3.10 Limitations of GDP as a measure of economic welfare

GDP is an indicator of economic activity that is measurable in money terms; it does not measure welfare as such. The measurement of welfare is a much more complicated business because welfare is essentially a matter of personal and subjective opinion. Most economic theories work from the assumption that if the availability of a particular good or service increases and there are no changes in the availability of other goods or services, welfare will remain unchanged or increase; but if there is an increase in one category and a decrease in another, it is much harder to assess the overall impacts on welfare.

International comparisons of welfare often use the measure of GDP per capita. This measure tells us nothing about wealth or income distribution, and therefore it does not directly describe the level of welfare either.

Another reason that detracts from the use of GDP as a measure of welfare is that it makes no distinction between beneficial and detrimental production - an oil spill or a major fire will drive up GDP figures, yet they will not necessarily increase welfare. Furthermore, GDP sheds no light at all on the aspect of environmental friendliness: the value of production is the same regardless of how much pollution it causes. Indeed a production method that causes more pollution may require extensive clean-up operations in the future, which will have the effect of increasing GDP, even though the adverse effects of pollution may have adversely affected welfare, too. Environmental issues have received much attention of late in connection with GDP: would it be possible to incorporate in these figures some indicator that describes the degree of pollution and its future repercussions?

Several studies have, however, found a clear connection between GDP levels and welfare in society: the higher the level of GDP, the better the prospects of providing high quality education and primary health care services, for example, which in turn translates into increased welfare. GDP remains the most easily accessible measure worldwide, but it is important to bear in mind its limitations.

The United National Development Programme UNDP has been working to develop a new welfare index that in addition to GDP per capita also includes other measurable components (e.g. life expectancy, education). The Human Development Index (HDI) has not yet achieved global approval and there still remain unresolved problems: for instance, it is unclear whether education should be counted in years or hours or in some other way, and how the different components should be weighted in the final results. Work is also ongoing to develop indices of sustainable development that incorporate environmental data and the long-term impacts of people's choices.

Examples

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