National income figures, usually GDP at factor cost, are the man figures used to compare living standards. This is because most countries keep and publish detailed national income data.
However, care has to be taken in using national income figures to compare living standards both over time and between countries. It is important to use GDP at constant prices (i.e. real national income) so that a misleading impression is not given because of the effects of inflation. It is also important to take into account differences in population size. A country with a large population is likely to produce more than a country with a small population. However, this output has to be shared out among more people so living standards are not necessarily higher. This is why economist divide output by population and compare real GDP per capita. Even when adjustments have been made for inflation and differences in population size, national income figures as a measure of living standards have to be interpreted cautiously.
A rise in real GDP per capital may have resulted from an increase in the output of capital goods. In the longer run this will increase productive capacity and result in more consumer goods being produced. However, in the short run people may not feel any benefit from more capital goods being made. An increase in weapons will also increase GDP but, again, may not necessarily improve living standards. If more police are employed and crime is reduced, the quality of people’s lives will be improved. However, if more police are employed to keep pace with rising crime, people will be feeling worse off. So economists have to look not only at the amount of goods and services produced but also at the composition of those goods and why the quantity has changed. In addition, the quality of goods and services produced should be examined. The same quantity could be produced this year as last year or five years ago but if the quality of the output has risen, living standards will have improved.
The distribution of income also has to be taken into account. National income may rise but if it is concentrated in the hands of a few, the living standards of the majority may not rise. See graph below from The Economist showing the Gini coefficient of income inequality.
National income figures also fail to take into account some items which affect the quality of people’s lives. A certain amount of economic activity is not declared, either to avoid paying taxes or because it is illegal. If there is an increase in, say, people providing home hairdressing services but not declaring them, people’s living standards may rise, although this increase will not be reflected in the official figures.
Differences in working hours and working conditions are also not taken into account. If output remains constant but working hours fall, people are likely to have a higher quality of life.
National income figures only take into account economic activities for which a payment is made. They do not take into account externalities and non-marketed activities. So, for example, an increase in pollution will reduce living standards while an increase in people decorating the homes of old people, on a voluntary basis, will improve the quality of life of the elderly. Neither of these will be recorded in national income figures.
All of these factors have to be taken into account in using national income figures to make comparisons both over time and between countries. However, some additional factors have to be considered when making international comparisons. Different statistical methods are employed in some countries and the degree of accuracy can vary. Tastes and needs can be different in different countries. For example, people living in a cold climate have to spend more on heating than those in warm countries, merely to enjoy the same standard of living. There is also the problem of selecting a rate of exchange to make the comparison. Exchange rate fluctuate and do not always reflect relative prices in compared using purchasing power parities which compare the cost of a given basket of goods in different countries.
The US economy has had the highest sustained level of unemployment since the Great Depression of the 1930’s. One reason for this has been the significant increase in income inequality as there is a redistribution of income from low income families to high income families. When you consider the proportion of income that is spent by both groups you will find that the lower income groups consume a much greater percentage of the their income than their higher income counterparts. Therefore we take more consumption out of the economy with slower growth and ultimately a loss of jobs = higher unemployment. Here is a clip from Paul Solman of PBS.
Our material well-being
• The standard of living is simply a measure of the economic or material welfare of the inhabitants of a country, a region or a local area.
• The baseline measure is real national output per head of population.
• Real income per capita is an inaccurate and insufficient indicator of living standards
Per Capita National Incomes
National income data can be used to make cross-country comparisons. This requires:
1. Converting GDP data into a common currency (normally the dollar or the Euro)
2. Making an adjustment to reflect differences in the average cost of goods and services in each country to produce data expressed at a ‘purchasing power parity’ standard
Data on per capita income based on a country’s total personal income are rarely available. Thus, the Gross domestic product (GDP) is more commonly used. However, the total personal income is generally lower than the gross domestic income.
A list of the top ten countries, and the lowest-ranking country, by GDP per capita (in terms of purchasing power parity – PPP – and nominal values) for the year 2010
Problems of accuracy:
Officially data on a nation’s GDP tends to understate the true growth of real national income per capita over time e.g. due to the expansion of the shadow economy and the value of unpaid work done by millions of volunteers and people caring for their family members. There may also be errors in calculating the cost of living
The scale of the informal “shadow economy” varies widely across countries at different stages of development. According to the IMF, in developing countries it may be as high as 40% of GDP; in transition countries of central and Eastern Europe it may be up to 30% of GDP and in the leading industrialised countries of the OECD, the shadow economy may be in the region of 15% of GDP
Having arrived in Spain (Mallorca) last night just before the euro final I could not post something about football – the Spanish know how to celebrate. Spain showed their class and are an exceptional team to have won three major tournaments in the last four years. Some have likened them to the Brazil team of 1970.
