‘If UK GDP increases over time, this implies the welfare of its residents improves’. Discuss.
“Gross Domestic Product (GDP) is the market value of all final goods and services produced within a country during a given time period- usually a year” (Parkin et al, 2008). This means that everything made within the country, as long as it is a final good, contributes towards the GDP. Wealth is defined as “the value of all the things that people own” (Parkin et al 2008). Welfare of residents refers to the overall living standards and income a household or individual receives, this is similar to GDP but is individual rather than referring to the whole nation. This is important as the wealth of a nation is not divided equally between all the residents. This inequality is depicted using the Lorenz Curve, which shows the cumulative percentage of income against the cumulative percentage of households (Parkin et al, 2008). The same curve can be drawn for the distribution of wealth; this curved will be bowed further as wealth is even more unevenly distributed than income.
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Fig20 The positive link between the welfare of residents and GDP can be seen on the assumption that “our living standards (welfare of residents) rises when our income rise and we can afford to buy more goods and services” (Parkin et al, 2008). When incomes increase then the total output of the country must also increase because in order for individuals to earn more money the economy must be growing, if the nation is producing more goods and services then there is more for the consumer to buy and also more choice in the market. This increases welfare because an increase in selection of goods and services improves quality of life. Increasing the total number of goods and services also decreases unemployment, firstly because in order to create more goods we need a bigger workforce, but in doing so, the newly employed also increase their income, meaning they have more disposable income to spend on goods and services, increasing demand further. Okun says “that for every 3% GDP falls relative to potential GDP, that unemployment of the total workforce rises 1%. When the economy operates at productive capacity, it will experience the natural rate of unemployment” (Anderton, 2006). So when there are unemployed resources in the economy then GDP is below potential GDP which means the economy is losing on potential GDP, as illustrated using the Lucas Wedge (Figure 2).
However, although there is a correlation between GDP and Welfare it’s not as clean cut as all that. As a general rule and for the majority of people the welfare does increase with an increase in GDP but in some cases when GDP for a country increases the welfare of its inhabitants can remain the same (or become relatively worse by comparison). “Social welfare cannot be the “sum” of all individuals’ welfare (or “utility”) because such an addition is meaningless” (Lemieux, 2006). Here Summer simply states that GDP cannot equal social welfare, this is because GDP is an average index which is a total of all services and goods sold, but welfare is referring to the people as individuals, and although we may have produced more goods and services we are not sure what has happened in comparison with the welfare of a person. If the country is producing more the supply will be trying to meet demand, this will change the equilibrium point and the price level will change (i.e. Inflation). However, if the wages of the residents do not change to make way for this rise in inflation then there welfare has decreased and they become worse off, this contradicts the statement that an increase in GDP will increase welfare of residents.
If the GDP increases then the average welfare increases, but the average does not mean everyone has gained. If the UK national wealth increases, this can be in small areas, for instance the South is a more prosperous area than the North. With this in mind we must realise that if there was a sudden increase in production in the South of England that the wealth of those who live there will increase along with GDP but the people living in the North will not be affected by this. This is because there will be no direct involvement with new increase in production, i.e. wages and new labour demands are tied to location, and although an individual may move down to the south in order to get the job, the vast majority will remain in the north, and therefore even though GDP increases it is area specific, it will discount the rest of countries population and wealth, and therefore in comparison to GDP, actual wealth will decrease although there has been no actual change.
The Lorenz Curve (Figure 2) shows the distribution of wealth as well as income. Wealth is distributed even less equally than income; therefore the curve will be even more bowed. The distribution of wealth is very important when considering the affects GDP has on welfare, when GDP is increasing. If GDP is increasing by 5% then let’s assume that wealth is also increasing by 5% too. However, this is not fairly distributed between all people, so the lower 20% of the population may only share 5% of the overall wealth. Therefore an increase of 5% would only result in the lower 20% gaining a 0.25% increase in wealth. GDP only provides an estimate as to what would happen to the residents’ welfare, not providing an accurate account of what is going on. The distribution of wealth is not considered in the GDP calculation making this method seriously flawed, this links back to the Lorenz Curve.
