The Economist has a lovely series on the shortcomings of the economics profession. This week, they are focusing on measurement issues in economics. These issues are all well known and accepted within the profession, but will make a good read if someone is new to the field.
They start with the complaint that economists often equate price and value and put a dollar figure on the value of certain products, commodities or even intangible aspects such as emotions and happiness. I don’t quite agree with this. One of the first lessons in the Microeconomics course that I teach at Takshashila is the difference between cost, price, and value. The perceived potential value of a certain commodity is necessarily higher or equal to the price that they pay. If not, they wouldn’t be undertaking the transaction. The price of a bottle of water in summer can be just Rs. 10, but the value that we derive from it will be much higher, if we are hungover and dehydrated, for example.
Then, it lists the familiar complaints with GDP as a measuring tool. Some of these are valid and provides a scope for improvement in the methodology, but some others are just plain bunkum. They start with the fact that GDP measurement is value neutral.
In a speech in 1968 Robert Kennedy complained that measures of output include spending on cigarette advertisements, napalm and the like, while omitting the quality of children’s health and education. Despite efforts to improve such statistics, these problems remain. A dollar spent on financial services or a pricey medical test counts towards GDP whether or not it contributes to human welfare.
Now, I would have categorised this in the pros column of GDP rather than the cons column, as The Economist has done. The mandate of GDP is to measure economic activity, not to make value judgement. We would want such measurements to be value neutral and not take moral positions. Imagine the consequences of ascribing moral weights while measuring economic activity. Who would have the moral authority to issue weights? Will spending money on alcohol have a lower weight than spending on religious rituals?
Another oft repeated complaint is that GDP does not measure unpaid activity or the social costs of environmental damage or resource abuse. These are valid concerns and the answer lies in continuously improving the methodology and capturing as much information as possible, and not discarding GDP, as some critics have suggested. GDP is still the most comprehensive tool available to measure economic activity.
Do listen to a podcast I recorded by Pavan Srinath on GDP. We go through the history of GDP calculation and try to address some of the problems with GDP as a measurement tool.