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China’s wisdom on GDP growth

3 July 2013 By Edward Hadas

“We should no longer evaluate the performance of leaders simply by GDP growth. Instead, we should look at welfare improvement, social development and environmental indicators.” That is a fine piece of wisdom from Xi Jinping, China’s president. Leaders of developed economies can learn from it.

Xi was speaking to a domestic audience about the choice of leaders within the ruling Communist Party. The desire for people who are “devoted fighters for the socialism with Chinese characteristics” is distinctly local, but Xi identified a fact which transcends all Chinese characteristics: GDP is a poor measure of economic progress.

Actually, for China, GDP is modestly helpful. In a country still so poor, increases in output correlate well with genuine economic improvements: factories and farms producing more and better goods, enterprises offering more and better services, and so on. Still, Xi is right that China is ready to outgrow this crude indicator. The idea is all the more relevant in richer economies, where GDP growth is a terrible measure of economic progress.

Xi lists only three of the many things that GDP does not capture. He could have added investment, which is counted only indirectly; quality, which is reflected dimly in “hedonic adjustments”; and the economic good, which is totally ignored. But his list is damning enough.

The lack of “environmental indicators” in GDP, which includes only things that are sold, is a greater problem in China than in more developed countries with stronger institutions. American mayors might be just as willing as their Middle Kingdom peers to ignore emission standards to attract a new factory. But the Americans have to worry about emissions limits as well as GDP, while up to now Chinese officials could mostly focus solely on production. 

The other two gaps identified by Xi – social development and welfare improvement – are certainly pertinent to China, but they are even more important for developed economies. 

Economic inequality is a sure sign of poor social development. GDP, an aggregate measure, misses it. GDP increases by the same 1 million yuan whether the money purchases food for thousands of malnourished peasants or stuffs hunting trophies for a few plutocrats.

Unbalanced growth is a problem in China, but at least the country is growing fast. Since real GDP is increasing by 6 percent to 8 percent annually, the poor are almost certainly getting richer, even if the rich are getting wealthier faster. Beijing may only need to nudge future growth to favour the poor.

In the United States and other developed economies, however, the overall annual GDP growth rate is no higher than 2 percent per person. With so little additional production to share out, it is much more likely that the rich become so much richer that everyone else actually becomes poorer. By most measures, this is exactly what has happened in America. That is unjust and should be politically unacceptable.

Economists who emphasise GDP are ill-equipped to understand this problem. Politicians who hope that faster total GDP growth will solve it are missing the point, too. In mature, developed economies, GDP does not increase fast enough to reduce inequality substantially. A fairer allocation of resources requires hard choices, by politicians and society at large, on wages and taxes.

Employment is a good example of Xi’s economic welfare. In China, higher GDP still basically brings higher employment, because job-creating investment in new production outweighs job-destroying spending on increased automation. Build a new factory, open a new store or supply a new service, and jobs come along naturally. 

In developed countries, where most economic desires are already satisfied, the balance is probably tilted the other way – increased productivity destroys more jobs than it creates. Higher GDP still correlates with increases in employment, but the prime causality is from new jobs to more recorded output, not the other way around.

Excessive focus on the single GDP measure leads policymakers in developed economies to see GDP-boosting monetary and fiscal policies as the best way to address high unemployment. The indirect approach is unlikely to succeed. If welfare were the explicit goal, as Xi suggests, they would ignore GDP and work on creating jobs directly.

Xi may struggle to get his way. It is hard to destroy traditions – almost icons – like GDP, even in a one-party state. It will be even harder in rich countries, if only because investors, who mostly love excessively simple ideas, have latched onto the measure. They would not be comfortable if policymakers used a dozen indicators, and a large dose of qualitative judgment, to set and evaluate policies.

However, the fight against GDP is worth the effort. After all, in almost every developed economy, inequality and excessive unemployment are far greater challenges than inadequate production. Under the circumstances, the use of GDP as the prime measure of economic success is scandalous.

 

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