session 1-2

Session 1-2 readings:

1. Measuring Economic Growth (Perkins et al., pp. 27-32)

1.1 GDP as a Measure of National Income

• Definition: GDP (Gross Domestic Product) is the total market value of all final goods and services produced within a country in a given period.

• Advantages:

  • Standardized measure allows comparison over time and across countries.

  • Essential for analyzing economic development trends.

• Limitations:

  • GDP does not consider income distribution.

  • It does not include non-market transactions (e.g., unpaid household work).

  • GDP growth does not necessarily imply improved well-being.

1.2 Exchange-Rate Conversion Issues

• Why is exchange rate conversion needed?

  • Each country measures GDP in its own currency (e.g., USD, EUR, INR).

  • To compare GDP across countries, we need a common unit (typically USD).

• Market Exchange Rate Method:

  • Converts GDP using the prevailing foreign exchange rate.

  • Example: India’s GDP per capita (2009) was 57,000 rupees.

    • Using an exchange rate of 49 INR = 1 USD, India’s per capita GDP would be $1,160.

  • Issue: Exchange rates do not reflect purchasing power.

    • Example: A haircut in Mumbai costs 200 rupees ($4 USD at the exchange rate), but the same haircut in Boston costs $40 USD.

1.3 Purchasing Power Parity (PPP) as an Alternative Measure

• Definition:

  • Adjusts GDP for differences in the cost of living between countries.

  • Ensures that the same basket of goods/services costs the same in different countries.

• Why is PPP necessary?

  • Market exchange rates distort real income levels, especially in developing countries.

  • Prices of non-traded goods/services (e.g., haircuts, housing, education) differ greatly between countries.

  • The ratio of traded to non-traded goods prices varies by country, making exchange-rate-based GDP misleading.

Example: India vs. USA

• Using market exchange rates:

  • India’s GDP: Rs 1,490 billion / Rs 50 per USD = $29.8 billion.

  • India’s GDP is only 12% of US GDP in this method.

• Using PPP method:

  • Adjusting for relative price differences, India’s GDP is $105 billion.

  • This means PPP-adjusted GDP is 3.5 times higher than exchange rate-based GDP.

• Conclusion:

  • PPP gives a more realistic measure of economic performance and living standards.

  • Lower-income countries have higher GDP under PPP than exchange rates suggest.

1.4 International Comparison Program (ICP)

• What is the ICP?

  • A global statistical initiative (launched in 1968 by the UN, now managed by the World Bank).

  • Collects price data for hundreds of goods and services across 146+ countries.

  • Provides PPP-adjusted GDP estimates for better international comparisons.

• Key Findings:

  • Low- and middle-income countries’ GDP is underestimated by exchange rates.

  • Example:

    • Norway → Exchange Rate GDP & PPP GDP are similar (~0.7 ratio).

    • India → PPP GDP is 2.8 times higher than Exchange Rate GDP.

    • The Gambia → PPP GDP is 3.3 times higher.

  • Global impact:

    • When using market exchange rates, low- and middle-income countries account for only 29% of global GDP.

    • When using PPP, their share rises to 44%.

2. Stiglitz, Sen & Fitoussi - Mismeasuring Our Lives (Executive Summary & Preface)

2.1 Why Was This Report Written?

• Commissioned by French President Nicolas Sarkozy in 2008.

• Led by economists Joseph Stiglitz, Amartya Sen, and Jean-Paul Fitoussi.

• Purpose:

  • Identify limitations of GDP as an economic and social indicator.

  • Recommend alternative measures for well-being and sustainability.

  • Improve statistical indicators for policymaking.

2.2 Major Issues with GDP

1. GDP Doesn’t Reflect Well-being

• GDP measures economic production but ignores quality of life.

• Example:

  • Traffic congestion increases fuel sales → GDP rises, but well-being declines.

  • Environmental degradation boosts GDP via cleanup costs, but lowers quality of life.

2. Inequality is Ignored

• GDP averages income, failing to reflect income disparities.

• If GDP grows but wealth is concentrated, most people might not benefit.

• Example: If the top 10% gains all income growth, GDP rises, but median income stagnates.

3. Sustainability is Overlooked

• GDP does not track debt, resource depletion, or environmental costs.

• The 2008 financial crisis showed how GDP-based economic analysis failed to predict instability.

• Key lesson: Growth driven by unsustainable factors (e.g., debt bubbles, overconsumption of resources) is misleading

2.3 Alternative Indicators for Progress

1. Shift from Economic Production to Well-being

• GDP should not be the sole measure of progress.

• Need measures of well-being that include:

  • Material living standards (income, consumption, wealth).

  • Health.

  • Education.

  • Social connections and political participation.

  • Environmental quality.

  • Economic and physical security.

2. Measure Household Income & Consumption

• Instead of focusing on total national production, focus on:

  • Household income: Tracks actual earnings and expenses.

  • Consumption levels: More relevant to individual well-being.

3. Incorporate Wealth & Sustainability

• Wealth is a better long-term measure than GDP alone.

