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Searching for the right substitute to GDP

Posted on 04-Dec-2009

When the G20 summit in Pittsburgh ended two months ago, the leaders’ statement focused on the need “to adopt a set of policies, regulations and reforms to meet the needs of the 21st century global economy”. In addition, it made a case for achieving “strong, sustainable and balanced growth”. But before we even set some objectives on growth, shouldn’t we redefine what growth is?

In economics, growth is usually referring to GDP growth. GDP is “The sum of the final uses of goods and services (all uses except intermediate consumption) measured in purchasers' prices, less the value of imports of goods and services” ( OECD Glossary). Does it mean that sustainable growth of goods and services produced leads to sustainability? Is a balanced GDP growth a good guarantee for a balanced growth between developed and emerging countries?

One week before Pittsburgh summit, a commission of specialists chaired by economists Joseph Stiglitz, Amartya Sen and Jean-Paul Fitoussi delivered a report on economic indicators and social progress ordered by French government. They pointed out the discrepancies of GDP as the unique measure of wealth and development. In an interview to a French newspaper, Stiglitz even urged the political leaders to end the “GDP fetishism”.

While GDP fetishism relates to the extensive use of the measurement rather than the measurement itself, the report points out also many of its flaws : unpaid work like raising children are not included in the calculations, while traffic jam, by increasing fuel consumption, and forest fire, with rebuilding costs, are. Qualitative improvements of the environment, or external benefits, of activities like national parks enhancement are totally dismissed. The biodiversity preservation, the part in water filtering process and the energy boost of a get-away in nature are among them. On the other side, the negative impacts, or external cost, of the wood industry for example can be underestimated.

The panel made some concrete suggestions, such as using NDP* rather than GDP or even household consumption rather than national consumption to reduce the gap between economic indicators and the household’s perception of reality. They also put forward the idea of considering social benefits provided by some countries: health care, education, sports facilities, cultural facilities, affordable housing. Therefore the income are more comparable : the adjusted disposable household Income including housework and leisure was 87 in France compared to 100 in the U.S. in 2005, while the unadjusted disposable income not including housework and leisure was only 66 to 100 for the same year. Likewise, the repartition of household income is more representative than the mean of household income.
Providing these recommendations are followed, it will have a great impact and not only on GDP measurement and the way national economies are competing one to another. It will change the way the market is moving on news. GDP is everywhere in portfolio theory : it is a major factor in asset’s valuation models (along with CPI, P/E ratio, etc…) (GDP Growth as Risk Factor in Equity Returns), it is used to gain a perspective on a firm’s performance under different economic conditions, it explains the demand for each country’s money, hence the exchange rates and it allows to select the best investment opportunities between several countries.

With sustainability, economic and social well-being weighting more in the models, countries and companies with awareness on those issues may gain a competitive advantage on the others. Actually, they already have one : Interface, Inc. (NASDAQ: IFSIA) claims to be « the world’s largest manufacturer of modular carpet” and to have “long term commitment to sustainability”. From 1995 to 2007 the company saved $372 millions with its environmental-impact reduction action (Sustainability in action).

Rather than a posteriori assessing the positive financial consequences for the economy of such initiatives, shouldn’t we consider a systematic quantitative monitoring of sustainability, individual well-being and social welfare so that the market take them into consideration as key factors in assets valuation and explanatory factors for price movements ?

* Net domestic product (NDP) is obtained by deducting the consumption of fixed capital from gross domestic product. Contrary to GDP, it accounts for the fact that while goods are being produced, some resources are used.