All Inclusive Economic Development: The GDP alternative offers a better measure of progress

India's dismal human development levels
India’s efforts to scale up investment in nurturing human capital and capabilities are far from satisfactory.

By Anandadeep Mandal and Neelam Rani

Gross domestic product (GDP) measures the economic output, i.e. the value of goods and services produced in a year in a given country. It is fair to think that there exists a positive link between investing in health and a country’s economic output. Does better health contribute in generating higher income through factors such as higher work productivity? Do uncontrollable diseases like malaria have an adverse effect on GDP? Researchers have shown that there is a statistically significant link between economic output and investment in health. However, the key issue is that – GDP is a narrow and an inadequate metric to capture the holistic and true value of health investment, leading to economic wellbeing.

Nevertheless, since the outbreak of COVID-19 and its eventual spill-over witnessed across the globe, questions have been raised regarding the usage of the narrow metrics of national prosperity traditionally used in economic debates — such as per capita gross domestic product (GDP). Consensus is emerging towards developing indicators that goes beyond GDP to measure economy of inclusive growth and wellbeing. Has time finally come for the policy makers to develop a more holistic metrics in monitoring a country’s progress?

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Here we ask, why does GDP dominate the measurements of a country’s development? What are the key issues in using GDP as a measure of development? What should the new set of indicators be to address a nation’s development and growth? Lastly, we propose a new all-inclusive multidimensional framework to measure a country’s economic development, capturing people’s health and wealth distribution of a nation.

Why GDP dominates economic discourse

In 1937, Simon Kuznets proposed a framework, the modern conception of GDP, to capture the productive capacity of individuals, firms and the government to the US congress. He warned against the limitations of using GDP as a welfare measure. He highlighted that differences between quantity and quality of growth should be distinguished and considered. However, GDP become the key performance indicator of economic development, as published in reports by the World Bank, International Monetary Fund and the economic bureaus of all developed and developing nations, including India.

GDP and its variants, such as GDP per capita and their growth rates are the common measures that are frequently cited by policy makers and the media. These are considered as important indicators in defining the current state of the economy. Further, since these data are available for historical periods, it allows researchers and policy makers to study an economy’s evolution and compare between countries.
What stands out in favour of GDP is its simplicity in contrast to other ‘mashup indices’. These newly developed indices combine many factors to create a single composite one. However, the combination of various others with GDP results in the loss of information of the key indicators of development that are independent of income.

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Imperfections in using GDP as a measure

In 1968, Robert F Kennedy stated, “the GDP fails to account for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials . . . it measures everything in short, except that which makes life worthwhile.”

Many researchers, economists and visionaries have also pointed out the imperfections in GDP as an economic development indicator. They argue that economic development cannot be only narrowed down to economic output. Rather, economic development is a multiple-layered process that originates from improvement of human conditions to enlarging people’s choices. The Stiglitz-Sen-Fitoussi commission highlighted the shortfall of GDP as a measure of “economic performance and social progress”.

Further, the Occupy Wall Street movement in the US and the Equality Trust in the UK have shown another limitation of the GDP. With growing inequality worldwide, an average score of GDP fails to incorporate the necessity of considering distribution of wealth. Example of inequality measures are Gini coefficient and the total income held by the top 1% percent compared to the remaining 99%. Here, we provide an example to illustrate this inadequacy of the GDP measure.

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Let us consider two nations India and Nigeria. Both have similar GDP/capita, i.e. $2010 and $2028 respectively in 2018, yet the countries’ health indicators vary widely. While the life expectancy at birth in Indian was 69 years in 2018, which for Nigeria was 54 years. Thus, using GDP per capita alone fails to capture the additional years 15 years of intrinsic value of life in India. These 15 years have economic value that goes beyond productivity. It is, therefore, fair to say that a country whose citizens enjoy healthy life outperforms another nation with same GDP per capita. In summary, GDP measures marketed goods and services. It fails to consider several key aspects of economic wellbeing that drives a country’s development, including environmental quality and utilitarian values such as health and education.

