This has become popular with a lot of governments worldwide especially in the UK and USA. Late last year I attended a conference at the University of Waikato and Professor Les Oxley took a session entitled
“Is GDP an appropriate measure of wellbeing?
….. and is anything else better?”
Traditionally we have used Gross Domestic Product as it measures:
- The total value of final goods and services produced in the economy
- The total of incomes earned in producing that output
The final purchases by households, business, and government by summing consumption, investment, government spending, and net exports
Historically origins of GDP
In the 1930′s, in response to the information gap revealed by the Great Depression, Simon Kuznets developed a set of national income accounts.
In the 1940′s, World War II planning needs were the impetus for the development of product or expenditure estimates (gross national product); by the mid-1940′s, the accounts had evolved into a consolidated set of income and product accounts, providing an integrated birds-eye view of the economy.
In the late 1950′s and early 1960′s, interest in stimulating economic growth and in the sources of growth led to the development of official input-output tables· In the late 1960′s and 1970′s, accelerating inflation prompted the development of improved measures of prices and inflation- adjusted output.
However there are negatives to GDP as a measurement which was outlined by President Kennedy in 1968.
“The Gross National Product counts special locks for our doors and the jails for those who break them … the destruction of the redwood and the loss of our natural wonder in chaotic sprawl … Yet (it) does not allow for the health of our children, the quality of their education, or the joy of their play … the beauty of our poetry or the strength of our marriages … it measures everything, in short, except that which makes life worthwhile.” President Kennedy 1968
Les Oxley produced a comparison of wellbeing between the USA and France – Are GDP and other measures highly correlated?
* GDP was not designed to measure wellbeing, especially at the individual level
* We continue to use it because we can measure it quite easily and use it for comparisons over time and space
* BUT it can mislead and potentially lead to mismanagement
* There are alternatives to complement GDP
* The complements are not freaky or the realm of weirdos in and out of economics – they are becoming more mainstream and the problems of using GDP for purposes for which it was not intended are becoming public
* Some of the best minds are trying to shift us away from SOLE use of GDP as an INDIRECT measure of wellbeing
I am off to the beach again for a few days – back again on 19th January.
Here is a very good TED talk from Shlomo Benartzi. It’s easy to imagine saving money next week, but how about right now? Generally, we want to spend it. Economist Shlomo Benartzi says this is one of the biggest obstacles to saving enough for retirement, and asks: How do we turn this behavioural challenge into a behavioural solution?
Shlomo Benartzi uses behavioural economics to study how and why we plan well for the future (or fail to), and uses that to develop new programs to encourage saving for retirement.
An article in the recent Eco@Otago publication, from the University of Otago in New Zealand, showed how the changing properties of a product which are unrelated to its natural characteristics can affect people’s satisfaction.
Beer with vinegar in it
Dan Ariely (of “Predictably Irrational” fame) and others carried out research in 2006 where they offered patrons at a bar two types of beer:
1. A common brew
2. A common brew with a few drops of balsamic vinegar.
They divided the testers into 3 groups:
1. They had no information about the beers’ ingredients – “blind”
2. They were told which beer had vinegar in it before tasting both – “before”
3. They were told which beer had vinegar in it after tasting both – “after”
If knowing about the vinegar has no impact on preference then the outcome of tastes tests should be the same across all groups. If knowledge about vinegar influences tastes then the results from the blind group should differ between the “before” and “after” groups. The study showed that revealing the vinegar in the brew did affect the satisfaction only if the tasters were told “before” they tried the beer. Therefore, expectations changed the satisfaction that tasters received from their drinks.
Coke or Pepsi?
A similar experiment explored the cultural influences on satisfaction. It involved a taste test with Coke and Pepsi, two similar products but each have their own cult following. This study conducted ‘functional magnetic resonance imaging’ (fMRI) while participants were tasting to identify the effect consumption of each drink had on brain function.
Participants revealed which drink they perferred and were then subject to either blind taste tests OR taste tests with information about which cola they consumed. Consumers who preferred Coke experienced greater brain activity in the prefrontal cortex, hippocampus and midbrain when they were drinking it – versus when tehy did not know it was the brand they tasted. Therefore knowledge of brand can actually produce a physical response during consumption.
Does a higher price = more satisfaction?
A similar experiment showed how economic decision-making is affected by price and satisfaction. In this study participants performed blind taste tests with fMRI scanning for 5 different types of wine. They also conducted taste tests after revealing the prices of the wines to the participants to see if their preferences depended on cost. There were two innovative elements of this study:
1. There were actually only 3 wines – two of the wines were re-administered to the participants but were assigned different prices before doing so.
2. The fMRI focused on the area of the brain believed responsible for satisfaction – the medial orbitofrontal cortex (mOFC).
Taste tests revealed that subjects exhibited more activity in the mOFC when they tasted highly-priced wine versus the same wine with a lower price tag. Therefore more expensive wines regardless of their composition led to the following:
Expected higher quality wine = higher price = physically generated enhanced experience.
Purchasing decisions are more complex than traditional textbooks describe and what goods are perceived to be has a significant influence.
