How is the economy doing?
There are many different ways to answer that question, from the serious (unemployment figures) to the goofy (watch hemlines: Skirts purportedly get shorter during a boom). But for more than 60 years, there has been only one measurement considered truly authoritative: Is gross domestic product going up or down?
Developed in the 1930s and 1940s to help governments address the challenges of the Depression and war, GDP is intended to show the sum total of activity going on in the economy and today holds unique power among economic indicators. The Federal Reserve Board uses it to guide decisions on interest rates; it can help win or lose elections. It shapes how nations think of themselves compared to other countries.
The trouble is, GDP is flawed. Over the years—in fact, right from the start—critics have pointed out that many activities drive GDP up despite being obvious evidence of damage to a society. Having to pay for security guards or extra police to patrol a dangerous neighborhood increases “growth,” in GDP terms. A natural disaster such as Hurricane Sandy also increases GDP, because the repair and rebuilding that has to occur afterward registers as economic activity. The destruction of existing capital—the houses and roads, the lives displaced, and the social harm caused—are not captured in the statistics.
GDP is similarly bad at reckoning with the loss of natural resources. When a factory spews smoke and spills pollutants into a river, GDP records both the factory’s activity and the money later spent on cleanup as positives—never reckoning with the loss of clean water, arable land, and fresh air.
There are also many positive national developments that go uncounted in GDP. Consumers gain enormously from innovations that GDP doesn’t track—from small improvements in the cushioning of running shoes, say, all the way to major health gains from new medical procedures. GDP doesn’t measure intangibles like intellectual property or free digital goods. As the economy has become richer, more complex, and diverse, based on services rather than manufactured goods, the gap between activity as measured by GDP and consumer gains from innovation has grown.
So GDP is a good measure of total activity in the economy, but when it comes to what most people care more deeply about—how well off we really are—it’s increasingly clear that we should be looking for alternative indicators. A handful of these have been developed or suggested—and a tour of these measures casts light not only on the limits of the GDP, but on how our definition of national well-being has evolved since it was born.
A national balance sheet
No business would rely only on its cash flow or profit-and-loss statement to measure its health; a balance sheet, showing assets and debts, is essential, too. Otherwise, you get a picture only of short-term gains and losses, but nothing that shows a true financial outlook for the future. Yet very few nations do a good job of measuring their assets and liabilities. A good balance sheet would include not only financial indicators like the national debt or liability for future Social Security, but also all the assets essential for future economic success: skilled people, infrastructure like roads and telecommunications networks, and natural resources.
Accurately calculating all this is a big job, and so far no country has tried to do it in a comprehensive way. Besides the difficulty of the task, it wouldn’t suit the short-term election cycle to have the long-term, balance-sheet health of the economy to contend with; it’s much easier to talk about jobs and deficits. But if we care about our children and grandchildren, not just ourselves, this more long-sighted measure of our country’s intangible assets and liabilities is vital to consider.
The United States won the Cold War not only because of military strength and strategic skill, but because the capitalist system made almost everybody better off, whereas Soviet planning was an economic failure for all but the elite. Today, the West could be facing a similar pitfall—but it’s one that’s hidden by GDP. If growth is increasing only for the top 1 percent or 10 percent of incomes, the GDP can still show growth, even though most of the population isn’t benefiting. For most of the post-World War II era, most countries had no urgent need to track income inequality, because societies were becoming more equal. Since the 1980s, however, that has changed dramatically.
An economic indicator that looked at the ratio of the highest incomes to incomes on Main Street (median incomes, in economic jargon) is starting to look like an essential addition to traditional economic statistics. There are political hurdles to a universally acceptable version: People will have different views about how much inequality is “too much.” But when so few people are gaining anything from conventional GDP growth, it has become something important to monitor.
Just as many businesses use a dashboard including a whole range of key indicators to judge how well or badly things are going, an economywide dashboard could include GDP growth but also other indicators of our well-being, such as education levels, health, environmental quality indicators, and hours worked. Australia is already using this approach, and a Paris-based think tank called the Organisation for Economic Co-operation and Development is piloting an online dashboard, the Better Life Index, that compares all the developed economies.
A drawback of dashboards is that they don’t give a single headline number, but that’s their strength, too: They show us a lot of factors that affect us and allow us to make informed choices when there are trade-offs. Promising as they are, they still need more work to make them really useful tools for reporting the economy.
Diane Coyle is an economist and the author of “GDP: A Brief but Affectionate History.”