No Such Thing as a Free Lunch: Principles of Economics (Part 102)

“Work done off the paid job is looked down upon if not ignored. Autonomous activity threatens the employment level, generates deviance, and detracts​ from the GNP...Work no longer means the creation of a value perceived by the worker but mainly a job, which is a social relationship. Unemployment means sad idleness, rather than the freedom to do things that are useful for oneself or for one's neighbour. An active woman who runs a house and brings up children and takes in those of others is distinguished from a woman who 'works,' no matter how useless or damaging the product of this work might be.”

― Ivan Illich, The Right to Useful Unemployment and Its Professional Enemies

Measuring National Output and National Income

(Part F)

by

 Charles Lamson

Limitations of the GDP Concept

We generally think of increases in GDP as good. Increase in GDP (or preventing its decrease) is usually considered one of the chief goals of the government's macroeconomic policy. Because some serious problems arise when we try to use GDP as a measure of happiness or well-being, we now point out some of the limitations of the GDP concept as a measure of welfare.

 

GDP and Social Welfare

If crime levels went down, society would be better off, but a decrease in crime is not an increase in output and is not reflected in GDP. Neither is an increase in leisure time. Yet, to the extent that households desire extra leisure time (instead of having it forced on them by a lack of jobs in the economy), an increase in leisure is also an increase in social welfare. Furthermore, some increases in social welfare are associated with a decrease in GDP. An increase in leisure during a time of full employment, for example, leads to a decrease in GDP because less time is spent on producing output.

Most nonmarket and domestic activities, such as housework and childcare, are not counted in GDP even though they amount to real production. However, if I decide to send my children to daycare or hire someone to clean my house or to drive my car for me, GDP increases. The salaries of daycare staff, cleaning people, and chauffeurs are counted in GDP, but the time I spend doing the same things is not counted. A mere change of institutional arrangements, even though no more output is being produced, can show up as a change in GDP.

Furthermore, GDP seldom reflects losses or social ills. GDP accounting rules do not adjust for production that pollutes the environment. The more production there is, the larger is GDP, regardless of how much pollution results in the process.

GDP also has nothing to say about the distribution of output among individuals in a society. It does not distinguish, for example, between the case in which most output goes to a few people and the case in which output is evenly divided among all people. We cannot use GDP to measure the effects of redistribution policies (which take income from some people and give income to others). Such policies have no direct impact on GDP. GDP is also neutral about the kinds of goods an economy produces. Symphony performances, handguns, cigarettes, professional football games, Bibles, soda pop, milk, economics textbooks, and comic books all get counted similarly without regard to their differing value to society.

In spite of these limitations, GDP is a highly useful measure of economic activity and well-being. If you doubt this, answer this simple question: Would you rather live in the United States of 200 years ago, when rivers were less polluted and crime rates were probably lower, or in the United States of today? Most people say they prefer the present. Even with all the "negatives," GDP per person and the average standard of living are much higher today than 200 years ago.

The Underground Economy

Many transactions are missed in the calculation of GDP, even though in principle they should be counted. Most illegal transactions are missed if they are "laundered" into legitimate business. Income that is earned but not reported as income for tax purposes is usually missed, although some adjustments are made in the GDP calculations to take misreported income into account. The part of the economy that should be counted in GDP but is not is sometimes called the underground economy.

Tax evasion is usually thought to be the major incentive for people to participate in the underground economy.

Why should we care about the underground economy? To the extent that GDP reflects only a part of economic activity instead of a complete measure of what the economy produces, it is misleading. Unemployment rates, for example, may be lower than officially measured if people work in the underground economy without reporting this fact to the government. Also, if the size of the underground economy varies between countries---as it does---we can be misled when we compare GDP between countries.

Gross National Income Per Capita

Making comparisons across countries is difficult because such comparisons need to be made in a single currency, generally U.S. dollars. Converting GNP numbers for Japan into dollars requires converting from yen into dollars. Since exchange rates can change quite dramatically in short periods of time, such conversions are tricky. The World Bank adopted a measuring system for international comparisons. The concept of gross national income (GNI) is GNP converted into dollars using an average of currency exchange rates over several years adjusted for rates of inflation.

*CASE & FAIR, 2004, PRINCIPLES OF ECONOMICS, 7TH ED., PP. 404-406*

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