Patrick Foley, Chief Economist at Lloyds Banking Group, recently wrote in The Daily Telegraph (UK) that the Olympic Games in London will boost the UK economy by £16.5bn. He sees construction, tourism, jobs and the ‘happiness’ effect will leave a lasting legacy.
The development of a neglected area of East London will have a huge impact with higher living standards and business opportunities. There are also huge tourism benefits that follow from the end of the games and this has been prevalent with most host cities in the past. The Games could create and support a total of 354,000 years of employment across the UK. Jobs that are directly associated with the Games themselves and through developing skills of the working population that help raise their prospects of jobs in the future.
There is also the ‘happiness effect’ with hosting one of the biggest sporting events which is likely to inspire consumer spending. A number of economists have looked at the economic impact of hosting significant sporting events and are in broad agreement that aggregate demand does increase. In 1996 when England hosted the European Football Championship it was estimated that the feel-good factor was equivalent to £165 gift for each of the UK population – it can be expected the London Olympics will be significantly higher than this figure.
The Financial Times has produced a series of three interactive 3D infographics covering business, economic and technological topics demonstrating the global breadth and expertise of the Financial Times. What is unique about these is that they are displayed in the Vanderbilt Hall in New York’s Grand Central Station so commuters can catch a glimpse of them on their way to catch that train. It is brilliantly done by David McCandless. If you heading to New York soon you must go to Grand Central and see for yourself. You can view the 3 presentations at FT Graphic World. They are on the following topics :
Recession & Recovery – see below.
Over the last two months the price of oil has gone up US$30 dollars a barrel and currently stands at US$110 . In the US there is the concern that the periods of stagflation evident in the oil crisis years of 1973 (oil prices up 400%) and 1979 (oil prices up 200%) are back to haunt the economy. James Surowiecki in The New Yorker mentioned that the recent increase in oil prices shouldn’t really have a significant impact on the economy for the following reasons:
* In the US petrol is a relatively small percentage of household spending.
* It is estimated that an increase in oil prices by $20 a barrel should equal only a 0.5% decline in GDP
* The current increase is not at the same level of previous spikes
* Not all price increases have an effect on growth eg. between 2002 and 2006 oil prices increased 150% yet the US economy grew at a high rate.
Research has shown that rising petrol prices have a notable influence on the level of happiness of American consumers. Petrol prices are probably the most visible prices in the market – every petrol station has them. Behavioural economist Dan Ariely has argued that the way we buy petrol watching the dollar counter ever increasing is essentially depressing. According to Surowiecki the danger at the moment is more psychological than economic. Some economists have suggested it is only when the price of a barrel of oil gets above US$130 that we will experience an oil crisis like those in the past.
In 1897 Irish philosopher and economist Francis Edgeworth set the utilitarian (happiness) foundations for highly progressive taxation. He pointed out that a utilitarian social planner will equalise the marginal utility of the population, but this requires equalising people’s disposable income (after tax). Edgeworth stated that those with greater than average productivity are fully taxed on the excess, and those endowed with lower average productivity are subsidised to bring them up to the average.
As specified in one study, the typical 6-foot American earned $5,525 more than a 5-foot-5-inch worker, after correcting for sex, age and weight. Research has identified that taller adults maintain jobs of higher standing and, on average, earn more than other workers. In developed countries, researchers have highlighted characteristics such as self-esteem, social superiority, and prejudice. Other studies have stated that on average, taller people earn more because they are more intelligent – an additional inch of height is associated with a one to two percentage
increase in earnings. If this is true height should be a useful indicator for determining an individual’s optimal tax liability. Therefore, a tall person of a given income should pay more in tax that a short person of the same income.
Using optimal-taxation formulas, Mankiw and Weinzierl (2007)* crunched the numbers and came up with a “tall tax” amounting to 7 percent of a tall person’s income. Short people would receive a 13 percent rebate. According to conventional utilitarian calculus, the optimal height levy is large. The optimal tax for white males in the US is divided into 3 height groups:
Medium = 1.77m – 1.84m
Tall = 1.85m
Taxing people by height is a rather unusual idea but it has been interesting to look into the research concerning optimal levels of taxation.
*The Optimal Taxation of Height: A Case Study of Utilitarian Income Redistribution Gregory Mankiw & Matthew Weinzierl (2007)
Thanks to Geoff Riley of the Tutor2u blog for this amusing clip of the inequality weather forecast. In earlier posts I mentioned the book that the clip is advertising – “The Spirit Level”. The book shows that there are a significant negative effects of the increase in inequality in an economy. Many graphs are presented which show how certain variables are influenced by the level of inequality. Here are some of their conclusions . Inequality:
*causes shorter, unhealthier and unhappier lives;
*increases the rate of teenage pregnancy, violence, obesity, imprisonment and addiction
On almost every index of quality of life, or wellness, or deprivation, there is a gradient showing a strong correlation between a country’s level of economic inequality and its social outcomes. Almost always, Japan and the Scandinavian countries are at the favourable “low” end, and almost always, the UK, the US and Portugal are at the unfavourable “high” end, with Canada, Australasia and continental European countries in between.
