The debate about how best to measure economic activity dates back to well before the ‘invention’ of GDP by Richard Stone and others during the Second World War (Stone 1947). The earliest attempt was William Petty’s 1665 estimate of income and expenditure in England and Wales, followed by a variety of other approaches in the 18th and 19th centuries. By the 1930s, partly in response to the demand from policymakers for a better handle on what was happening in the economy, the current approach to national income was taking shape (Coyle 2014).
One of the key questions debated in the 1930s concerned the aim of a single headline indicator of the economy as a whole. Should it measure social welfare, or should it instead just measure the level of activity? Simon Kuznets, often misleadingly described as the father of GDP, argued in favour of the former, but the needs of wartime production settled the debate in favour of an activity measure: GDP.
Economists have always been aware that GDP does not measure welfare, but in practice its growth has come to be widely used as the general litmus test for the health of the economy, both in the economic literature and in the media and public policy debate. So it is not surprising that the tension between measuring welfare and measuring economic growth has re-emerged several times over the decades since World War II. James Tobin and William Nordhaus argued in 1972 that maximising the growth of GNP (more commonly used then) was not a proper objective for economic policy (Nordhaus and Tobin 1972). They proposed a Measure of Economic Welfare in its place.
Subsequently others have suggested a number of alternative measures. One of the best-known is the Index of Sustainable Economic Welfare, proposed by Herman Daly and John Cobb in 1989, and its successor the Genuine Progress Indicator (Daly and Cobb 1989). This subtracts a range of ‘costs’ from GDP, including resource depletion, pollution, and the costs of crime, commuting, and unemployment. By definition, growth in the GPI (or similar indices) is lower than GDP growth.
However, one flaw of the single alternative indicators is that they all omit positive contributions to welfare that are not captured in the GDP statistics either. Despite the use of hedonic price indices to capture some of the quality improvements in a range of goods such as computers or housing, GDP understates – probably to a large degree – the increases in consumer welfare due to quality improvements, new goods, and increased choice. Even apparently trivial innovations such as a novel flavour of breakfast cereal seem to have led to large gains in consumer welfare (Hausman 1996).
A further flaw is that the alternatives to GDP obscure the conceptual distinction between activity and welfare, and all involve an implicit weighting of the different dimensions of welfare. For some purposes – macroeconomic policy for one – an activity indicator is essential. What’s more, the prominent alternative indices do not all rest equally firmly (if at all) on an explicit theory of social welfare; for example, the components of the GPI and the components of the widely-used Human Development Index differ greatly because of the choice of component indicators. Finally, a single welfare indicator obscures unavoidable trade-offs between components. The most obvious trade-off is that between income and what is often called ‘work-life balance’, or in other words the amount of leisure.
For these reasons, dashboards of indicators have much to recommend them as ways of monitoring social welfare, although these are relatively new. One example is the OECD’s Better Life Index. Another is the annual publication Measures of Australia’s Progress. The trade-offs are explicit in a dashboard, and individuals can place their own preferred weights to different sub-indicators in assessing progress.
The other issue obscured by proposed alternatives to GDP is the question of sustainability. Although this is clearly a contributor to social welfare, combining sustainability indicators into a single index along