Why you should care
Because while GDP is the most widely used measure of success, it may be misleading.
Imagine two people. Let’s call them Bill and Ben. Bill is a midranking investment banker who clears 500,000 pounds ($680,000) a year after tax. Ben is a gardener who takes home 25,000 pounds ($34,000). Who is better off?
If we judge them by income, then Bill is clearly richer; 20 times richer, to be precise. But who is wealthier? For that, you’re going to have to know more about their stock of assets and broader circumstances.
In national accounting terms, Bill’s 500,000-pound salary is the equivalent of gross domestic product. It is the “flow” of income earned in a year. But, as any mortgage lender knows, that doesn’t tell you anything about his wealth or his salary next year or the year after that.
Did I mention that Bill is up to his neck in debt after a crippling divorce, or that he has an expensive cocaine habit? He’s sold off most of his assets, including his vintage Harley-Davidsons. All he is left with is a costly mortgage and several payments on his (scratched-up) Porsche. At 59, he’s also washed up at work. In fact, he is about to be fired when the bank shifts its derivatives trading team from London to Frankfurt.
Ben, meanwhile, lives in the 100-million-pound country estate he inherited from his great-aunt. On the weekends, he potters about for fun in his own Versailles-inspired garden, paying himself a nominal salary.
This year, before he turns 21, he plans to sell the estate and move into a modest flat in Knightsbridge. He’ll invest the 95 million pounds he has left over and live off the interest while he completes his studies as a patent lawyer, a profession that should earn him a bit of pocket money in the years ahead.
Now who looks richer? Bill the banker or Ben the gardener?
Michal Kalecki, the Polish economist, is said to have described economics as “the science of confusing stocks with flows.” Investors scrutinize a company’s balance sheet as well as its profits and losses. Yet, when it comes to sizing up a nation, we are mostly stuck with GDP, which counts the value of goods and services produced in a given period.
GDP numbers can be misleading. That applies especially to resource-rich countries. Saudi Arabia’s income per capita of around $20,000 a year depends on the price and production volume of oil, which will one day run out. At that point, unless the Saudis figure out a way of replacing lost income — through developing high-tech industries staffed by educated people — it will become the Bill the banker of nations.
As Paul Collier, professor of economics and public policy at the Blavatnik School of Government, says, it is a lesson hard to glean from national income statistics. You need regular updates of a country’s balance sheet to “blow the whistle” on unsustainable policies.
Yet it is not something lost on astute leaders. Much of the urgency behind the reform efforts of Mohammed bin Salman, Saudi’s 32-year-old crown prince, stems from an apparent determination to diversify the economy before it is too late.
“Policies that create wealth go beyond increasing output,” say Kirk Hamilton and Cameron Hepburn, in their recent book National Wealth: What Is Missing, Why It Matters. “They involve investments today for returns in the future.”
I have long had vague misgivings about GDP as an accurate barometer of living standards and the sustainability of wealth. As a young reporter for the Financial Times in Latin America in the 1990s, I quickly learned to report minutely on the quarterly gyrations of GDP and to lend my articles a touch of gravitas by deploying GDP as a denominator. Tax revenue or debt levels or education expenditure were best expressed as a percentage of GDP to facilitate cross-country comparisons. Yet beyond knowing that GDP was a measure of economic output, I never stopped to think exactly how it was calculated or precisely what it meant.
Later, as a correspondent in Japan, I wondered why people seemed so well-off when nominal GDP had not budged for 20 years. Deflation and low population growth were part of the answer. That meant real per capita income was higher than the nominal number suggested. But the quality of services and technology also made a difference to living standards. To GDP, an elegant Mitsukoshi department store was the same as a Walmart, and a clapped-out British commuter train did just as well as a Japanese Shinkansen traveling at 200 mph and arriving with a punctuality measured in fractions of a second.
Later still, in China, I marveled at year after year of double-digit growth, but worried that no one was taking any statistical reckoning of the not-so-hidden costs of growth in poisoned air and depleted soil. It seemed perverse that, if China spent money cleaning up its mess, that too would count as growth, much as GDP counts money spent to repair the damage after natural disasters, terrorist attacks or war. Any activity, it seemed — digging a hole and filling it up again — would do.