Alternative measures of economic development

Clearly, GDP should not be solely used but with other all-inclusive indicators. There are several other alternatives proposed by economists, but William Nordhaus, 2018 Nobel Prize winner in economics, proposed the most influential one, “health economy”. While the “health economy” considers improvement in country’s health status into measures of national income, in recent time Jones and Klenow’s (2016) proposal combines consumption, leisure, equality and mortality. In this regard, the Human Development Index (HDI) published by the United Nations Development Programme (UNDP) measures living standards across three major dimensions: i) GDP per capita, ii) education and iii) life expectancy at birth. In the HDI measure, education and health are kept at par with the economic measure.

However, HDI is more complicated to calculate than GDP and hence, it has not seen much traction among multilateral agencies. Further, HDI is not useful as a time-series data because of its limited availability and its value ranges from o to 1 and its units are not easily inferenced. Several other indices were initiated by UNDP, such as gender inequality index and multidimensional poverty index. But, majority of the nations do not seek to compute and value them much while assessing their performance and growth.

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Environmental economics provide yet another alternative to GDP. It is the “value of life years” (VYL) approach. To illustrate – Suppose you have to choose between two alternatives, the improvements in health since 1950s and the improvements in material goods. Put alternatively, you have to choose between wi-fi, mobile phone, computers, etc. and an extra 32 years of life expectancy comprising on the materialistic improvements. Majority, as examined by Nordhaus’s question, will choose a higher life expectancy. The concept of VYL considers the intrinsic value of higher life expectancy. Thus, it is fair to assume that VYL provides a more inclusive picture of economic wellbeing than using GDP alone. In the Global Health 2035 report, World Bank president, Jim Kim, noted that for every $1 invested in reducing deaths form infection and maternal and child health conditions will yield an economic output/return of $9-20. The report also shows that improvement in human survival has economic value beyond its direct linkage with GDP.

Nevertheless, the computation of VLY is subjective and the value of a statistical life is heavily dependent on whom the study is based on. Further, the monetary value of VLY is based on methodologies such as discrete choice experiments, time trade-offs and standard gambles. Approaches include willingness-to-pay to reduce the risk of dying or estimating the willingness-to-pay to reduce risk, based on consumptions choices. Thus, these outcomes are significantly dependent on the sample chosen for the study.

Beyond GDP: moving forward

We have summarized how GDP gives an illusionary picture of how well an economy is performing by narrowing the value of health and undermining its significance in economic development. We have discussed a few alternatives but have also highlighted their limitations and practical usage. The complexity of creating a composite measure includes is primarily because of these two issues: First, what measures should be included? and second, what is the relative value of these measures to each other? Invariable, to conclude what measures should be included is a subjective matter and hence a consensus is difficult to achieve.

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Against this backdrop, we present an alternative framework to measure the economic development of a nation that captures economic wellbeing. Our proposed measure is similar to HDI, but without its major limitations.

Alternative ‘All Inclusive Economic Development (AIED) measure = (GDP per capita) X (Life Expectancy Coefficient, i.e. LEC) X (Employment Rate) X (1/ (1+ Gini Coefficient)); where LEC = (Life Expectancy in years) / (100+Life expectancy in years).

This measure captures the output of an economy, dimensions of health and income, i.e. the expected lifetime contribution to the economy in good health, and equality of opportunity captured by the scaled factor of Gini coefficient. A Gini coefficient of ‘0’ indicates perfect equality in an economy and a Gini coefficient of ‘1’ indicates complete inequality. This measure unlike the other alternatives get rid of aggregating fundamentally different things like, income, and education and life expectancy in years. Thus, unlike other measures this has a straightforward interpretation.

Time has come for us to shift emphasis from measuring economic production to measuring all-inclusive economic growth that captures people’s wellbeing. We trust that our measure of economic development defines a multidimensional concept that includes health, wealth and economic wellbeing. However, we believe that for alternative metrics to challenge GDP hegemony, three necessary actions are required. These are repeated use of the new metrics, policy leadership that values the new measure and knowledge dispersion that supports the emergence of the alternative.

(Dr Anandadeep Mandal is Assistant Professor (finance) at the University of Birmingham, UK. Dr Neelam Rani is Associate Professor (finance) at IIM Shillong.)