ECON1007 MACROECONOMICS

WRITTEN ESSAY

TOPIC=GROSS DOMESTIC PRODUCT

1250 WORD

(ii) define GDP, and how it is used. Be sure you explain the difference between nominal and real GDP, and aggregate and per capita GDP.

van den Bergh's paper is divided into several se

ctions. Once you have read the whole paper (at least once) select one of the following sections to complete part (iii): (5) Does GDP convey any useful information?

(iii) Select one section of the paper listed above, and undertaking your own research, discuss in more detailboth sides of the issues you have selected.

7of19 Related to this point is the belief that GDP growth is generally needed or sufcient for (close to) full employment. How- ever, the empirical evidence for this view is weak (Saget, 2000). Instead, the long run equilibrium employment rate is likely to depend on other factors than the rate of GDP growth, notably effects of search time (jobs and employees), structural mis matches between education and work, the gap between gross and net income, and the gap between income and unemploy- ment benets (e.g., Pissarides, 2000). Further, GDP growth does not necessarily reduce unemployment for several other reasons: it may involve outsourcing associated with retaining much of GDP domestically while moving jobs to elsewhere; and growth often goes along with creative destruction, i.e. disruption of old economic activities, which in turn implies (tem- porary) unemployment in specic sectors or job types. Of course, employment in combination with wages or productivity will affect the GDP, suggesting the relevance of a reverse causality (and correlation at times). GDP per capita is often interpreted to convey information about productivity. However. a correct productivity measure- ment needs to be related to the number of hours worked, which shows much variation between countries, as well as over time. GDP per hour is a more useful indicator of productivity than GDP per capita. In addition, it is evident that an increase of labour productivity cannot serve as an ultimate goal for a society. Productivity is indeed a very partial indicator from a wel- fare perspective. Another often expressed view is that GDP provides a basis for estimating tax revenues. This might then allow one to fore- cast taxes, to evaluate creditworthiness in the case of providing loans to countries (as done by the IMF and the World Bank), or to determine fair nancial contributions of member states to a federation of states (e.g., USA, EU). In this case, GDP does not function as a performance indicator but more modestly as a mode] variable.8 of course, estimates based on disaggregated information (e.g. value added per sector) will be required in order to arrive at a sufciently accurate estimate of tax revenues. In other words, for tax calculation purposes, there is no real need to aggregate national accounts into a GDP. Within environmental economics the environmental Kuznets curve (EKC) hypothesis received much attention during the 19905. It represents the idea that initially economic growth goes along with an increase in environmental pressure up to a turning point, after which GDP per capita and environmental pressure become delinked. One explanation for such a delink ing is that the environment is a luxury good: once income levels are sufciently high, voting and buying will be redirected to 'green' policies and products. Another explanation is the older idea that with a higher income more funds will be available for environmentally relevant innovations and investments. Empirical evidence for the EKC hypothesis shows, however, that it holds only for a subset of indicators. Moreover, these indicators are all partial in nature and often unrelated to long term environmental sustainability. In particular, problem shifting may occur to other countries or environmental dimensions not captured by the environmental indicator. In addition, ndings usually depend on cross-section analysis and can not be used straightforwardly to predict intertemporal patterns for single countries (de Bruyn 81 Heintz, 1999; Stern, Common, 81 Barbier, 1996). What comes out of these studies is that nearby problems relating to human health, like local water and air pollution, are solved if income rises, but that many other environmental problems are not solved or at best shifted in space (e.g., export of solid waste, incineration) or time (e.g., landlls). In general, it is therefore not true that economic growth solves environ- mental problems. This means that GDP information is not as relevant to understand the dynamics of solutions to environ mental problems as was initially believed. Third, the existing international standard for national accounts and GDP supports the uniformity of data on GDP. Many observers regard this as a strong feature of the GDP indicator, as it contributes to a clear economic comparison of countries. It should be realized. however, that international comparability is a necessary but an insufcient condition for the usefulness of any indicator.10 In conclusion, the foregoing arguments in defence of GDP are unable to alter the view that GDP represents a serious infor mation failure, as concluded in Section 3. The defences of the GDP indicator reect mistaken beliefs, irrelevant consider ations, or a focus on the role of GDP information as an intermediate variable. Moreover, all defences lack a clear interpretation in terms of overall social welfare and happiness. It is customary to point to the importance of GDP growth for developing countries. One would expect welfare growth here to show a higher correlation with GDP growth than in rich countries (especially because of the arguments related to lexico- graphic preferences in Section 