Photo by Getty/Illustration by Bloomberg View
Photo by Getty/Illustration by Bloomberg View

Which is better for a country’s well-being: $10 million spent constructing a jail, or $10 million spent producing a line of smartphones? How about clear-cutting rain forests to produce $10 million in lumber? Or a storm that requires $10 million in repairs?

Using today’s most common shorthand of national welfare, gross domestic product, all of the above are equal. GDP measures only output, and makes no claims on the quality of that output, let alone on subjective concepts such as social progress or human happiness. It does what it was intended to do -- offer a value of marketed goods and services produced in a country in a given time frame -- and does it reasonably well.

Unfortunately, as you’ll probably gather from the reaction to this week’s announcement that U.S. GDP unexpectedly declined in the last quarter of 2012, politicians have increasingly come to rely on this measure as a singular tool for calibrating public policy. This is a mistake.

As useful as GDP is, it has some crucial flaws. It can obscure growing inequality and encourage the depletion of resources. It can’t differentiate between spending on good things (education) and terrible things (cigarettes). It doesn’t measure the economic services that nature provides, such as the dwindling wetlands that once protected New Orleans from storms, or those that don’t come with a market price, such as raising children. It fails to account for the value of social cohesion, education, health, leisure, a clean environment -- in other words, as Robert Kennedy once put it, GDP measures everything “except that which makes life worthwhile.”

Some Improvements

This is why more and more economists and activists are pushing to update GDP. The risk, though, is trying to incorporate too much into one indicator -- particularly when it comes to subjective measures such as happiness or well-being. A far better approach would be to improve some of the measurements used in national accounts, and develop a wider range of individual indicators of welfare to inform public policy.

In doing so, here are four guidelines to keep in mind.

First, economists need faster access to accurate information about growth, especially during recessions. Consider that the original estimate of GDP growth for the fourth quarter of 2008 was a contraction of 3.8 percent. Over several years that figure was revised to 8.9 percent -- suggesting a much more severe recession than most people realized in early 2009 when Congress was debating President Barack Obama’s stimulus bill. Several researchers, notably Jeremy Nalewaik of the Federal Reserve, have said that gross domestic income had suggested the onset of the recession earlier and with greater accuracy than GDP had. Nalewaik and several co-authors argued that a combined GDP-GDI measure would be more accurate, helping to offset some of the measurement errors that inhere in GDP and ideally giving policy makers a better economic picture when it most counts.

Second, we should take better account of non-market production -- like household work -- that affects the economy. The Bureau of Economic Analysis, which compiles the national-income accounts of the U.S., has done an admirable job in recent years of using “satellite accounts” to take a more comprehensive snapshot of the economy. These enable experimentation with what data the bureau collects, without jeopardizing the credibility of the existing national accounts.

For instance, a recent study calculated a satellite account for household production -- including non-market domestic services such as gardening and housework, returns on consumer durable goods, and return on government capital -- and found that GDP would have been 26 percent larger in 2010 if it had included such criteria. The study also found that the historical annual growth rate of GDP would have been slower and measures of income inequality would have been lower. Although such data necessarily entail uncertainty, they can still offer illuminating detail that’s missing from traditional measures.

Education, Health

The use of satellite accounts should be expanded prudently (note to Congress: that means giving BEA more money), especially to better account for education and health care. As a 2005 National Research Council study pointed out, non-market measures should be consistent with existing national accounts and, where possible, should use market analogs to determine value -- for instance, by estimating the value of parental care using the cost of private child care or the income a parent would forgo by staying home.

Third, because GDP measures average income, it can obscure important discrepancies at the household level. When incomes rise disproportionately for the well-to-do, for instance, mean income can increase even though many regular workers see their paychecks cut. As a report from the think tank Demos recently noted, although U.S. GDP more than doubled over the past 30 years, median household income grew by only 16 percent. One possible solution, which the authors support: Create new measures of household data for disposable income to better capture families’ welfare and buying power.

Fourth, economists are generally converging on the idea that some measurement of environmental impact could be added to GDP. The current system doesn’t account for pollution, the depletion of natural resources or the economic benefits nature can provide. Fortunately, data on environmental accounting are improving, and it’s possible, statistically if not politically, to place a monetary value on environmental depletion that could be subtracted from GDP. One way to begin might be to experiment with satellite environmental accounts.

What about measures of social well-being? This information is important, but measures proposed as a replacement or improvement to GDP, such as the Genuine Progress Indicator, typically suffer by including ideological or subjective criteria. Better to collect such data as part of a limited dashboard of additional indicators -- on health, the environment, social cohesion and so on -- that is separate from GDP. This is the approach recommended by the Stiglitz Commission, which did exhaustive work on this subject for the French government.

GDP is a universal, objective and very useful measurement. But we should recognize its limitations. Increasing GDP shouldn’t be governments’ only objective. Nor should GDP be considered a definitive measurement of human welfare. For that, we’ll have to expand our data. And, ultimately, hold our politicians to better account.

To contact the Bloomberg View editorial board: view@bloomberg.net.