Welfare Versus GDP: What Makes People Better Off

from the International Monetary Fund

— this post authored by Geoffrey Bannister and Alexandros Mourmouras

For years, economists have worked to develop a way of measuring general well-being and comparing it across countries. The main metric has been differences in income or gross domestic product per person. But economists have long known that GDP is an imperfect measure of well-being, counting just the value of goods and services bought and sold in markets.

The challenge is to account for non-market factors such as the value of leisure, health, and home production, such as cleaning, cooking and childcare, as well as the negative byproducts of economic activity, such as pollution and inequality.

Charles Jones and Peter Klenow proposed a new index two years ago (American Economic Review, 2016) that combines data on consumption with three non-market factors – leisure, excessive inequality, and mortality – in an economically consistent way to calculate expected lifetime economic benefits across countries. In our recent working paper, Welfare vs. Income Convergence and Environmental Externalities, we updated and extended this work, attempting to include measures of environmental effects and sustainability. In this blog we look at our results from updating the new index.

Our findings clearly suggest that per capita income or GDP does capture the main component of well-being. And health – a key component of well being – is critical to raising welfare and income.

The well-being index

What emerges from Jones and Klenow’s work is a consumption-equivalent index that measures welfare derived from consumption, then adds the value of leisure (or home production) and subtracts costs related to inequality. This calculation is made for each country over one year and then multiplied by the life expectancy in each country. This gives us a measure of average expected lifetime welfare based on consumption, leisure, inequality, and life expectancy. (Click here for a further discussion of the well-being index.)