In keeping with Spanish football, I came across Simon Kuper, co-author of Soccernomics, on the eZonomics website by ING. One particular part of the site focuses on soccer – Cup-o-nomics – in which current issues in the sport are related to economics. With the Euro 2012 Championship on he has written several articles about players. managers etc.
In July 2007, the Spanish striker Fernando Torres moved from Athletico Madrid to Liverpool. Torres commanded a salary of £90,000 (NZ$175,500) a week at Liverpool, equivalent to £4.6m (NZ$9.1m) a year. Interestingly enough this was a salary cut as at Athletico he was on an annual salary of €8 million (about NZ$10.5 million). However within a year of signing for Liverpool the purchasing power of his income decreased for the following reasons:
1. The pound depreciated against the euro (hard to believe now) by around 20%. Most foreign players tend to send home a lot of their salary and therefore Torres needed to use more pounds to buy euros.
2. After 2008 and the financial crisis the UK experienced over 5% inflation which again would have lessened the purchasing poser of his income. Most soccer players are on a given salary for the duration of their contract and therefore don’t have their income indexed to the CPI or cost of living.
Even all this said, Fernando Torres is probably not too worried about exchange rate fluctuations or inflation rates when you look at his salary and the season he has just had with Chelsea and Spain.
You may remember the post I did on the economic centre of gravity (ECG) by LSE’s Danny Quah. By economic centre of gravity he refers to the average location of the planet’s economic activity measured by GDP generated across nearly 700 identifiable locations on the Earth’s surface. Recently the McKinsey Global Institute showed how the economic centre of gravity – the geographic center of the world’s annual economic growth – has moved since AD 1 to a forecast year of 2025 – at a speed of 140kms per year.
1. Until 1700 China and India were about 60% of world GDP
2. British and American Revolutions which led to mass urbanisation and productivity gains ECG moved West
3. 1980’s-90’s it gravitates back to the East with the expansion of Japan and other asian economies. This is even with the Asian Crisis in 2000.
4. 2000 – 2010 sees a massive shift to the east with the impact of the Financial Crisis plus the continued growth of developing nations in the east.
McKinsey put the growth down the speed at which cities are growing especially in India and China. This has ultimately given rise to productivity and a growing consumer class. Much of this future growth (approximately 47%) will be driven by 440 developing world cities.
Nigeria, the eleventh largest producer and the eighth largest exporter of crude oil in the world, typically produces over 2.4 million barrels per day (b/d) of oil and natural gas liquids. However, according to the IMF, while the Nigerian economy has benefited $800 billion dollars in oil revenue since 1960, this has added basically nothing the Nigerian economy or the standard of living of the average Nigerian. In fact the World Bank estimates that since 1960 $100 billion of the $800 billion in oil revenues have gone missing.
For most economies that have natural endowments like oil or minerals, there is the risk of the economy experiencing the ‘resource curse’. This is when a natural resource begins to run out, or if there is a downturn in price, manufacturing industries that used to be competitive find it extremely difficult to return to an environment of profitability. According to Paul Collier, Nigeria has a resource curse of its own, the civil war trapin which 73% of the low income population have been affected by it, as well as a natural resource trap- where the so-called advantages of a commodity in monetary value did not eventuate – on average affecting only 30% of the low income population. It seems that in Nigeria there is a strong relationship between resource wealth and poor economic performance, poor governance and the prospect of civil conflicts. The comparative advantage of oil wealth in fact turns out to be a curse. governments and insurgent groups that determines the risk of conflict, not the ethnic or religious diversity. Others see oil as a “resource curse” due to the fact that it reduces the desire for democracy. You can read the full version of this article by going to the econoMAX website below:
Here is a TED Talk by Richard Wilkinson who is the co-author of “The Spirit Level – Why More Equal Societies Almost Always Do Better”. The books focuses on how inequality in a country is conducive to unhealthier, unhappier, greater obesity, higher crime rates etc. However critics have said it lacks substantive data – can we say that because New Zealand has a bigger income gap than Greece that it has greater social problems? Richard Wilkinson goes through a lot of the graphs and data that he mentions in the book.