2). Even so, I have been unable to nd a thorough study that supports this widely held belief. Kenny (2005, p. 10) summarizes the empirical evidence as follows: \"There has been convergence across a wide range of indi- cators of the quality of life. Given that there has not been convergence in the standard income indicator, this may suggest that income is only one among a number of factors in determining quality of life outcomes In turn, this suggests some hope that improvements can be sustained even in the absence of sustained income growth." Finally, three common defences of a different nature need to be mentioned here as well. The rst one emphasizes the role of GDP information as an input to (macro)economic models or analysis. Such a use of GDP information is not the particular aim of the criticism here, even though it is doubtful whether it is an important use. given that most empirical macroeco nomic models are actually bottom-up models rather than developed around an aggregate notion of GDP.9 The central point to notice is that the foregoing discussion was not about using GDP as an intermediate mode] variable but as a goal variable with an implicit or explicit social welfare interpretation. An example of a constructive exercise using GDP as an intermediate variable is Bird (2001 ), who shows a positive statistical relation between measures of risk and the share of social spending in GDP and concludes that the Welfare State encourages risktaking which in turn may stimulate innovative behaviour and activities. A second common type of defence is that GDP growth is just one of multiple goals of macroeconomic policy, including also stable prices, low unemployment, acceptable income distribution, etc. However. from a methodological angle it should be clear that adding indicators does not undo or compensate for the shortcomings of the GDP indicator, certainly not if the specic GDP-related goal is unconditional GDP growth. 5. Does GDP convey any useful information? Another response by economists is to state that despite the shortcomings discussed in Section 2, the GDP indicator still conveys useful information. Here I review a number of common arguments in favour of this position. Perhaps the most persistent argument is that GDP positively correlates with a number of indicators that try to capture elements of well-being or qualityof-life, such as life expectancy at birth, infant mortality, adult literacy rate. and indices of political and civil liberties (see especially Beckerman, 1976, 1999; Lomborg, 2001; Simon, 1981). Three comments are in order here. First, that such positive correlations can be observed for specic periods of time is not denied here. However, the empirical evidence from alternative aggregate welfare measures and individual happiness research (Section 2 and Appendix AA in the Appendix) indicates that the correlation ranges from close to zero to negative for many rich countries beyond a certain income level. Second, the various quality-of-life indicators mentioned represent partial rather than complete welfare evaluations. Their precise contribution to overall welfare is thus not evident. In fact, one can come up with another set of qualityof-life indicators, such as pollution, living space, serenity, direct access to nature, congestion and work stress, with which GDP per capita correlates negatively in certain income ranges. Third, correlation does not guarantee causality. Although liberty, health and literacy often will act as necessary conditions for sustained GDP growth they do not necessarily improve by continued growth beyond a certain income level. These various counter-arguments are supported by an exten- sive empirical study by Easterly (1999). It uses a panel dataset of 81 indicators covering up to four time periods (1960, 1970, 1980, and 1990) and seven areas: (1) individual rights and democracy, (2) political instability and war, (3) education. (4) health, (5) transport and communications, (6) inequality across class and gender, and (7) \"bads\". Depending on the statistical method used, it is found that income per capita has an impact on the quality of life that is signicantly positive for only 32, 10 or 6 out of 81 indicators. The author concludes that the results can be partly explained by long and variable delays be- tween growth and changes in the quality of life. and that for many quality-of-life indicators global socioeconomic progress (#growth) is more important than homecountry growth. A specic argument is that economic growth increases the national pie, making it easier to solve distributional problems or invest in \"expensive policies" (e.g., related to environment or health). But once the GDP has increased, nothing will have changed, and indeed the same argument can be endlessly used to postpone certain difcult redistribution and policy choices. A sub-argument is that the public budget will increase with income growth. This, however, raises the question whether an ever larger public budget is desirable in the rst place. If the objective is to make people happier, it is difcult to know in advance whether the public budget needs to fall. rise or remain constant as a proportion of GDP if the latter increases. A widespread belief is that GDP growth creates condence and economic stability. But the pro-cyclic effect of GDP infor- mation discussed in the Section 3 implies that stability and instability go hand in hand, as negative expectations reinforce disappointing GDP growth rates. Expectations become reality through the perceptions and information about GDP. Without GDP information, this particular, fundamental cause of instability would therefore no longer exist. Of course, other sources of economic instability would still be present