We Should Amend, not Discard, National Income Accounts-Becker

The justification economists give for concepts of national income, such as Gross Domestic Product (GDP) and Net Domestic Product (NDP), is that the price of a good measures both the utility households gain from consuming that good, and under competition price also measures the cost to sellers of producing the good. This interpretation of the value of goods sold in terms of both utility and production costs helps justify not only concepts like GDP, but also helps link consumer price indexes to the cost of producing a given level of utility to the average consumer, and also ties producer price indexes to the cost of producing given amounts of output.

A tremendous achievement of the 1930s was the construction of early measures of GDP and NDP by pioneers in national income accounting, like the Nobel-winning economists Simon Kuznets and Richard Stone. They recognized from the outset that their national income accounts only very imperfectly measure what is produced each year, let alone consumer utility. Despite these limitations- I discuss in detail a couple of these shortly- these national income accounts have proved very useful in quantifying changes over time in the real value of what is produced in numerous nations and regions of the world. They have also provided useful measures of changes in the degree of inflation at different time periods.

For example, measured real GDP shows clearly that the worldwide Great Depression of the 1930s was far more severe in its effect on production and incomes than the world recession of the last couple of years. The growth in real GDP during the third quarter of 2009 strongly suggests that this recession ended during that quarter. Data on the growth of GDP per capita also clearly indicate that China and other rapidly developing countries during the past couple of decades significantly reduced the gap between their own standard of living and that of the wealthy Western countries, although cross country comparisons of real GDP typically make additional price adjustments to national income accounts  for differences in purchasing power.

Similarly, indexes of changes in consumer and producer prices unambiguously show that the middle and end of the 1970s were periods of substantial inflation in the United States and Europe, that Japan had significant deflation during the 1990s, and that many countries experienced mild deflation in prices during the recent recession.

So despite their various limitations, measures of aggregate changes in real output and prices, and other concepts related to the national income accounts, have been valuable tools for policy-makers, economists, and others. Although the United Nations Human Development Index (HDI), which tries to rank countries by their level of “human development”, has the virtue of incorporating improvements in life expectancy-I return to this subject later- in all other dimensions it is far inferior to national income accounts. In constructing the HDI for different countries, this index gives equal weight to measures of their life expectancy, education level, and GDP. Since education is an important source of improvements in life expectancy and GDP, the HDI involves serious double counting by including education as an independent variable on an equal footing with these other variables. Moreover, even aside from the double-counting problem, the 1/3 weight attached to life expectancy, education, and GDP are completely arbitrary, and not based on any analysis of either consumer utility or costs of production.

Although national income accounts are far more useful than the HDI and other suggested alternatives, these accounts have serious omissions and other limitations.  Posner discusses many of these, so to avoid too much duplication I will concentrate on only two. GDP and other output measures do not include work in the household (neither does the HDI), such as time spent on child rearing, preparing meals, and other valuable household activities. These activities have traditionally occupied much more of the time of women than men, so that GDP and related measures of output exclude very important production mainly by women.

New national time use surveys for the United States and other countries allow this omission to be corrected, at least to some extent.  Time use surveys give the amount of time spent on child rearing and other forms of work in different households, and also the time spent on leisure. Other data sets provide evidence on the hourly earnings of women and men in different households when they are working in the labor force. By multiplying the time spent at household work, and perhaps also the time spent on leisure, by measures of their actual or potential hourly earnings, one can derive an estimate of the cost of household time that is conceptually similar to measures of the cost of producing market work.

Such measures of total output or income adjusted for household time would be imperfect, but they would be superior to income measures like GDP that exclude the value of household work. For example, when increases in economic development and education raise the time married women spend in the labor force mainly by reducing the time they spend working at home, national income accounts exaggerate the increase in total output by failing to subtract reductions in output produced at home.

National income accounts do not incorporate improvements in life expectancy, which is a major limitation because of the magnificent advances in health and declines in mortality during the past 100 years throughout the world. The HDI has the virtue of incorporating life expectancy into its measure of human development. However, this index ignores modern economic research that provides a method to use consumer and producer behavior to combine changes in national income with changes in various types of mortality risk into a single index of what is called “full” income. This method calculates the "statistical value of life", which measures how much individuals are willing to pay for various reductions in mortality rates (see the fuller discussion in my post on Dec.15, 2007).

The concept of “full” income combines changes over time in GDP with estimates of the value placed on reductions over time in mortality risks (or increases in mortality, as in some African countries in recent years due to the Aids epidemic). Such full income measures combine changes in life expectancy and in ordinary income not in an arbitrary way, but by extending the willingness to pay concept used in national income accounting to valuations of changes in life expectancy.

