Does Material Progress Matter?

The conundrum of GDP

Risk & Progress| A hub for essays that explore risk, human progress, and your potential. My mission is to educate, inspire, and invest in concepts that promote a better future for all. Subscriptions and new essays are free and always will be. Paid subscribers gain access to the full archives.

---

The headline might read that the GDP grew 2.1 percent this quarter, but does this really matter? Few among us stop to think about what GDP is, what it actually measures, or what it means for them when it grows or shrinks. For the cynical among us, the growth of GDP represents the expansion of human greed and environmental destruction. But it turns out that GDP is a reasonably good indicator of material progress and material progress is anything but greedy or destructive.

A Brief History of GDP

Gross Domestic Product, or GDP, is a metric that was born out of a World War 2 need to determine the total productive capacity of an economy to support a war effort. The metric was never intended to be a measure of well-being for the inhabitants of that economy. Nonetheless, its cousin, GDP per capita, or the GDP divided by the total population, has become commonly used to measure well-being regardless. 

There are three ways to measure Gross Domestic Product, you can measure the total output of the economy, the total expenditures within the economy, or all of the incomes. For most of us, the measurement of total expenditure is the most familiar and understandable. This measurement roughly follows the formula below:

GDP = Consumer Spending + Investment Spending + Government Spending + (Exports-Imports)

In practice, this extremely simple calculation is fraught with fuzziness and room for error. Adding up the sales of tangible goods, for example, is relatively easy, but intangible services are notoriously difficult to calculate. This fact is salient because economies are gradually dematerializing, with an ever greater share of the productive capacity devoted to services. This makes calculations of growth increasingly difficult as economies develop and mature.

Criminal activity, such as drug sales and prostitution, alongside the shadow economy, have to be indirectly estimated by pouring over police reports and crime statistics. Meanwhile, household services, such as child-rearing by parents, are entirely ignored by statisticians. A well-known paradox, that a widower who marries his former housekeeper lowers GDP because he no longer pays her a wage, exemplifies this problem. 

Partly, this is a matter of convenience because there is no agreement about how to measure the value of those services. Nevertheless, the OECD estimates unpaid and uncounted household services account for an average of 15 percent of GDP, meaning that our economies are probably under-sized in economic reporting.

Even something as simple as export and import totals can be misleading; trade statistics do not delve into intermediate stages. For example, goods shipped from China to the US are counted toward the US trade deficit, but since many of those products contain American-made components that were first shipped to China, the data vastly overstates the trade deficit. This is just another reason that worrying about trade deficits is a fool’s errand.

GDP also fails to fully capture quality and technological improvements of goods and services over time. Televisions, for example, have trended larger, lighter, more energy efficient, and thinner, with improvements to color and resolution. The value of these improvements will not show up in GDP statistics.

Nor do statisticians capture the value of that which is free. The free access to information on Wikipedia or the cornucopia of websites, apps, videos, and music made by creators online, certainly has value but does not factor into GDP.

The Easterlin Paradox

Given the difficulty of calculation, it begs the question of whether or not GDP is a reliable indicator of growth at all, or whether it matters. One question researchers have asked is, does GDP growth lead to improvement in subjective well-being? For decades it was thought that there was no link between a society’s economic development and its level of happiness or contentment. 

This belief arose from research conducted by Richard Easterlin. Easterlin used survey data from people in various countries that asked them questions about subjective well-being. He found that at a specific point in time, general happiness varies with income between and within countries, but over time happiness does not trend upward as incomes rise. 

That is, he found that while higher-income individuals are typically happier than lower-income individuals, higher incomes don't produce greater happiness over time. This contradiction became known as the Easterlin Paradox, or the contradiction between the point-of-time and time-series findings in the research. Obviously, this outcome does not make intuitive sense.

In an attempt to explain this contradiction, other researchers suggested that beyond a certain level of GDP per capita, enough to satisfy the basic material needs of clothing, housing, and food, further growth did not lead to improvements in well-being. Instead, beyond this level of wealth, respondents looked past their absolute income and instead toward their relative income when answering surveys about life satisfaction.