• Countries should track physical, human, and social capital.

• Example:

  • A country with a high GDP but depleting forests and natural resources is not truly wealthy.

4. Consider Non-Market Activities

• Household labor, unpaid caregiving, and community work add real economic value.

• Example: If people hire childcare instead of caring for children themselves, GDP rises artificially.

5. Include Subjective Well-being Indicators

• People's self-reported happiness, life satisfaction, and emotional experiences should be included in national statistics.

• Example: Denmark has high happiness rankings despite lower GDP growth.

2.4 Key Recommendations

1. Improve GDP Measurement

   • Adjust for income distribution and purchasing power.

   • Consider real household income instead of national production.

2. Use Alternative Well-being Indicators

   • Track health, education, security, and environmental conditions.

   • Develop "quality of life" indices.

3. Account for Sustainability

   • Monitor debt, resource depletion, and ecological impact.

   • Include balance sheets for national assets and liabilities.

4. Develop Multidimensional Measures

   • Well-being involves more than income.

   • Must consider education, work-life balance, governance, and inequality

• GDP is a flawed but widely used measure – it ignores inequality, non-market activities, and sustainability.

• PPP is better than exchange rates for cross-country income comparisons.

• Stiglitz, Sen & Fitoussi argue for a shift from GDP to well-being-focused measures.

• Economic growth is not always progress – we need better, multidimensional metrics

QUESTIONS

1. What does GDP measure?
   a) The total population of a country
   b) The total value of goods and services produced within a country
   c) The amount of money in circulation
   d) The total value of international trade
   → Answer: b) The total value of goods and services produced within a country

2. Which of the following is a limitation of GDP?
   a) It does not account for income distribution
   b) It includes all non-market transactions
   c) It perfectly measures well-being
   d) It considers environmental sustainability
   → Answer: a) It does not account for income distribution

3. Why is exchange-rate conversion necessary for GDP comparison across countries?
   a) Because each country measures GDP in its own currency
   b) Because exchange rates remain constant over time
   c) Because all countries use the same price levels
   d) Because exchange rates reflect real income levels
   → Answer: a) Because each country measures GDP in its own currency

4. Which method uses the prevailing foreign exchange rate to convert GDP?
   a) Purchasing Power Parity (PPP)
   b) Market Exchange Rate Method
   c) Inflation-adjusted GDP method
   d) Gross National Product (GNP)
   → Answer: b) Market Exchange Rate Method

5. What is a major drawback of using market exchange rates to compare GDP?
   a) They do not reflect purchasing power differences between countries
   b) They are fixed and never change
   c) They always overestimate the GDP of developing countries
   d) They only apply to traded goods, not services
   → Answer: a) They do not reflect purchasing power differences between countries

6. What does Purchasing Power Parity (PPP) adjust for?
   a) Differences in trade balances
   b) Differences in the cost of living between countries
   c) Variations in currency exchange rates
   d) Global population changes
   → Answer: b) Differences in the cost of living between countries

7. Which international program provides PPP-adjusted GDP estimates?
   a) World Health Organization (WHO)
   b) International Comparison Program (ICP)
   c) World Trade Organization (WTO)
   d) United Nations Development Program (UNDP)
   → Answer: b) International Comparison Program (ICP)

8. Who led the report "Mismeasuring Our Lives"?
   a) Adam Smith, Karl Marx, and John Keynes
   b) Joseph Stiglitz, Amartya Sen, and Jean-Paul Fitoussi
   c) Milton Friedman, Paul Krugman, and Robert Solow
   d) Thomas Piketty, David Ricardo, and John Nash
   → Answer: b) Joseph Stiglitz, Amartya Sen, and Jean-Paul Fitoussi

9. Why does GDP fail to reflect well-being?
   a) It only measures economic production, not quality of life
   b) It includes environmental and social factors
   c) It takes into account people's happiness levels
   d) It prioritizes sustainability over growth
   → Answer: a) It only measures economic production, not quality of life

10. What is one reason GDP does not capture inequality?
    a) It averages income without considering how wealth is distributed
    b) It always increases when wealth is fairly distributed
    c) It focuses only on poor people’s income
    d) It does not measure economic growth
    → Answer: a) It averages income without considering how wealth is distributed

11. Why is GDP not a good measure of sustainability?
    a) It does not track resource depletion or environmental costs
    b) It adjusts for natural resource consumption
    c) It considers future generations' well-being
    d) It includes all unpaid labor and social contributions
    → Answer: a) It does not track resource depletion or environmental costs

12. Which of the following is NOT an alternative indicator recommended by Stiglitz, Sen & Fitoussi?
    a) Well-being indicators
    b) Household income and consumption
    c) National debt levels
    d) Environmental sustainability
    → Answer: c) National debt levels

13. What is one key recommendation from "Mismeasuring Our Lives"?
    a) Rely exclusively on GDP for economic decisions
    b) Track well-being measures like health, education, and environment
    c) Ignore income distribution when calculating economic performance
    d) Increase economic production without considering sustainability
    → Answer: b) Track well-being measures like health, education, and environment