If Britain were instead to concentrate on making its citizens’ incomes as equal as those of people in Japan and Scandinavia, we could each have seven extra weeks’ holiday a year, we would be thinner, we would each live a year or so longer, and we’d trust each other more. Guardian Newspaper
A hat tip to colleague Richard Wells for this cool website. Put together by FedEx all you need to do is mouse over each country to find out how it measures on the happiness index out of 10. However, as shown below, they adjust the size of the country so that it correlates to its level of happiness. Click here to go to the site.
Robert Frank – professor of Economics at Cornell University and author of the book “The Economic Naturalist” – wrote his usual thought provoking piece in the New York Times. His focus was on the increasing levels of inequality in the US economy and how economists seem to be unwilling to grapple with this matter – to them it requires a moral judgment by philosophers. But surely economists promote policies, like tax cuts for the higher-income groups, that increase inequality substantially. Also, economics was founded by moral philosophers – Adam Smith was a professor of moral philosophy at the University of Glasgow and author of the celebrated “Wealth of Nations,” which was itself peppered with trenchant moral analysis.
Frank comes up with some very interesting stats:
Recent research by Frank and other economists found that the counties where income inequality grew fastest also showed the biggest increases in symptoms of financial distress eg:
- these counties had the largest increases in bankruptcy filings.
- largest increase in divorce rates
- long commute times as families move to cheaper housing to make ends meet
- the middle-class squeeze has also reduced voters’ willingness to support even basic public services.
There is no persuasive evidence that greater inequality bolsters economic growth or enhances anyone’s well-being. Yes, the rich can now buy bigger mansions and host more expensive parties. But this appears to have made them no happier. And in our winner-take-all economy, one effect of the growing inequality has been to lure our most talented graduates to the largely unproductive chase for financial bonanzas on Wall Street.
Click here for the full article.
There is an excellent article in this week’s New Yorker magazine by James Surowiecki in which he explains, with the help of Yale Professor Robert Shiller (co-author of Animal Spirits), the costs of inflation but also the need for prices to rise in the US economy. Surowiecki suggests that if the Fed were to raise its inflationary target from around 2% and commit to higher prices it might change people’s behaviour especially as debt burdens would be reduced and money would lose value in the future. But central bankers are more concerned with stable prices than with lost jobs and they tend to look after the interests of lenders, for whom inflation is generally bad news.
Inflation helps debtors and spenders at the expense of creditors and savers and it seems to reward those who have conducted themselves irresponsibly, and to penalise those who were more cautious. But, according to Surowiecki “the economy doesn’t exist, in the end, to reward virtue and punish vice. It exists to maximize our well-being, and, currently, doing that may require helping the undeserving and irresponsible, if only because there are so many of them.”
Click here for the full article.
New Zealand and Australia are tied for first as the most generous nations on earth from the new Gallup’s World Giving Index
Gallup asks people which of the following three charitable acts they have undertaken in the past month:
*donated money to an organisation?
*volunteered time to an organisation?
*helped a stranger, or someone they didn’t know who needed help?
Findings from the analysis showed that:
*giving is strongly correlated with happiness than with a nation’s GDP
*giving is an emotional rather than a rational act
*giving increases with age – explained by changes in disposable income
*women are more likely to give than men – however very close – 30% as against 29% for men
Got this link from Geoff Riley who runs the excellent Tutor2u Blog. Statistician Nic Marks asks why we measure a nation’s success by its productivity – instead of by the happiness and well-being of its people. He introduces the Happy Planet Index, which tracks national well-being against resource use (because a happy life doesn’t have to cost the earth). Which countries rank highest in the HPI? You might be surprised.
Many thanks to Geoff Evans (ACG Parnell) for this great graphic on Gross National Happinesss. The term was coined in 1972 by Bhutan’s former King Jigme Singye Wangchuck, who has opened up Bhutan to the age of modernization. The Himalayan kingdom the size of Switzerland with no McDonalds, no ATM machines, no traffic lights, and until ten years ago no TV, is for many people an earthly paradise. Bhutan is ranked 130th in the UN Development Program’s ratings, close to Haiti and Bangladesh. Most visitors rate it almost infinitely higher using the measure of Gross National Happiness. GNH value is proposed to be an index function of the total average per capita of the following measures:
1. Economic Wellness: includes consumer debt, average income to consumer price index ratio and income distribution
2. Environmental Wellness: Includes pollution, noise and traffic
3. Physical Wellness: Measures physical health including severe illnesses
4. Mental Wellness: Includes usage of antidepressants and rise or decline of psychotherapy patients
5. Workplace Wellness: Includes jobless claims, job change, workplace complaints and lawsuits
6. Social Wellness: Includes discrimination, safety, divorce rates, complaints of domestic conflicts and family lawsuits, public lawsuits, crime rates
7. Political Wellness: Includes the quality of local democracy, individual freedom, and foreign conflicts.
Interesting to see from this graph that New Zealanders are happiest around public holidays and Valentines Day. I would like to see what happens to the data after the Rugby World Cup next year – there would either be a serious peak or trough depending on the performance of the AB’s.