New Economic Measurement: A Value-Based Approach

COVID-19 placed the Australian economy into recession for the first time in nearly three decades. Despite the headlines of a devastated economy and, more recently, the speed of the economy’s ‘rebound’ following the Nation’s ‘reopening’, little thought is given to what actually constitutes a recession.

Success can be all manner of things. In the context of this article, I will outline how economic measurement can be adjusted to deliver improved social, environmental and economic outcomes. While perfect measurement is unachievable, as we must trade off the costs of collecting and analysing more data with the benefit of improved data, drastic improvements can and should be made.

Since the 1930s, economic growth and societal wellbeing have been largely measured through a single metric, gross domestic product or GDP. The goal of GDP is quite straightforward, it is simply an estimate of the value of goods and services produced within an economy over a specific period of time. While GDP is exceptionally good as a compilation of certain material factors, it has little regard for quality. Production, irrespective of the environmental and social cost, is viewed favourably while unpaid and volunteer activities are overlooked entirely. Many service activities connected to a modern digital economy are omitted from national accounts whilst rising levels of inequality, both spatially and between households, are ignored. Concurrently, low interest rates have fuelled rapid asset price inflation in equity and property. This feeds into higher imputed rents, suggesting that we are better off despite increasing wealth inequality and cost of living. On the other hand, productivity, a key determinant of living standards, has flatlined in most of the developed world.

Although the term GDP frequents the media and political speeches, the manner in which it is calculated is both imprecise and subject to a multitude of choices. GDP can be estimated using three approaches that examine either production, income or expenditure. Technically speaking, each approach should result in the same answer but in practice the adoption of asymmetric assumptions results in disparities.

Before even going into the shortcomings of GDP, the fact that we emphasise an aggregate, as opposed to a per capita, measure is egregious. This enables GDP and economic growth to be positive alongside declines in average living standards. Australia averted technical economic recession for nearly three decades despite experiencing falls in per capita GDP since around 2010.  

The emphasis on aggregate GDP is largely due to the fact that GDP can only be lifted by growing the size of the economy, either by:

(i) Having more people (notably by shifting previously unpaid groups of individuals such as women into paid employment or promoting in-migration) or;

(ii) Raising the productivity of existing workers.

Of these two techniques, option one is far easier. Interestingly enough, Australia’s record low unemployment rate and rising wage growth in the first half of 2022 is largely the result of reduced in migration during the COVID-19 pandemic!

Although GDP provides a useful benchmark, its emphasis on consumption results in a measure that rewards higher prices. This creates a perverse situation where a government that ends up paying a premium, as a result of flooding the market with infrastructure projects, lifts GDP more than a government which managed to build the same infrastructure for a lower price by better managing demand. The New South Wales Government has recently suffered from infrastructure cost escalation amidst a hot market. Another excellent example lies in healthcare spending. According to data from the World Bank (2017), for a comparable level of healthcare, the United States spends 17 percent of its GDP on healthcare compared to just over 9 percent in the United Kingdom and Australia. This suggests that people in the United States are better off because the nation has a more inefficient healthcare system! Furthermore, rapid house price growth that has generated ridiculously high price to income ratios in cities such as New York, San Francisco, London, Hong Kong and Sydney, are to be encouraged due to their positive impact on a nation’s GDP! As of March 2022, Australia’s property increased in value to nearly $10 trillion, up $2 trillion in a single year (Cary, 2022).

Concern with GDP in isolation is problematic. We need to ask ourselves whether a policy focus on maximising GDP is really making us better off. Since the 1990s, Japan has often been branded an economic backwater despite the nation’s low unemployment, rising standards of living, strong industrial and research base, low crime rates and high life expectancy. Was the nation really better off in the heights of an asset bubble when the Imperial Palace in Tokyo was worth more than the entire state of California? On the other hand, Australia’s multi-decade streak of GDP growth has been applauded despite the nation’s growing levels of inequality, weak industrial base, unaffordable housing and slow productivity growth.

There is an old adage that ‘what gets measured gets done’; this makes it critically important that our measurement and performance incentive structures are designed to guide decisions towards those that benefit society. Before diving into any proposals for how this might be achieved, it is important to note that making adjustments to measures of economic success are likely to entail unintended consequences. What may sound intuitive or fair does not necessarily result in desirable outcomes. For example, measuring unpaid housework would likely have a larger impact on poorer households, thereby leading to a perceived fall in inequality!

Essentially, GDP’s failure to measure quality is the root cause behind the disconnect between higher spending/growth and improved economic outcomes. Going forward, economic growth must be underpinned by an emphasis on value, not expenditure. Measures of success must look at social mobility, inequality, educational attainment, life expectancy, environmental sustainability, commute times, housing affordability, work-life balance, unemployment and employment quality. Though these measures only scratch the surface and are themselves subject to significant shortcomings, they illustrate the requirement for a syndicate of measures to be employed when assessing economic success.

An enhanced framework for economic measurement must be less concerned about an economy’s size/growth and more interested in the quality of life enjoyed by its citizens. This is vital if we are to escape a system which generates aggregate measures that have little bearing on lived experience.

Moving towards a holistic set of measures that emphasise ‘value’ and ‘wellbeing’ will unlock government spending for policies that improve societal outcomes (such as protecting the environment), reduce the incentive for firms to conduct business in a manner that deteriorates standards of living (environmental destruction, unethical practices), and enable superior responses to major shocks such as the COVID-19 pandemic which are not about falls in headline GDP and ‘recession’ but about their impact on people’s livelihoods.

On a final point, the implementation of a revised economic measurement framework does not negate the importance of maintaining a balanced budget over the long-term. We cannot always maximise outcomes to the desired extent, what a syndicated measurement model achieves is the delivery of greater spending efficiency or value that reduces economic wastage. Knowing what we want to measure, as opposed to following a system which promotes activities that undermine societal welfare, such as higher expenditures resulting from inefficiency, inflated asset prices and pollution, is an enormous step in the right direction.

Economics is not a natural phenomenon. Economics is about people. What we measure and the policies we enact must reflect this mentality. Without change, we risk stimulus being directed towards policies that exacerbate inequalities by lifting components of GDP that have little, or even a negative, influence on the nation’s standard of living.

References

Cary, R. (2022). Australia’s housing market is now worth almost $10trillion with more growth on the way. Retrieved from: https://www.smartline.com.au/mortgage-news/australian-property-market/australias-housing-market-is-now-worth-almost-10-trillion/

World Bank. (2017). Current health expenditures (% of GDP). Retrieved from: https://data.worldbank.org/indicator/SH.XPD.CHEX.GD.ZS?end=2019&most_recent_year_desc=false&start=2019&view=bar