This conclusion, of course, has profound implications. If rising incomes do not raise subjective well-being, there may be no point and purpose in growing the economy at all. Indeed, this idea has become ingrained in the public psyche. Many today believe past a basic level of material satisfaction, continued growth only serves to feed the greed of the super-wealthy…the only people who would benefit alongside yawning wealth inequality.

But all theories attempting to explain the paradox fell short. New research, conducted by Betsey Stevenson and Justin Wolfers, takes advantage of a wider breadth and depth of data than was available to Easterlin. They conclude that, at least in most countries, there is no paradox at all; the relationship between material progress and well-being is actually quite robust.

Stevenson and Wolfers compared respondents’ answers to questions of subjective well-being to the log of GDP per capita using data from some 131 countries. They found a positive correlation that exceeded 0.8. They also found no evidence of a satiation point beyond a certain level of GDP per capita needed to satisfy basic material needs.

Their research also revealed errors in survey questions used in prior studies. For example, while surveys from Japan initially appeared to confirm the Easterlin Paradox, Stevenson and Wolfers found that survey response categories were changed multiple times in the 1960s, distorting the results. When they accounted for that change, life satisfaction rose sharply in the 1950s and 1960s, then more slowly in the 1970s and 1980s, before beginning to fall in the 1990s, roughly mirroring the performance of the Japanese economy.

The key takeaway is that economic growth, as measured in GDP per capita, does generally lead to improved subjective well-being and there is no obvious satiation point; economic growth may matter after all.

HDI: An Alternative

But why limit ourselves to one metric? Some thinkers, such as Amartya Sen, believe that we ought to measure growth and human progress using a “capabilities approach,” which emphasizes the ends (a decent standard of living) over the means (GDP per capita).

Under this framework, poverty is not merely the deprivation of financial resources but rather the deprivation of the capability to live a good life. “Growth” therefore, is understood to be the expansion of the opportunities and capabilities available to individuals. For example, while a person who is fasting has the same nutritional state as one who is starving, we would not treat them identically disadvantaged; the latter has no capability to eat, as opposed to the former.

In response to this thinking, the UN developed an alternative measure of growth known as the Human Development Index, or HDI. The HDI compiles a number of proxies for human capabilities, including life expectancy, school enrollment, literacy, and yes, a variant of GDP per capita. This, it is argued, better accounts for actual human progress than a rough measure of gross economic production.

HDI tracks GDP per capita rather well, a fact that shouldn’t be surprising because GDP forms a component of the index. But what happens when we remove GDP from the index entirely and focus solely on its non-monetary components? To the surprise of many, HDI performance doesn’t change much at all; GDP per capita and HDI are still robustly correlated. Thus, for all of its shortcomings, GDP is a reasonably good indicator of human progress and prosperity.

This is likely because of a positive feedback loop between capability and material growth. Material growth begets greater capability and opportunity, which is seized by individuals who beget additional growth, and so on.

Implications for Progress

For all of its fuzziness in measurement, GDP remains the best metric of material progress that is currently available to us. Other measures, like HDI, that attempt to provide a more holistic view of human progress, closely track GDP anyway. Furthermore, subjective measures of human fulfillment and life satisfaction, also appear to be strongly correlated with material economic performance. 

As Diane Coyle wrote in her book, GDP: A Brief but Affectionate History:

To be poor is to have little choice available, and the increase in possibility is the most important aspect of escaping from poverty. On this view, economic development is a combination of increasing individual capacities…and increasing range of opportunities…Economic development is an increase in freedom.

This all means that contrary to the media and the popular social narrative, economic growth is not merely a shallow measure of material greed, but a key, if imperfect, performance indicator for society, progress, and human well-being.  In retrospect, the conclusion should have been obvious. Material progress enables more of us to live to our full potential.

---

You May Also Like…

Between Utopia and Dystopia

What is Progress?