Foreign Trade University ESSAY MACROECONOMICS Question: Some people believe that Gross Domestic Product (GDP) is an inadequate measure of societal well-being and should be replaced by the Human Development Index (HDI) Do you agree with them? Hanoi, November 2012 Nowadays there are a number of methods to calculate and evaluate the wellbeing of a nation, and the most common of them is national income, which is usually expressed as Gross Domestic Product (GDP) However, Human Development Index (HDI), which was introduced by United Nation Development Program (UNDP) in 1990, is considered by many people as a better replacement for the GDP in evaluating the well-being of a society This essay will state the definitions and origins of GDP and HDI, then discuss why HDI is better than GDP in measuring the societal well-being of a nation GDP, which was firstly presented by Simon Kuznets in his report to U.S Congress in 1937 (Dickinson 2011, p.1), is “the market value of all final goods and services produced within a country in a given period of time” (Mankiw 2003, p.208) GDP can be calculated by main ways: expenditure, income and product approach Each way has its own formula and elements but the results are always the same The most usual way is the expenditure method, which defines the GDP as the sum total of private consumption, gross investment, government spending and net export (Mankiw 2003, p.211): Private Consumption Gross Investment Government Spending Net Export GDP Figure - The components of GDP While GDP has been used by most countries in the world for about three quarters of a century, HDI only appeared just 22 years ago In 1990, the UNDP presented the formulation of HDI in its first annual Human Development Report (HDR), which introduced the concept of “human development” as progress towards greater human well-being, and provided country-level data for a wide range of wellbeing indicators (Stanton 2007, p.3) From that time, HDI has been the centerpiece of the HDRs, and the latest edition, HDR 2011, includes HDI rankings for 187 countries The Human Development Index is a summary measure for monitoring long-term progress in a country’s average level of human development in three basic dimensions: a long and healthy life, access to knowledge and a decent standard of living (UNDP 2011, p.168) The following diagram will explain how to calculate the HDI using the new method for 2011 onwards: Define the goalposts Set the minimum and maximum values for the variables: Life expectancy at birth Mean years of schooling Expected years of schooling Combined education index GNI per capita (PPP $) Calculate the sub-indices The three dimension indices - Life Expectancy Index, Education Index and Income Index - are calculated as follow: For education, the equation is applied to each of the two sub-components, then reapplied to the geometric mean of the resulting indices For income, natural logarithm of the actual, minimum and maximum values is used Produce the HDI The HDI is the geometric mean of the three dimension indices: Figure - Steps to calculate the HDI (Source: UNDP 2011, p.168) As can be seen in the formulas for calculating GDP and HDI presented above, the HDI embraces the enlargement of all human critical choices: life expectancy, education and income, while GDP focuses only on the third choice - income Since we aim to measure the societal well-being, which means we focus on the comfort, happiness and life-satisfaction of people, there are many factors affecting it, not only the income or productivity A person’s access to income may be one of the choices, but it is not the sum total of human endeavor Human development is a process of enlarging people’s choices The most critical of these wide-ranging choices are to live a long and healthy life, to be educated and to have access to resources needed for a decent standard of living Additional choices include political freedom, guaranteed human rights and personal self-respect (UNDP 1990, p.1) Therefore, HDI is far more comprehensive and multidimensional than GDP in measuring well-being of society Secondly, while certain activities that have a negative impact on the people's well-being could end up being recorded as great contributions to the GDP, HDI is less likely to be influenced by those activities For example, rising criminal activities can increase the country's GDP through greater expenditures toward maintaining law and order (e.g., hiring of additional police members, purchase of guns, prison, etc.), thus the Income Index will increase However, those activities can harm or kill people, therefore Life Expectancy Index will decrease Besides that, crimes are usually committed by less educated people, so the Education Index will decrease, too Two indices fall and the remaining index rises; as a result, we cannot assert whether the HDI will change or not However, the probability that HDI will change slightly or remain constant is relatively high Another example is the consequence