Measuring the Standard of Living (Essay Technique Video)

In this revision video we look at a possible answer to this 25 mark essay question: "To raise standards of living, countries should focus solely on increasing GDP per capita." To what extent do you agree?

Introduction to the essay:

The baseline measure for a nation’s standard of living is real GDP per capita adjusted for purchasing power parity. This measures the inflation-adjusted value of goods and services produced within an economy over a year, measured in PPP adjusted terms to take into account variations in the cost of living between countries.

1st main point:

Success in raising GDP per capita is important for basic living standards because it is a direct way of cutting extreme poverty measured at $1.90 a day PPP.

This is best exemplified by the progress that China has made in improving material standards of living over the last 25 years. Here GDP per capita relative to the USA increased from 5% in 1992 to 25% in 2016. China achieved upper-middle-income status as a developing country in 2010 and the World Bank estimates that Chinese income per capita increased from $980 in 1990 to $14,239 in 2015 (PPP). China reached all of the Millennium Development Goals (MDGs) by 2015 and the country is now ranked 90th of 188 countries on HDI with a fast-growing middle class.

Evaluation

However, focusing on GDP capita may cause us to ignore rising relative poverty / inequality. In China, the Gini index has risen from 0.3 in the 1980s to 0.53 in 2013 and this a big risk to social cohesion. There are large gender & regional inequalities (especially between coastal and interior)

2nd key point:

A rise in real GDP per capita is important as it allows more people to afford life-sustaining goods such as health and education and it lowers the long-term costs of  malnutrition.

Raising real GDP per capita is key to sustaining gains in human development. One chain of reasoning is that higher per capita incomes leads to increased consumption which then helps to create new jobs thus providing a flow of factor incomes for people in work. If more people earning regular wages and higher incomes, this will then contribute to rising tax revenues for a government to pay for public services including basic public and merit goods. It also allows the state to provide basic welfare assistance. 

Evaluation:

However, improved GDP per capita does not guarantee big improvements in human development. Equatorial Guinea has a GDP per head of $21k but an HDI ranking of 138 and is a country riddled with corruption and conflict. Qatar is the richest country in the world but lies only 38th on the HDI index. 

3rd key point:

A third justification to focus on higher real GDP per capita is that it can raise the level of private savings and capital investment which is important for future economic growth.

The Harrod-Domar model emphasizes the role of savings to help fund capital investment. In many lower and middle income countries gross national saving is insufficient to fund investment. If policies are successful in lifting GDP per capita, then an increase in national savings leads to an expansion in net investment which helps to grow a country’s capital stock. Through a virtuous circle effect, the extra investment leads to a rise in real GDP which supports higher incomes and consumption. Many emerging countries such as India and Indonesia have a higher level of saving and investment as per capita incomes rise.

Evaluation:

One problem with this argument is that, in many countries, financial institutions are not efficient at allocating capital to productive uses. Also, many of the gains from rising incomes flow to elites who send their money out of a country rather than retain it for domestic investment.

4th key point:

A government should not focus solely on GDP per capita because it is  an inaccurate indicator of changes in the standard of living. 

Firstly, per capita GDP understates real living standards due to the shadow economy and the value of unpaid work by volunteers and people caring for their family. Higher per capita incomes might have come from working longer hours which negatively affects our quality of life. 
Also, GDP per head increases when we spend money “defensively” protecting against crime, or cleaning-up the effects of pollution and waste. There are also big difficulties in accurately measuring the true value of welfare we get from consuming products for free via the internet. Many economists now see GDP as deeply flawed.

Evaluation:

However we can adjust GDP to take account of criticisms. For example, the Genuine Progress Indicator (GPI) adjusts for environmental costs and benefits, and surveys of measured well-being. HDI data for most countries is now adjusted to take into account gender and income inequalities.

Building the Evaluation - Final Reasoned Comments

Overall, I would argue that changes in GDP are an inadequate measure of human well-being. Some economists argue that we should now concentrate on median real disposable incomes rather than income per capita. This allows us to consider the effects of taxation and inequality. The Legatum Institute has developed a Prosperity Index and the Kingdom of Bhutan has, since 1972, published an annual Gross National Happiness Index! GDP is an important indicator not least because it reflects the productivity of an economy and we should not ignore it when assessing the standard of living. But material welfare is not the same as economic and social well-being. From health to education and the sustainable stock of natural capital that we leave to future generations, well-being is a multi-dimensional idea that GDP alone cannot measure. I would favour focusing on progress in the middle of the income distribution and therefore I would replace GDP per capita with median household income as my main measure.