How to measure the economic growth of a country?

How to measure the economic growth of a country?

Economic growth is now measured by increases in a country’s per capita net national product. Economists often do this not because they are convinced of the theoretical and statistical accuracy of these figures as indicators of development, but rather because there is no other superior readily available alternative.

The major limitations of the per capita national income indicator as a measure of welfare are the following and in no case should be overlooked by a serious growth analyst:

The per capita income figure indicates nothing about the types of goods and services produced in a country. It also fails to measure the amount of welfare which people derive from the use of these goods and services.

Often an increase in per capita national income involves considerable social cost in the form of environmental pollution, overcrowding in cities or overwork under tremendous stress.

To use India as an illustration, why should we include in the national income money spent on bus services in our major metropolitan cities, as well as the money spent on automobiles which are being usually used by the people to get to and from work?

And why should we include the money spent on cleaning the environmental pollution caused by the industrial development? Some economists now rightly suggest that all such expenditures are to be treated as costs and should be subtracted from the national income.

Many goods and services do not pass through the market and are thus not included in the national income estimates. In no country, for example, unpaid housework and self-repairs are considered as production.

However, in less developed countries non-inclusion of goods and services which do not pass through the market distorts national income estimates far more than in industrialised developed countries because of their greater relative importance in the former.

Even when a system is developed to estimate the value of certain non-marketed production with a view to include it in the national income, there remains a bias in the estimates on the’ downward side. Often the processes of monetisation and commercialisation cause overstatement of growth rates in developing countries.

According to Clarence Zuvekas, “What is recorded as increased output may simply reflect a transfer of production from the household or barter economy to the market place, where it will be recorded for the first time?”

Estimates of national income and the rate of increase in it tell us nothing about the exploitation and waste of natural resources. Natural resources of a country make an important contribution to its national income.

Minerals and forests are two important natural resources. While the forest wealth of a country is renewable, mineral resources once destroyed cannot be renewed at any cost.

When private companies owning mineral resources in a country raise the output of minerals, the level of national income rises. Quite often these companies in their attempt to minimize the cost indulge in reckless exploitation of these resources.

It is well known that in Middle East natural gas in a massive quantity is burnt as oil companies find it uneconomical to put it to some use. Such a policy of cost reduction may push up the national income of the country in the short run, but it will definitely lower down the economic welfare of the country in the long run.

The rate of increase in national income fails to throw any light on the distribution of income in the country. Distribution of income in a country greatly influences the level of economic welfare. In all those countries where large income inequalities exist, a major part of national production is appropriated by a small number of persons.

If a part of the income of this class is transferred to those households which are below the poverty line, the level of economic welfare will show great improvement. People below the poverty line subsist under sub-human living conditions.

Therefore, a small transfer of income from the rich to them will raise their economic welfare considerably, while this will not cause any significant decline in the welfare of the former. This implies that given a constant level of national income a more equitable distribution of income will raise the level of economic welfare.

This proposition has been contested by Pareto, who asserted that inter­personal comparison of utility is not possible. There are many other professional economists who endorse Pareto’s views on inter-personal comparisons. A.K. Sen, however, asserts that “such comparisons can be given a precisely defined meaning.

In fact, various alternative frameworks are possible.” Sen Now finds many supporters who firmly believe that in certain cases it is possible to compare the welfare which two individuals derive from a given amount of income. Once this point is established it is not inappropriate to argue that if money is taken away from the rich and distributed among the poor, the level of economic welfare should rise.

Further, since a redistribution of national income on more equitable basis can raise the level of economic welfare, it would not be correct to consider the increases in the national income as a satisfactory index of economic welfare.

National income figures of different countries cannot always be legitimately used for comparing their economic welfare. Difficulties arise in making comparisons of per capita national income of different countries on account of conceptual differences, exchange rate problem and the great differences in domestic relative price structures among countries.

In most Western countries more or less a uniform concept of national income has been adopted. This however is not the same as the one adopted in the socialist countries.

Following Marxist theory the socialist countries prepare only the estimates of material production, and thus their per capita national income figure understates their output as compared to the output in Western developed economies.

Further, whereas the rate of growth in socialist countries measures increase in material production, in Western countries it reflects the increase in output of both goods and services.

It is this reason why growth rates measured in terms of per capita income for the various countries should be compared only after making the necessary adjustments which are generally quite difficult to make.

For making comparisons of per capita national income of different countries national currency values are converted to their equivalent in U.S. dollars. This involves a serious problem in a system of fixed exchange rates. In this system some currencies will be undervalued or overvalued.

For example, the Indian rupee was overvalued for a considerable period of planning and therefore, calculating India’s per capita national income on the basis of official exchange rate overstated its dollar equivalent. Even if exchange rates are allowed to float the problem is not completely solved because in choosing some exchange rate for a given year there will remain an element of arbitrariness.

Relative price structures are not the same in all countries. This creates problem in making comparisons of the per capita national income in different countries. In comparing China and the United States, for example, the problem is that should we accept the reported national income figures based on Chinese price for Chinese goods and U.S. prices for U.S. goods.

Or should we use prices which prevailed in China or the United States for the output of both countries? The choice of method in this case will make great difference. Prices of essential commodities which constitute a major part of the output are very low in China, and therefore, people in this country easily manage comfortable living in small incomes.

The same income in the United States will not ensure even subsistence living because of relatively higher prices. It is this reason why the reported GNP per capita figures for China are misleadingly low. For China the World Bank reported that its GNP per capita in 2003 was $ 1,100. As against this, China’s GNP per capita based on the purchasing power of its currency is estimated at $ 4,990 in the same year. 13

Keeping in mind these limitations of the national income figures one should use them with caution to have an idea of the growth performance of the concerned economies. From the figures of GNP per capita in U.S. dollars for the year 2003 given in World Development Report 2005, one should not conclude that the living standards in developed countries are about fifty times higher than in the low income economies.

The estimates of GNP per capita measured at purchasing power parity (PPP) indicate a lower degree of disparity. These estimates are definitely superior for making international comparisons.

The rank order of countries determined on the basis of their GNP per capita measured at PPP would certainly give us an idea of the differences in levels of development among the various regions of the world.

Among the developing countries one finds that the GNP per capita is significantly higher in the Middle East and Latin America than in Asia and Africa. By and large this is also reflected in the differences in their level of development.

However, there are some exceptions to this common trend. In Cuba, for example, one finds considerable development without any significant growth. In contrast, there is Brazil where growth has not been accompanied by much development.