GDP is increasingly being seen as too crude a tool, failing to reflect factors such as wellbeing and sustainability. Nick Spencer and Aled Jones consider some alternatives, and the implications for actuaries.
Since the 1940s, growth in gross domestic product (GDP) has led to a world in which the average person is now wealthier, healthier, better fed, older and more connected, and there are three times as many people on the planet. But how accurately does GDP measure this broader success?
Simon Kuznets first proposed the use of GDP in its modern form in a 1934 report to the US Congress. During the Second World War, economists in the UK developed GDP in order to measure the amount of productive capacity that could be mobilised for the country’s war effort. After the war, it was used to measure the affordability of investment for rebuilding efforts. Since then, GDP has become the standard metric of a country’s economic progress.
However, in that first report to Congress, Kuznets also stated: “With quantitative measurements especially, the definiteness of the result suggests, often misleadingly, a precision and simplicity in the outlines of the object measured.”
While GDP might be a useful war-planning tool, its ‘often misleading’ quantification has been heavily critiqued in the past few decades, especially for what it misses and its failure to reflect the distribution of growth.
What does GDP miss?
Firstly, and crudely, GDP measurement is focused on paid goods and services. Some adjustments are made for implied rents but, as a whole, housework, childcare, community activities and volunteering all count for nothing. Governments are assumed to add no value – their spending is measured but no allowance is made for any improvements they make in productivity or value in health, education or services.
GDP also collapses all economic activity into one measure, with no distinction between ‘good’ and ‘bad’ activity. Something that has a negative social impact, such as a natural disaster, can positively affect GDP owing to the extra activity from rebuilding. But should disasters be seen as a net gain? The depletion of natural capital assets, atmospheric damage from burning fossil fuels, and degrading ecosystems also do not count as losses.
These missing degradations can lead to limits to future growth. The seminal 1972 report The Limits to Growth (bit.ly/39TndCd) from the Club of Rome explored these limits. They projected material limits to availability of resources in the 21st century. The majority of their scenarios illustrated a peak in (real) GDP growth towards the middle of this century.
The Limits to Growth was produced before the world started to focus on climate change. However, the impact of unmitigated climate change on economic activity will also be severe. Figure 1 shows the GDP projections from the IFoA/Ortec Finance sessional paper on climate scenarios (bit.ly/3nttqHP). This projected a global GDP peak before 2080 in a failed transition pathway. Effectively, the degradation from physical climate impacts exceeds the ‘innate’ productivity growth that has created the increased global prosperity since the 1940s.
GDP also hides the distribution of wealth both globally and within nations. High-income countries have 16% of people but consume 47% of global GDP. Within countries, inequality is hidden by the use of average measures of GDP or GDP per capita.
Alternative measures
Given these trends and limitations in the use of GDP as a tool, true economic growth has almost certainly been overstated. Simply extrapolating from past growth is thus naïve, and this approach will almost certainly need to be recalibrated.
Several other metrics have been proposed to sit alongside GDP in order to provide a more holistic measure of progress. These include the Human Development Index, the Index of Sustainable Economic Welfare, Gross National Happiness, the OECD Better Life Index and the wellbeing framework (bit.ly/3OPTkkH) proposed by the Sarkozy Commission in 2009.
Professor Sir Partha Dasgupta’s review for the UK Treasury (bit.ly/39XS1Bz), covering the economics of biodiversity, proposed thinking about the impacts on three ‘wealth capitals’: productive (economic) capital, human capital and natural capital. This would provide a more complete reflection of a country’s ‘wealth’ – but almost certainly implies less growth of economic capital when balancing against the human and natural impacts.
All of these new measures blend in additional factors that are not captured by a simple metric of productivity. These include, but are not limited to, climate change, biodiversity, non-renewable resources, mental and physical health, freedom and justice, life expectancy, and more subjective measures such as self-reported happiness.
Because of the increasing visibility and inescapability of the impacts that could result if we exceed our sustainable resources, the case to include a dashboard of these more complete metrics that would sit alongside GDP is growing stronger every day. In the UK, the Dasgupta review and the recent Environmental Audit Committee inquiry (bit.ly/3QSxWx4) on aligning the UK’s economic goals with environmental sustainability show that these debates are now occurring at the heart of governments.
What does this mean for actuaries?
The first and most direct implication arises from the implicit GDP growth assumption that lies in future investment-return projections. Actuaries should allow for a far broader range of future economic growth rates. While the information age and the Fourth Industrial Revolution might unleash a new wave of productivity growth, transitions are visibly required to address resource constraints, so projections will need to consider the limits of growth. Actuaries should also reflect on the economic impacts that could result from rebalancing government policy away from purely financial growth.
Actuaries are already familiar with distributive inflation effects when projecting claims and liabilities (such as salary, construction and goods). The shift in policy and broader economic transitions will likely create more divergent inflation pathways, so more care will be required in selecting the most appropriate measure and assumed future rate. And such a transitionary inflation environment may affect interest rate policy, which again may be more divergent across different futures.
“GDP collapses all economic activity into one measure, with no distinction between ‘good’ and ‘bad’ activity. Something that has a negative social impact can positively affect GDP”
Actuaries may also be asked to illustrate their organisation’s impact on reducing inequalities or enabling inclusive finance. These objectives may be formalised in broader regulatory requirements – which already exist in some countries – or achieved more informally as an expectation of financial businesses, as well as a business opportunity. A more granular understanding of GDP and wellbeing measures will help actuaries to develop these illustrations. For those working in public policy, shifts in GDP expectations and considerations of social capital feed into the ‘social time preference rate’ described in a report for the Treasury, Social Discount Rates for Cost-Benefit Analysis (bit.ly/3AayEQG).
Finally, GDP can be seen as a reflection of the government’s ability to raise taxes. If there is less GDP growth, that could have implications for public healthcare funding – and thus affect long-term mortality and morbidity trends.
A new approach
An initially arcane discussion on GDP construction leads to a much more pluralistic consideration of governmental goals and economic outcomes. The assumed use of historic trends in projections need to be overhauled to reflect a range of outcomes from techno-optimist to limited growth.
Policy objectives can affect future growth, inflation and interest rates.
Actuaries will need to become fluent in the core growth discussions and ‘three-capital’ thinking. Educational resources include the IFoA’s recent blog ‘Moving Beyond GDP’ (bit.ly/3NwjCHM) and submission to the Environmental Audit Committee (bit.ly/3HZxv03), as well as the Dasgupta review. Defining different objectives, such as wellbeing, would affect the whole sociopolitical economy. More details on valuing economies can be found in Mariana Mazzucato’s book The Value of Everything.
Actuaries should reflect on whether they are making the right allowances in their projection models for these transitions in policy and for broader transitions in sustainability. Business as usual, involving the maintenance of historic trends, is increasingly the least likely outcome.
Nick Spencer is a sustainable investment adviser at Gordian Advice, a Council Member and a past chair of the Sustainability Board
Aled Jones is a professor and director of the Global Sustainability Institute at Anglia Ruskin University, and chair of the IFoA Biodiversity Working Party
