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GDP's blind spots ignore full impact of education spending

Date

Nicholas Gruen

There's plenty wrong with gross domestic product as a measure of national wellbeing. As Bobby Kennedy said, it measures everything in life except what's most important.

It measures the dollar value of all transactions in the marketplace. So if your TV is stolen and you buy another, install a burglar alarm and vote for more cops on the beat, GDP goes up at every turn. And if we dig resources out of the ground, or otherwise degrade our environment, GDP is blind to the way we are running down our natural capital but registers the dollar value of the resources we take to market.

So is there a better indicator? The Bureau of Statistics is unconvinced and, as a result, its Measures of Australia's Progress project assembles numerous indicators over social, economic and environmental domains but pointedly refuses to aggregate them into one index.

If you were building a single index of wellbeing and social wellbeing seemed to be improving while environmental wellbeing was deteriorating, how would you decide which mattered more?

Where the bureau is scrupulous about avoiding such value judgments, plenty of attempts to measure national wellbeing are content with quite superficial judgments. This is almost invariably the case with ''composite'' indices, which compile diverse indicators over broad domains and then aggregate them almost frivolously into a single indicator.

Bhutan's Gross National Happiness Index weights its nine different domains of wellbeing equally ''to avoid bias''. But that doesn't avoid bias so much as ensure it by default, rather than design. To take an example from Bhutan's index, wouldn't extreme poverty or illiteracy (domains six and eight) be a worse fate than an extremely bad work-life balance (domain two)?

The Organisation for Economic Co-operation and Development's Your Better Life Index was released with much fanfare last year but it's not much better. It identifies 11 domains. But it gives little thought to how they might be interrelated - for instance, we spend much of our income on housing, so the domains of ''housing'' and ''income'' are not independent but closely interrelated. Like Bhutan's index, all the OECD's 11 domains are weighted equally by default. Visitors to its website can dial up or down the relative significance of any domain but the feature contributes more to entertainment than enlightenment.

The final alternative - which we took to build the Herald/Age Lateral Economics Index - is to start with the national accounts and then try to adjust them for all their inadequacies. That entails herculean assumptions but at least they force one to deal with the difficulty of one's task, which is to somehow account for like and unlike things in order to weigh them all in some single measure of wellbeing.

We adjust the accounts to reflect resource depletion and the risk of global warming and changes to ''human capital'' or know-how. We also adjust wellbeing for major improvements in our health - for instance, increased life expectancy - and for difficulties that are widespread and have clear and measurable impacts on wellbeing such as increasing rates of mental illness, obesity, long-term unemployment, overwork and inequality.

And, after a year, there's a clear pay-off. Where the OECD index often does little more than echo its users' self-identified priorities, our index identifies two other major issues. Because our measure starts with national income rather than national production, terms of trade declines have figured prominently in our reporting since December last year - before they became a pundit's talking point.

But the really big news in the HALE index is the significance of human capital, or the know-how of our population, which dwarfs all other capital. And ''human capital'' has been surging, as we've been schooling the baby ''boomlet'' of the mid-2000s and increasing the size and know-how of our workforce with skilled migration and higher retention rates.

None of this will end the volatility of the business cycle. The fall in iron ore prices could easily portend trouble. But, at least for the medium-term, it's very reassuring. At a time when the national conversation briefly turned to education last week, the HALE index bids us to consider it much more than the economic pundits tend to.

If long-term unemployment surges during a recession, or the chances of avoiding severe climate change slip away, or if income distribution becomes much more unequal, the HALE index will remind us what we all know but our economic reporting sometimes forgets: that such things matter just as much to our wellbeing as dollars in our pockets.

Nicholas Gruen is chief executive of Lateral Economics.

