intro econ textbook for decades has taught this point. My favorite quotation on this point from a 1968 speech by Robert Kennedy.

 Oulton makes the useful distinction that GDP is a measure of output that is not and was never intended to be a measure of welfare, but that per capita GDP is clearly a component of welfare--that is, when one makes a list of all the factors that benefit people, a higher level of consumption of a wide range of goods and services is an item on that list. In addition, per capita GDP is a broader indicator of welfare because looking around the world, GDP is clearly broadly correlated with health, education, democracy, and the rule of law.

For thinking about social welfare, it is often useful to look at statistics other than GDP. For example, here's one of my earlier posts about economists attempting to estimate "Household Production: Levels and Trends."

My own favorite comment on this point is from a 1986 essay by Robert Solow ("James Meade at Eighty," Economic Journal, December 1986, 986-988), where he wrote: "If you have to be obsessed by something, maximizing real National Income is not a bad choice." At least to me, the clear implication is that it's perhaps better not to be obsessed by one number, and instead to cultivate a broader and multidimensional perspective. But yes, if you need to pick one number, real per capita GDP isn't a bad choice. To put it another way, a high or rising GDP certainly doesn't assure a high level of social welfare, but it makes it easier to accomplish those goals than a low and falling GDP.

2) GDP ignores distribution. 

Yes, it does. Again, GDP is a measure of output, not of everything that can and should matter in thinking about society. I've often noted on this website that inequality of wages and household incomes has been rising in recent decades, and that I believe this trend is a genuine problem.

But even though high and rising inequality is (I believe) a problem, that doesn't mean that high or rising GDP is the cause of the problem It's not at all clear that being in an economy with a higher level of GDP leads to more inequality. From a global perspective, many economies with the greatest level of inequality are in Latin America or in Africa. Many high-income countries in western Europe have much greater equality of incomes than the U.S. economy. Periods of rapid economic growth in the U.S. economy--say, back in much of the 1950s and the 1960s--were not associated with rising inequality.

Oulton writes: "Inequality concerns are real but there is still a case in my view for separating questions of growth from questions of distribution." In my own mind, this analytical distinction started in earnest (although I'm sure there were predecessors) with John Stuart Mill's classic 1848 text, Principles of Political Economy, where the first major section of the book is about "Production" and the second major section is about "Distribution." In Mill's "Autobiography," he writes that  he came to appreciate this distinction, and indeed to view it as one of the central distinguishing features of his book, as a result of discussions with his wife, Harriet Taylor Mill. Mill wrote:

"The purely scientific part of the Political Economy I did not learn from her; but it was chiefly her influence that gave to the book that general tone by which it is distinguished from all previous expositions of political economy that had any pretension to being scientific.... This tone consisted chiefly in making the proper distinction between the laws of the Production of wealth—which are real laws of nature, dependent on the properties of objects—and the modes of its Distribution, which, subject to certain conditions, depend on human will."

3) Happiness should be the grand aim of policy. 

The question here, of course, is how "happiness" is judged. It's true that on surveys which ask people to rank how happy they are on a scale from 1-10, the happiness level of people in high-income countries isn't much higher than a few decades ago. There is an ongoing argument over how to interpret these results. Is happiness really "positional"--that is, I judge my happiness relative to others at the same time, and so if everyone has more consumption, happiness doesn't rise? Are these kinds of survey results an artefact of the survey itself: that is, someone who answers that they are "7" on the happiness scale in 2010 isn't saying that they would also be a "7" on the happiness scale if they had a 1970 level of income. Here's a post from last May on the connections from economic growth to survey questions about happiness, with some emphasis on how it applies in China.

My sense is that most people actually get a lot of happiness from the goods and services of a modern economy, and they would not be equally happy if those goods and services were unavailable. Oulton makes an interesting argument here that there is a battle between process innovation and product innovation.  If both process innovation and product innovation rise together, then people have higher productivity and incomes, and happily spend those incomes on the new products that are available. If process innovation rises quickly, but product innovation does not, then people would have higher productivity and incomes, but nothing extra to spend them on--and thus might opt for much more leisure. Oulton has a nice thought experiment here:
"Imagine that over the 220 or so years since the Industrial Revolution began in Britain process innovation has taken place at the historically observed rate but that there has been no product innovation in consumer goods (though I allow product innovation in capital goods). UK GDP per capita has risen by a factor of about 12 since 1800. So people today would have potentially vastly higher incomes than they did then. But they can only spend these incomes on the consumer goods and services that were available in 1800. In those days most consumer expenditure was on food (at least 60% of the typical family budget), heat (wood or coal), lighting (candles) and clothing (mostly made from wool or leather). Luxuries like horse-drawn carriages were available to the rich and would now in this imaginary world be available to everyone. But there would be no cars, refrigerators, washing machines or dishwashers, no radio, cinema, TV or Internet, no rail or air travel, and no modern health care (e.g. no antibiotics or antiseptics). How many hours a week, how many weeks a year and how many years out of the expected lifetime would the average person be willing to work? My guess is that in this imaginary world people would work a lot less and take a lot more leisure than do real people today. After all, most consumer expenditure nowadays goes on products which were not available in 1800 and a lot on products not invented even by 1950."
Of course, over the last century or so workweeks have gotten considerably shorter, and in that sense, people have chosen to take some of the rewards of process innovation in the form of more leisure. But most people prefer to follow a path where they can earn sufficient income to enjoy the results of product innovation. As I like to point out, the modern economy offers a fair amount of freedom in terms of work choices.  Throughout their lives, people often have a choice about whether they will choose to follow a job path that is less demanding in time and energy, but also provides lower income. Some people seek out such choices, but most do not.

4) GDP and the costs of environmental damage. 

Oulton quotes from a 2012 Royal Society report that is concerned about overpopulation and a sustainable environment. He writes: "In its preferred scenario GDP per capita is equalised across the world at $20,000 in 2005 PPP terms by 2050 (Report, page 81). The UK’s GDP per capita in 2005 was $31,580 in 2005 PPPs so this would imply a 37% cut. When they think about economic growth natural scientists tend to think about biological processes, say the growth of bacteria in a Petri dish. Seed the dish with a few bacteria and what follows looks like exponential growth for a while. But eventually as the bacteria cover most of the dish growth slows down. When the dish is completely covered growth stops. End of story."

 Of course, the world economy isn't a petri dish, and people aren't bacteria. Economist have been drawing up models of economic growth with fixed amounts of land or minerals, or where economic activities emit pollution, for some decades now. Oulton summarizes the basic lesson: "These models all have in common the result that perpetual exponential growth is possible provided that technical progress is sufficiently rapid."

In other words, it's certainly possible to draw up a disaster scenario where resource or environmental limitations lead to grief at a global level. It's also possible that with a combination of investments in technology and human capital, economic growth can at least for a considerable time overcome such limitations. For an example of analysis along these lines, the United Nations has put out the first of what is intended to be a series of reports on how changes in different types of capital can offset each other (or not), which I posted about in "Sustainability and the Inclusive Wealth of Nations."

As Oulton notes, the practical question here is not whether resource and environment limits must eventually bind at some distant point in the future, "but only whether it makes sense to advocate growth over the next 5, 10, 25, 50 or 100 years." 

In the U.S. economy, 15% of the population is below what we call the "poverty line," and their life prospects are diminished as a result. About 2.5 billion people in the world live on less than $2/day
 I do not see a practical way of raising the standard of living for these people, or for their children, unless rising GDP plays a central role.