In GDP terms, Wikipedia, which puts the sum of human knowledge at our fingertips, is worth precisely nothing.
In my most recent job, as Africa editor, I discovered that GDP data — often treated as sacrosanct and used, for example, to determine appropriate levels of borrowing — were virtually meaningless. Normal methods of compiling GDP, which rely on costly surveys of businesses and households, were often too expensive for cash-strapped governments to undertake. Besides, they failed to account properly for activity in the massive informal and subsistence sectors. Terry Ryan, chairman of Kenya’s National Bureau of Statistics, told me that if — as the official data suggested — some 72 percent of Kenyans lived on a dollar or two a day, then “72 percent of my people are dead.”
In Nigeria, minor changes to methodology implemented in 2014 revealed that the economy was 89 percent bigger than assumed, making a mockery of previous estimates. Again in Kenya, one group of economists said they could monitor the economy more accurately than GDP from outer space. Satellite imagery of night lights showed that national income statistics were missing swathes of activity outside Nairobi, the capital.
As I began to read more in the course of researching a book, The Growth Delusion, I found that I was far from alone in my skepticism. There was a whole academic literature, a mini-industry becoming more respectable by the day, questioning the ability of GDP to reflect our lives.
Invented in the 1930s by Simon Kuznets, initially as a way of calculating the damage wrought by the Great Depression, GDP is a child of the manufacturing age. Good at keeping track of “things you can drop on your foot,” it struggles to make sense of the services — from life insurance and landscape gardening to stand-up comedy — that comprise some 80 percent of modern economies. The internet is more perplexing still. In GDP terms, Wikipedia, which puts the sum of human knowledge at our fingertips, is worth precisely nothing.
Nor does GDP have much useful to say about income distribution, one of the themes of our age. Kuznets warned urgently that his measure should never be confused with well-being. Yet in treating GDP as the nonpareil of numbers, it is a warning we have ignored.
Among GDP’s shortcomings, the distinction between flow of income and stock of wealth, highlighted by the story of Bill and Ben, is one of the most serious.
Partha Dasgupta, professor emeritus of economics at Cambridge University, has been trying to invent ways of measuring wealth for decades. The “rogue word” in gross domestic product, he says, is “gross”: “If a wetland is drained to make way for a shopping mall, the construction of the latter contributes to GDP, but the destruction of the former goes unrecorded.”
When I went to see Dasgupta, now in his mid-70s, at his rooms at St. John’s College, he began with the intricate interplay between wealth and income. One could think of it in terms of life planning, he said. A family might use income to purchase an asset — say, a house — or it might trade in an asset to pay for an education, which, in turn, could later be converted into higher income. With any entity — a family, a company or a nation — wealth is “what enables you to plan,” he said, by “converting one form of capital into another.”
With nations, some forms of capital are easier to count than others. So-called manufactured capital comprises investments in roads, ports and cities. It is relatively easy to value and many countries keep inventories of capital stock. Human capital is the size and skill of a workforce. Natural capital includes nonrenewables, such as oil and coal, and renewables, ranging from farmland to complex ecosystems that provide water, oxygen and nutrients.
Attempts to value some of these assets can appear absurd. In 1997, the environmental economist Robert Costanza caused an uproar with his estimate that the planet’s natural capital — “nature” to you and me — was worth $33 trillion. His sums, published in the scientific journal Nature, were pilloried by both conventional economists, who thought the exercise unscientific, and by environmentalists, who objected to the very idea of hanging a dollar tag on an ocean or a rainforest. Costanza found, for example, that lakes and rivers were “worth” $1.7 trillion, while nutrient cycling, an “ecosystem service,” provided $4.9 trillion of benefit to mankind.
To call his calculations back-of-the-envelope would be to malign envelopes. Yet when challenged on his methodology, he responded, “We do not believe there is any one right way to value ecosystem services. But there is a wrong way, and that is not to do it at all.”