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6 comments

  • Dr Gruen, you have a PhD in economics according to your company's website. Surely you're familiar with the broken window fallacy?

    http://en.wikipedia.org/wiki/Parable_of_the_broken_window

    Maybe I've misunderstood, but the start of your second paragraph seems to be a pretty clear instance of the reasoning. Yes, GDP will capture the economic activity you describe resulting from a theft. But nonetheless it seems to me GDP growth will almost certainly remain lower (at least over the medium term) than it otherwise would have been if the theft had never happened, since the resources allocated to a security system, more police etc could instead have been used on more desirable and productive goods and services.

    Whereas the case of degrading the environment is quite different - we are diminishing a capital stock important to our future income, just because the real economic benefits we derive from nature (and the expected value of damage we do to it) aren't easy to quantify. This is a genuine failure of GDP as a metric - in the long run we'd expect lower growth to occur as a result of lost biodiversity, reduced fresh water etc, but unlike the theft this (relative) loss probably won't show up in national accounts on the kinds of timescales that concern policymakers.

    (My apologies if the argument is fatally flawed - I don't have any formal training in economics so perhaps I've missed something....)

    Commenter
    Jordan
    Location
    Sydney
    Date and time
    September 11, 2012, 11:03AM
    • @Jordan, who writes: "But ... GDP growth will almost certainly remain lower (at least over the medium term) than it otherwise would have been if the theft had never happened, since the resources allocated to a security system, more police etc could instead have been used on more desirable and productive goods and services."

      While we can be confident that the resources allocated to increased security would otherwise be used on more desirable goods and services, we cannot assume that these resources would be used on more productive goods and services.

      For a discussion of productive investment, including the role of education I recommend UWA's Prof Tim Mazzarol's "Building a national innovation system: What can we learn from Korea?", at http://theconversation.edu.au/building-a-national-innovation-system-what-can-we-learn-from-korea-9449

      Commenter
      David_FTA
      Location
      Queensland
      Date and time
      September 11, 2012, 12:18PM
    • I had the same thoughts about the broken window argument when I saw that paragraph too. I also don't have any economics training though, so may be missing some difference which means this doesn't apply.

      Commenter
      Commenter2095
      Date and time
      September 11, 2012, 1:20PM
  • "To take an example from Bhutan's index, wouldn't extreme poverty or illiteracy (domains six and eight) be a worse fate than an extremely bad work-life balance (domain two)?"

    Having known intimately for long periods of time people that fall in the illiterate and/or extreme poverty, I don't think the answer to your question is anywhere near straightforward or obvious as you imply.

    Commenter
    Ashar
    Location
    Brisbane
    Date and time
    September 11, 2012, 11:06AM
    • Very much agree @Ashar. These arguments always remind me of the Parable of the Mexican Fihserman and Wall Street Banker, which teaches us that happiness is more than money and freedom isn't just financial.
      .

      Commenter
      Mr T
      Location
      Northcote
      Date and time
      September 11, 2012, 12:24PM
  • Mr Gruen (I assume it is not Dr), what makes your assertion that subjectively aggregating statistical data measuring dissimilar outcomes, gathered originally for dissimilar objectives, achieves any meaningful or reliable outcome?

    I could add the breeding rates of Koala Bears to your index and it would be impossible to argue it wasn't just as relevant.

    I argue that the reason that the ABS doesn't aggregate disparate data, is that IT IS DISPARATE.

    By all means hypothesise on a range of statistical data which might indicate 'progress' of a nation and even some correlation between various SEPERATE national activities. But to just subjectively aggregate it into an index, presumably weighting various activity as positive or negative, is simplistic, erroneous, subjective, misleading and outright poor economic science.

    For example, the fact that finite fossil fuel resources are being consumed at an increasing rate could be argued to be a 'positive' for the environment, as when they (eventually) run out we will be forced to move to less 'carbon intensive' or infinite sources of energy.

    The fact is you don't KNOW that digging up fossil fuels is positive or negative for the nation, although you wouldn't find many economists (or citizens) who would say it has been an economic negative for Australia in the last decade or so.

    It is clearly dependent on the time scale you use for your subjective analysis.

    Commenter
    Bemused
    Location
    Sydney
    Date and time
    September 11, 2012, 1:46PM
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