“NNP (Net National Product) is an even better measure of welfare because it captures the level of net income created by and available to the individuals living in a country” (Spant, 2003). Gross Domestic Product calculates the total products and services created in a country. The problem occurs because some countries have a large Foreign Investment; therefore the figures calculated in the Gross Domestic Product are an inaccurate measure of the welfare of the people living in the country, as the GDP may not reflect the residents’ income or wealth, but show the wealth of a country from contributions made by other nations. Gross measures are aimed at showing the production a country has as compared to Net figures which concentrate on the welfare of citizens. GDP does this because of the inclusion of FDI (Foreign Direct Investment), although including this shows that the output of a country is rising it does not mean to say that the welfare has increased too.
“Using GDP overestimates the real rate of economic growth” (Spant, 2003). GDP also ignores depreciation and therefore is not a reliable source of information for the UK economy (in terms of wealth, at least), because of this we have to ignore the assumption that when GDP increases so does welfare. Using a different measure would be a more accurate source if ones intentions were to find the residents’ welfare.
Green Net National Product (GNNP) is a proposed new measure that should be considered as a new measure to go alongside GDP, the advantages of using GNNP is that as well as removing depreciation is also considers what services and goods are being produced. For example if military material is being produced then this does not really increase the welfare of residents, for example, if the tanks that are being produced to fight a war outside of the country then this does not increase the welfare of the citizens, however, if instead houses are being built then this does increase the welfare of residents as this directly is improving living conditions within the country (Stiglitz, 2006). This would provide a much more accurate measure for welfare; however it would also require much more calculation as you would need to work out what services and products were providing benefit to the welfare of people.
Another difference between GDP and GNNP is that the latter takes into account the depletion of Natural Resources. Therefore in the UK when the coal mines where closed although this produced a decrease in GDP and welfare of those employed, it would have caused the GNNP either to decrease slightly or possibly rise as the side effects of mining are massive towards the environment, therefore we can argue that welfare increased, although income decreased as people were living in a healthier environment.
Human Development Index (HDI) is a collection of measures that can provide a better insight into the welfare; the index is compiled using data such as the mortality rates and birth rates, literacy levels and income using real GDP. This is more beneficial in terms of a measure of welfare as it takes into account more than just GDP; it takes in educational and health factors which heavily contribute towards the welfare of a person. This would be better than relying on just GDP alone, because at the end of the day we need to have more information that just average income. Using the Green Net National Product we see the a country has actually improved welfare standards, because the services and products included in the total to calculate GNNP only include ones that help increase the welfare and services that affect the welfare of residents, as to when we use Gross Domestic Product all we see is that the total of goods and services produced has risen for the country yet it does not specify what goods and services they were.
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Perhaps a combination of GNNP and HDI would give an even better evaluation of an economy, i.e. swapping GDP out of the Human Development Index and replacing it with Green Net National Product. This would not only then look at the Human Development factors, that are already covered in the HDI, but would also portray a more detailed income-to-welfare ratio as GNNP is a more accurate measure of a countries self investment. Using a combination of these factors would surely be the most logical choice as it will give a much better picture as to what extent human welfare is actually increasing by (Stiglitz, 2006). Therefore we can say that with an increase in Green Net National Product in the UK will increase the welfare of residents’.
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Parkin et al (2008). Economics. 7th ed. Harlow: Pearson Education Limited. 412-471.
Spant, R. (2003). Why Net Domestic Product Should Replace Gross Domestic Product as a Measure of Economic Growth. Confederation of Professional Employees (TCO). 7 (3), 40.
Stiglitz, J. (2006). Good Numbers Gone Bad. Available: //money.cnn.com/magazines/fortune/fortune_archive/2006/10/02/8387507/index.htm?postversion=2006092508. Last accessed 04 Dec 2009.