Monday, June 30, 2008

Measure and Mismeasure of the Canadian Economy

GDP — or Gross Domestic Product — is the most widely used indicator of the overall size and health of a country 's economy.

The "Gross" in GDP means that it includes the costs associated with the depreciation of things like buildings machinery and equipment.

The "Domestic" refers to the requirement that the economic activity must take place within the boundaries of Canada, so goods produced by Canadian companies overseas are not factored in, and goods produced for foreign companies in Canada are.

As for "Product," GDP measures the result of production — the value of all good and services produced in one year.

When you see GDP growth figures cited, they're usually "real" GDP figures. Real GDP excludes the effects of inflation, so it's easy to see if the economy "really" grew, or if inflation alone was responsible for the increase in a country's total output.

The growth in real GDP is widely used as a standard to indicate the economy's health. It is this growth figure that economists look for in the GDP reports that Statistics Canada churns out and releases at the end of every month.
How is GDP calculated?

Statistics Canada gathers much of the raw data it uses to calculate GDP from its own surveys, like the monthly survey of manufacturing or the survey of employment, payrolls and hours. It also gathers data from other federal departments and agencies, other levels of government and from private industry.

There are many ways to express a country's GDP. Statistics Canada calculates the country's GDP by industry. It divides the economy into goods-producing industries (like manufacturing, construction, and energy) and service-producing industries (like retail trade, health care, and finance).

GDP is calculated on a "value-added" basis. In other words, only the value of production added at each state of the manufacture of a product is counted. If this didn't happen, production would be double-counted and GDP would be inflated.
Problems with GDP

GDP, to put it bluntly, is a blunt instrument. It was designed in the wake of the Great Depression as a way of measuring the size of a country's productive output. But in the decades since, it has been wielded as a sign of economic well-being, even the happiness of the citizenry. If a country's real GDP rises by four per cent in a year, it doesn't seem to take long before you see politicians taking credit for building a "strong" economy. Times are good, and all that.

Even as a measure of economic output, however, GDP has its limitations. Take a look at the first quarter of 2008, when the Canadian economy contracted at an annualized 0.3 per cent that quarter and the U.S. economy grew by 0.9 per cent.

That leaves the impression that the Canadian economy was doing worse than the U.S. economy, which was struggling with rising unemployment, slumping auto sales, and one of the worst housing downturns in decades.

"Without resorting to hyperbole, this understates the relative performance of the Canadian economy by a country mile," said BMO Capital Markets economist Doug Porter in a report he titled "Does GDP Matter?" (He says yes, but not as much as usual.)

More fundamental criticisms of GDP arise when one takes a look at what it measures, and especially what it doesn't. GDP, for instance, does not measure unpaid housework and caregiving. When a maid or professional caregiver is hired, however, that does add to a country's GDP. GDP figures also do not take into account the economic value of the many hours of volunteer work.

GDP includes the costs of rebuilding after a devastating hurricane or earthquake, even though it merely restores the status quo. It also counts the cleanup of an oil spill as "production," just as it counts the billions spent fighting crime and preventing terrorism or dealing with a health epidemic.

And finally, GDP fails to take into account how a country's wealth is divided. A huge gap between rich and poor is irrelevant in the GDP scheme of things, while it clearly matters if one is talking about a healthy society. GDP is a measure of quantity, not quality.
What are some alternative measures?

The increasing use of GDP figures as a proxy for progress and well-being has led to the development of some creative alternatives that attempt to capture the intangibles that make people happy and a society healthy.

Measure of Economic Welfare (MEW) — The MEW is the work of Yale University economists William Nordhaus and James Tobin. They developed their Measure of Economic Welfare back in1972 as one of the first attempts to address the shortcoming and mismeasures of GDP. It proposed accounting for such variables as household work, pollution, and spending on crime. This measure was to form the basis of several later attempts to measure well-being.

Index of Economic Well-being (IDEW) — This index is the work of the Ottawa-based Centre for the Study of Living Standards.It's a weighted average of what the Centre considers to be the four main components of economic well-being: consumption flows, stocks of wealth, inequality, and indicators of economic insecurity like unemployment and poverty in old age.

The Centre found that the economic well-being of Canadians, as measured by the IDEW, has increased at a much slower rate over the last 25 years than real GDP per capita. Its last look at 14 industrialized OECD countries found Norway was at the top of its Index of Economic Well-being, while Canada was in 10th spot, the U.S. was 11th, and Spain was 14th.

Genuine Progress Indicator (GPI) — The GPI was developed in 1995 by Redefining Progress, a private research institute based in California. It arrives at its Genuine Progress Indicator by taking GDP figures and then adjusts them to take into account income distribution. It adds points for household and volunteer work, and subtracts points for the costs of things like crime, pollution, car accidents and the loss of leisure time. Under its per capita GPI formula, the U.S. has been basically treading water for the last 30 years — making no real progress in that time, even though real per capita GDP had jumped significantly.

Nova-Scotia-based GPIAtlantic has developed its own Genuine Progress Index to reflect the standard of living in Nova Scotia. Its GPI is constructed along similar lines to the GPI from Redefining Progress. But GPIAtlantic doesn't turn its index into a single number. One of its research studies found that volunteerism adds $1.9 billion a year to Nova Scotia's economy — a figure that doesn't find its way into traditional GDP reports.

Index of Sustainable Economic Welfare (ISEW) — Developed in 1989 by Herman Daly and John Cobb, the ISEW takes into account private spending on defence (a negative), domestic housework (a positive), the costs of environmental harm (a negative), and it corrects for income inequality.

Human Development Index (HDI) — This index is the work of the United Nations Human Development Report. It calculates an annual HDI that ranks the world's countries on their achievements in three main aspects of human development: health (life expectancy at birth), knowledge (as measured by literacy rates and school and college enrollments) and standard of living (as measured by GDP per capita based on purchasing power parity.) For 2007-08, Iceland was in first place, Canada was fourth, the U.S. 12th, and Sierra Leone was last, in 177th place.

Happy Planet Index (HPI) — The Happy Planet Index was developed by the British-based New Economics Foundation to, in their words, "show the relative efficiency with which nations convert the planet's natural resources into long and happy lives for their citizens." In other words, it doesn't really measure whether people are "happy". Its most recent HPI ranking puts Vanuatu, Colombia and Costa Rica first, second, and third. Canada is in 111th place (just below Benin), and the U.S. is 150th.

Finally, in 1972, the King of Bhutan came up with the Gross National Happiness (GNH) indicator that he felt would be more in tune with his country's Buddhist values (i.e. sharing prosperity, protecting the environment, and preserving culture).

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