Beyond GDP

Economic growth should be defined as growth in inclusive wealth.
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We are encouraged to think that to consume material objects is to contribute to the social good.
Average income in the UK in 1990 was about 25 per cent less than in 2005.

In September last year the United Nations General Assembly adopted a set of Sustainable Development Goals (SDGs) to be met by the year 2030. These range from poverty eradication and improvements in education and health to the protection of global assets, including the oceans and a stable climate. However, neither the SDGs nor their background documents explain how governments should judge the sustainability of the development programmes they undertake to meet the goals. It is currently taken as a given that the only way the SDGs can be met is for the world economy to enjoy healthy rates of economic growth. Unfortunately it is universal practice to interpret economic growth as growth in gross domestic product (GDP).

GDP is the market value of the final goods and services that an economy produces in a year. It measures the flow of economic activity over the year. Because GDP does not allow for the depreciation of capital assets (for example, the deterioration and destruction of nature), GDP can increase even as the economy’s productive capacity declines. The correct measure of productive capacity is the social worth of an economy’s entire stock of capital assets, including not only manufactured capital (roads, buildings and machines) and human capital (health, education), but also natural capital (the atmosphere, the oceans, terrestrial ecosystems and sub-soil resources). This is a much more inclusive notion of wealth.
In contrast to GDP, the inclusive measure of wealth is a stock.

By economic growth we should now mean growth in inclusive wealth. Assessing whether the SDGs are sustainable will require governments to check that the development programmes they undertake to meet them raise their economies’ inclusive wealth. As of now no one knows whether the SDGs can be met on a sustainable basis.

There are ample grounds for thinking that the world economy’s inclusive wealth has declined in recent decades. Data on capital stocks are sparse (unlike private firms, nations don’t produce balance sheets), but rough estimates suggest that the rate at which humanity is using nature’s services exceeds the rate at which nature is able to regenerate itself by a multiple of 1.5. That means if the current rate of our use of nature’s services were to be sustainable, we would need 1.5 Earths.

It will prove hard to break the long-standing habit of viewing economic success in terms of GDP growth. One reason is that we do not know how to de-couple GDP from recorded employment. If economic losses occurred gradually and were shared in a manner deemed fair by the general public, there would be nothing catastrophic for people in a country where the average income is $35,000 a year to suffer an income loss of even 25 per cent, let alone 5 per cent. Average income in the UK in 1990 was about 25 per cent less than in 2005.

It is difficult to maintain that UK citizens enjoyed significantly lower levels of personal well-being in 1990 than they did in 2005. Findings in hedonic psychology based on large-scale questionnaires suggest that a general rise in private consumption among a population already enjoying a high standard of living adds little to happiness.

In contrast, employment is known to be a powerful factor in a person’s sense of well-being and self-worth. It would be a catastrophe if a 25 per cent drop in average income in a rich country were accompanied by a comparable drop in employment. Citizens would justifiably demand that any significant drop in GDP be shared by all. But that would require employment not to decline.

Governments in modern economies have either been unable to or have chosen not to prevent inequities from appearing in employment and income, especially in hard times. The one route they have taken to achieve full employment is the design of policies that are thought to boost the demand for goods and services.

All decision makers, be they Keynesians or otherwise, share the view that aggregate demand needs to keep rising if employment levels are to be sustained. Politicians and media commentators express anxiety when spending on the High Street shows signs of decline. We are encouraged to think that to consume material objects is to contribute to the social good. And we are not encouraged to ask whether the composition of output could be so altered (for example, toward improvements in the quality of public spaces) as to weaken the link between employment and GDP. It is more than an irony that short-run macroeconomic reasoning is wholly at odds with the now-universal desire for sustainable economic development.