Weaning the World from Its GDP Fetish
Annual meeting season is upon us for the world’s leading multinational financial institutions, The World Bank and International Monetary Fund (IMF). While their annual forecasts and quarterly updates remain vital indicators of the health of the world economy, they share a glaring, possibly even fatal flaw: an overreliance on Gross Domestic Product (GDP) growth as the primary measure of success.
The problems posed by over-relying on GDP have been known from the start. Indeed, Simon Kuznets, the US economist who conceived what was called Gross National Product during the Great Depression, warned that “the welfare of a nation can scarcely be inferred from a measure of national income.”
To be fair, the IMF and World Bank have not entirely ignored the issue. World Bank member states often object to the growth-centric focus and policy prescriptions GDP forces upon them, often to the detriment of their populations (and the enrichment of corrupt elites). In response to these sentiments, the IMF’s Finance and Development blog posted a provocative piece this March from University of Manchester economist Diane Coyle. The post called for GDP to be abandoned in favor of a new metric that takes factors such as inequality, human capital, and environmental resilience into account.
“This is a vitally important debate, given the widespread belief that—as calculated by GDP—recent economic progress has not measured up,” Coyle wrote. ”[S]o the erosion of GDP’s status as a reasonable measure of economic welfare is a serious matter indeed.” But she also gets bogged down in the debate over whether it is better to approximate human progress with a single number – the one undeniable advantage of decades of GDP calculations – or to capture a more holistic picture through an index covering a broad set of factors.
For me, the answer must lie somewhere in-between. A small set of primary measures that are not merely invisible components of sprawling mega-index, but rather form a dashboard of the most fundamental, root drivers of prosperity. When these ‘primary measures’ look strong, other benefits tend to follow. For example, more inclusive democracies tend to have higher voter participation, pursue stronger antitrust actions, and wage less war. Therefore, ‘the percentage of voters required by a ruler to gain power’ would be a ‘primary measure’ of an inclusive democracy, while higher voter participation and greater equality would be correlated outcomes that contribute to prosperity.
Over the past several decades, in my work for corporates, governments, and many forms of investors, I have witnessed successful, far-sighted strategies to develop prosperous economies. Whether it is Singapore, the Boston-Cambridge metro, or Greater Manchester in the UK, I have found that the stars at generating prosperity score high in the following key measures:
- Inclusive Democracy – Not all democracies are equal measured by the percentage of the electorate required to gain power. In Nordic countries, the figure is typically about 40%; that compares with only 25% in the UK. Inequality correlates directly with this metric.
- Efficient, High-quality Public Services – Regions that provide a high-quality basket of basic services at a competitive per capita cost, reap a very high return. Education, health, childcare, affordable housing, low-cost clean energy enables workforce participation by a broader segment of society, which, in turn, drives a virtuous circle of economic mobility, lower costs from the negative impact of crime, and a broader tax base to further improve services.
- Robust Balance Sheet – Star nations nurture public assets, while keeping public and private debt under control, and thereby preventing asset bubbles. Public assets such as land, real estate, infrastructure, and state-owned companies often present excellent opportunities for value creation through professionalized asset management or privatization. Sustained investment and commercial operation of these assets is rewarded with higher revenues streams which governments can re-invest to generate further prosperity.
- Innovation, Connectivity, Entrepreneurship (ICE) – The ICE triumvirate is the cornerstone of productivity growth. Innovation, measured by the growth in well-paid jobs in innovation sectors that enhance prosperity, such as digital technology or clean energy, is the only true defense against the threat to jobs from automation or lower-cost workforces. Crucibles of innovation are fueled by access to global flows of goods, services, talent capital, and knowledge as measured by the McKinsey Connectedness Index. And a supportive environment for entrepreneurship, as measured by the Global Entrepreneurship Development Index (GEDI), is essential for generating the new businesses as well as attracting large corporates that cannot afford to be left behind.
- Environment and Sustainability – This measure focuses on the reduction of waste and the displacement of carbon dioxide emissions, through the implementation of emerging clean technologies and new business models.
- Stability and Security – Macroeconomic and financial sector stability; low risk of social and political upheaval; and strong security and emergency readiness make for safe havens that attract long-termism from top talent, investors and corporates alike.
To be sure, aspects of these views exist in the annual reports of the IMF and World Bank, as well as some of the world’s leading investment banks, economic advisory firms, think tanks, and academic institutions. But none has created a compact set of metrics, validated by diligent back-testing, that reliably measures prosperity growth and provide a framework for prioritizing policy actions. This approach – or one modeled upon it – is certainly within reach.
The lifetime achievement award to be presented to Dr. Kuznets at the next Nobel ceremony, a fitting complement to his Nobel Economics honors in 1971, is a greatly deserved accolade for the founder of GDP – a seminal, necessary metric that helped pull the world from the chaos of the mid-20th Century. However, it is long time for GDP to be retired, and for a modern model for measuring prosperity to take the stage.