Some economists view any attempt to account for natural depletion with suspicion. When I asked Lawrence Summers about it, he decried what he saw as a bogus attempt by environmentalists to limit growth. His main complaint was that wealth accountants were quick to shout when resources had been depleted, but slow to acknowledge when they had been augmented.
New technology, such as fracking and deep-sea drilling, Summers said, had increased exploitable oil and gas reserves. Video conferencing was a breakthrough that meant people could hold more international meetings while reducing travel-related emissions.
But wealth accountants, he said, were never honest enough to concede how innovation could add to wealth as well as subtract. “It’s all a doom-and-gloom operation,” he practically growled down the phone. “In favor of everybody staying at home. Everybody staying home and knitting.”
GDP is backward-looking. It merely tots up total production over a specific period in the past.
Summers is right that it is difficult to know how much current capital stock is worth, since its value can change depending on technological or political developments. Cobalt was once a mildly interesting byproduct of copper; now it’s a must-have component of electric car batteries. Oil has been liquid gold and may yet be again. But stricter environmental regulations could one day render it a stranded asset worth nothing.
More philosophically, it is hard to put a price on the future. One of the supposed virtues of wealth accounting is that it is forward-looking. It analyzes today’s stock of capital that will produce tomorrow’s income stream. GDP, on the other hand, is backward-looking. It merely tots up total production over a specific period in the past. So, in theory, wealth accounting should help one generation think about the next.
Yet in practice, as my colleague Martin Wolf told me, there are limits. We may love our children and their children and even their unborn children. But what about the children after them and those after them? “The question of sustainability is partly: Who cares about the future?” he said. In the long run, “we will all be zero-energy soup.”
Such practical and philosophical considerations aside, there is now real momentum behind wealth accounting, even among the most orthodox of institutions. This month, the World Bank will release the most comprehensive attempt yet to crack the problem.
“The Changing Wealth of Nations 2018” is the fruit of years of work by a dedicated team. It builds on research published in 2006 and 2011. In its latest iteration, the bank produces comprehensive wealth accounts for 141 countries between 1995 and 2014. For each country, there are estimates for “produced” capital, including urban land, machinery and infrastructure. Natural capital includes market values for subsoil assets, such as oil and copper, arable land, forests and conservative estimates for protected areas, which are priced as if they were farmland.
For the first time, the bank makes an explicit attempt to measure human capital. Using a database of 1,500 household surveys, it estimates the present value of the projected lifetime earnings of nearly everyone on the planet.
“We’re looking at GDP as a return on wealth,” says Glenn-Marie Lange, co-editor of the report and leader of the bank’s wealth accounting team. “Policymakers need this information to design strategies to ensure that their GDP growth is sustained in the long run.’’
Among the report’s findings, the full details of which are embargoed, is a huge shift of wealth over 20 years to middle-income countries, largely driven by the rise of China and other Asian countries. A third of low-income countries, however, especially in Africa, have suffered an outright fall in per capita wealth over that period, in what could be a dangerous omen about their capacity for future growth. In the world as a whole, the report finds, human capital represents a whopping 65 percent of total wealth. In 2014, this was $1,143 trillion, or about 15 times that year’s GDP.
The report is particularly illuminating in tracing the path to development as countries, in the manner described by Dasgupta, trade in one form of capital for another. Crudely put, they use income derived from natural resources to build up other forms of capital, principally in infrastructure, technology, health and education. So, while natural capital accounts for 47 percent of the wealth of low-income countries, it represents only 3 percent of the wealth of the most advanced.
The lesson, says Collier of the Blavatnik School and author of The Bottom Billion, a book about failing economies, is that spurts of GDP don’t tell you anything if you don’t know about underlying wealth. In Africa, countries such as Nigeria have converted resources into consumption booms, but have largely failed to build the infrastructure or invest in the healthy, educated population that will sustain future growth.
Much of Africa, says Collier, has “dug itself up and chopped itself down, but didn’t build enough in its place. It’s not sustainable growth. It’s a fiction of the flow data.” It is a lesson that Bill, the indebted banker with limited future earning prospects, would have done well to take to heart.