07/09/2013 06:16 pm ET | Updated Sep 08, 2013

GDP Growth and Diminishing Returns

Tighten your belts. A new paper suggests the optimum gross domestic product (GDP) may be only $7,000 per person.

It is commonly taken as an article of faith that economic growth is a good thing, and the bellwether for measuring it is GDP (see sidebar discussion at bottom of post). If the GDP is going up, hallelujah, our economy is vital and robust; if it's holding steady or going up by only a percentage point or two, we are all on shaky ground because our economy is stagnant; and if it's going down, we should all be depressed because we're in a depression.

But is economic growth a priori a good thing? Some economists have argued that it is not. For example, in 1995, Manfred Max-Neef, an economist from the Austral University of Chile, proposed an alternate hypothesis referred to as the "threshold hypothesis," which challenges the notion that economic growth is necessarily desirable:

"For every society there seems to be a period in which economic growth brings about an improvement in the quality of life, but only up to a point -- the threshold point -- beyond which, if there is more economic growth, quality of life may begin to deteriorate."

Is Max-Neef's hypothesis correct? And, if so, what is the threshold where continued economic growth leads to a deteriorating quality of life? And, is that threshold the same for all countries or does it vary?

Writing in the journal Ecological Economics, Ida Kubiszewski from the Australian National University and co-authors attempted to address these questions. To do so, they compared the trends in GDP from 17 nations to the trends with another metric of economic activity called the genuine progress indicator (GPI).

Factoring in ‘Community Capital’ Through GPI

The authors write: "While GDP is a measure of current production, the GPI is designed to measure the economic welfare generated by economic activity, essentially counting the depreciation of community capital as an economic cost." Factors used in the GPI but not included in GDP include: environmental costs, crime, pollution, and income disparity as negatives, and volunteering and household work as positives.

My own take on the GPI as implemented by Kubiszewski et al is that it is an interesting variant on GDP; it captures a lot that the GDP misses, but it also has some drawbacks. To me the most serious of these is that a lot of what goes into the GPI is squishy, it requires making subjective value assumptions, like the negative value of income disparity.

And some factors are extremely difficult to quantify -- for example, the cost of climate change whose impacts and their timing are uncertain. And so the GPI seems to be a very useful qualitative tool, but as a quantitative tool, perhaps not so much.

I welcome comments from economists to straighten me out on this if needs be.

The authors' analysis was limited to 17 countries where the GPI has already been assessed, including the United States, China, India, Japan and a number of European nations. In each country they calculated and then compared the GPI per capita with the GPI per capita over a period of years dating as far back as 1950 and running up to the present. (The analysis also considered other economic indicators such as the Ecological Footprint and Human Development Index discussed in the sidebar below.) The results are rather intriguing.

A Case of Diminishing Returns

In developing countries with low GDPs per capita, there was a clear correlation between increasing GDP and GPI. In these cases, as GDP increased, the GPI metric also increased, suggesting that overall welfare was also increasing. But there was a point at which this relationship broke down. Just as Max-Neef had hypothesized, at some point or threshold, further increases in GDP were generally accompanied by a slow decline in GPI. And interestingly, the threshold, the point where the correlation between GDP and GPI broke down, was about the same for all countries: a GDP of $7,000 per person.

The implication is that there is no real, long-term benefit to a society of growing its economy beyond an average GDP of $7,000 per person.

Now, because of the qualitative aspects of the GPI, I would not take the value of $7,000 to be definitive. But even so, it's pretty astounding when you consider that we Americans currently try to make do in an economy with an average GDP, by one estimate, of almost $50,000 per person. (The per capita income in the United States, defined as the total income of all people 15 years and older divided by the total population, is about $27,000 [xls]. Of course, because of income disparity, most Americans have less than $27,000 per year.)

Kubiszewski and co-authors conclude:

"If we hope to achieve a sustainable and desirable future, we need to rapidly shift our policy focus away from maximizing production and consumption (GDP) and towards improving human well-being (GPI or something similar).”

I can accept that notion and even applaud it: let's focus on well-being instead of materialism. Growth for growth's sake is so retro.

But what about taking Kubiszewski et al's conclusions to a more concrete level? The study suggests Americans would be just as well off, if not better off, if we slashed our eonomy by a factor of five or so. That would mean five times less goods and services and five times less consumption. Who among us is going to be the first to volunteer to take that cut? And there, my friends, is the rub.

Sidebar: Gross Domestic Product

Gross domestic product or GDP is defined as:

"The monetary value of all the finished goods and services produced within a country’s borders in a specific time period. ... It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory."

In the United States, GDP is calculated quarterly by the U.S. Commerce Department. See a listing of the various national GDPs here.

Most politicians and economists will tell you that we should root for ever-increasing GDPs. After all, a higher GDP means more stuff being bought and sold and that's a good thing, right? Not so, some have argued, including the Commission on the Measurement of Economic Performance and Social Progress, chaired by the Nobel Prize-winning economist Joseph Stiglitz. Just because our economy is generating more goods and services does not necessarily mean we're better off. In fact we may be worse off.

For example, clear-cutting a forest for its timber will add to the GDP but may very likely leave us poorer over the long term. The same goes for overfishing the ocean or removing mountains to mine for coal. As recent findings in China indicate, air pollution from economic activity can have a staggering impact of life expectancy.

And the GDP leaves out important activities, leaving unaccounted, for example, the economic benefit we get from unpaid services such as parents staying home to take care of children. For more see this post.

GDP Alternatives

Economists have proposed a variety of alternatives to the GDP to develop a better measure of how the economy is supporting and benefiting people and the planet.

Peter Bartelmus of the Bergische Universität Wuppertal in Germany and others have proposed using a "green GDP" or the environmentally adjusted net domestic product (EDP), which factor in environmental assets and services into the overall equation. If too much production is from depleting natural resources, the GDP may increase but the green GDP may actually decrease.

Other metrics that have been proposed include the Ecological Footprint, which assesses society's impact upon the environment; Biocapacity, which measures natural resource (e.g., arable land) capable of producing products or taking up waste; and the Human Development Index developed by the United Nations Development Programme to measure the overall well-being of people. (For more, see here [pdf] and here.)

This post focuses on another alternate metric called the Genuine Progress Indicator or GPI.

Crossposted with TheGreenGrok | Find us on Facebook