A common finding is that the usual measures of per capita incomes grew only a little more rapidly during the decades 1960-2000 in poor and less developed countries than in richer countries, even after accounting for the rapid growth in the world’s two most populated countries, China and India. That finding on changes in world inequality is greatly altered when comparisons are made not of GDP per capita but of full income per capita. Phillipson, Soares, and I construct such measures of full income for about 100 countries for these decades (see our "The Quantity and Quality of Life and the Evolution of World Inequality" The American Economic Review, March 2005). Since mortality declined more rapidly in poorer countries than richer ones, adding the value placed on declines in mortality to measure changes in full incomes have a much greater effect on adjustments for poorer countries than for richer countries. The result is that the growth rate in full incomes are generally much more rapid in poorer countries than in richer ones, which implies that inequality in full incomes per capita declined greatly across nations during the past several decades, even though inequality among countries in GDP per capita did not change much.

 

Despite all the limitations of national income accounts, they are still the best available way to measure changes over time in the amount of production in an economy, and even for comparisons of real output per capita among different countries. Nevertheless, these accounts can be made even better by including the value of time spent at home, and the value of improvements in life expectancy. A demonstration that such changes in national income accounting are feasible would encourage serious efforts at including some of the other improvements in national income accounts discussed by Posner and others.

 

 

Comments

[Ted H]

I agree with most of your points besides your criticism of the HDI. The number in and of itself is meaningless, it really functions as a comparative and a yearly change metric so the arbitrary coefficients and the double counting would be irrelevant to the metrics usefulness.

Personally, I think the HDI metric is stupid because I see no reason to attempt to combine them. Just give me the adult literacy rate. Give me the life expectancy. I can figure out for myself how a country is doing. I don't even believe we need some grand figure to tell me the state of a country, nor do I believe it's even possible.

I think most metrics that try to combine things that are unrelated are worthless since it doesn't tell me anything at all. GDP tells me something, what does a number that incorporates GDP and literacy or another seemingly unrelated factor tell me? It tells me nothing.

[Bernard D.]

Prof. Becker,

Today we often hear about the U.S. that "we don't make things anymore." If possible, would you post on the subject of the U.S. as a services-based economy, and the decline in U.S. manufacturing (at least in terms of manufacturing jobs)? I'm curious to get your thoughts on our position in the global marketplace in the future. Can we maintain our standard of living without a strong manufacturing base, or am I wrong in thinking that we don't have a strong manufacturing base anymore?

[Rok Spruk]

Professor Becker,

I agree with you on the criticism of HDI as a measure of economic welfare. In fact, HDI is based on significant analytical flaws among which is its failure to capture the measurement of endogenous features that affect its main variables (life expectancy etc.). In addition, HDI is not based on sound econometric analysis but rather on particular aggregation of constructed variables.

Even though changes in life expectancy can indicate a positive improvement in terms of economic well-being, there is still a lack of appropriate empirical methods to evaluate the real economic impact of life expectancy on economic output over time. I'm particularly critical to HDI's weight on education.

There are many countries in the world where education participation on primary, secondary and tertiary level is rather high. However, when measuring the impact of education level on income per capita growth, the results can be against the anticipated theoretical expectations.

That's why I believe the education variable should be drastically reconstructed. Why? For example, the performance of U.S secondary school pupils relative to the OECD countries is rather dismal. However, each year the U.S universities produce a lot of genius-minded graduates in science, engineering, law, economics etc. The impact of these graduates on valuable output in private and public sector is highly endogenous and there is a notable statistical fallacy in judging its impact on labor market. I was rather surprised when I saw France placed high on HDI rank, especially in terms of education - when annually French students and enterpreneurs immigrate to countries such as Switzerland, Canada and the U.S due to high tax rates and onerous regulatory burden that impairs innovation.

In fact, innovation in econometric modelling and statistical evaluation of particular variables regarding the effect on output and employment, alongside the improvement in measuring the real income per capita - is the major challenge that can hopefully improve the measurement of standard of living. Thus, national income accounts should definitely not be discarded. But of course, there is an opportunity to foster the measurement of national income accounts in a more comprehensive way for further theoretical and empirical purposes.

[Thomas Esmond Knox]

I have not seen any acknowledgement of Richard Stone. Do you understand his achievement? He was an accountant.

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Such measures of total output or income adjusted for household time would be imperfect, but they would be superior to income measures like GDP that exclude the value of household work.

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I have not seen any acknowledgement of Richard Stone. Do you understand his achievement? He was an accountant.

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I think the HDI metric is stupid because I see no reason to attempt to combine them. Just give me the adult literacy rate. Give me the life expectancy. I can figure out for myself how a country is doing. I don't even believe we need some grand figure to tell me the state of a country, nor do I believe it's even possible.

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I'm curious to get your thoughts on our position in the global marketplace in the future. Can we maintain our standard of living without a strong manufacturing base, or am I wrong in thinking that we don't have a strong manufacturing base anymore?

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I have not seen any acknowledgement of Richard Stone either.

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Does household work not reflected in the GDP solely refer to stay-at-home parents?

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It's a good idea not to discard the National Income Accounts. Should just amend it.

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