of having environment polluted Suppose that the government eliminated all environmental regulations, so that firms could produce goods and services without considering the pollution they create As a consequence, the GDP might increase, but life expectancy of people would be reduced because of environmental pollution, therefore the HDI might change a little bit or not change at all Moreover, Khadija Haq (2007, p.4) claimed that HDI could be used as an indicator for policy-makers to inform public policies when compared to GDP If a country’s HDI rank is higher than its GDP per capita rank, policy-makers may assure that their social priorities are headed in the right direction and the country are building an adequate base of human capital for accelerated growth in the future It also reminds them to take action to correct the imbalance on the economic growth side as social progress cannot be sustained for long without an adequate economic base Conversely, if the rank of HDI is lower than that of GDP per head, it reveals the inequitable distribution of economic benefits among all sections of society It will prompt them to believe that it is plausible to generate greater welfare at that level of income in comparison with the countries of the same GDP per capita and they will have motivation to devise policies so as to change the situation One more thing is, HDI can be usefully disaggregated by gender, geographic region or others to present relevant policy choices Since disaggregated HDI may reveals the weak point in a country, such as poverty density in a particular region, lack of education in a particular group, it act as an early warning for the authority to address these issues in a timely manner (Haq 2007, p.9) Particularly, for some developing country, HDI is relevant as it captures far more reality than GDP Khadija Haq (2007, pp.5-7) listed three advantages of HDI for policy makers of developing countries The first advantage is that HDI starts a desirable healthy competition among countries to surpass its neighbors or favorite competitors in rankings Such competition forces the government to review why their country lags behind one or more neighbors and induces them to undertake policies to overcome shortcomings Second, HDI identifies the area which needs prior attention For instance, if the HDI of a country is low, resulted from short life expectancy due to some infectious epidemics, the government will have to emphasize on improving the sanitary standard, especially in rural, remote and mountainous areas Third, analyzing HDI can help identify the future potential of a country’s economic growth If a country has already built up considerable human capital, by choosing the right macroeconomic policies, the economy can grow significantly in a reasonably short time period Beside many strengths of HDI that we have mentioned above, it still bears some minor drawbacks Some people may argue that HDI, though more comprehensive than GDP, still cannot include all the aspects in life But the fact is, “The contrast between what great things human beings can achieve and what limited lives most women and men end up living is truly remarkable.” (Amartya Sen, n.d cited in Pagliani 2011, p.26) It means not all people can achieve the same list of expectation In addition, some other factors such as political freedom, self-respect, moral or spiritual aspects…are not available in data and difficult to measure in terms of number Another shortcoming of the HDI is the high correlations between the subcomponents, thus leads to a supposition that HDI can be calculated only with GDP per capita Allen Kelley (1991 cited in Stanton 2007, p.22), for example, begins by agreeing with HDR 1990 on the essential differences between HDI to GDP per capita and (see Figure 3, which reproduces a graph of the HDI versus GDP per capita from HDR 1990 updated with 2001 data from HDR 2003), but then plots HDI against log income per capita (see Figure 4, which reproduces Kelley’s graph with updated data), and concludes that, “The notable disparity between HDI and GDP/N, as highlighted in the HDR, vanishes Indeed, log GDP/N appears to represent a reasonable approximation to the HDI.” Figure - HDI versus GDP/N Rankings (2001) (Source: UNDP, 2003 cited in Perkins et al., 2006) Figure - HDI versus Log GDP/N Rankings (2001) (Source: UNDP, 2003 cited in Perkins et al., 2006) Figure - HDI versus GDP/N by country (Source: UNDP, 2003 cited in Perkins et al., 2006) However, health and education, as well as other well-being indicators, depend not only on income but also on many other factors In Figure 5, the scattered pilot shows the considerable variances of HDI around the GDP/N-HDI trend line, especially in countries with low income per capita It means that all of the information in HDI could not be expressed only with GDP per capita, and HDI still provides additional, more nuanced information about the well-being of a society (Stanton 2007, p.27) In conclusion, HDI, as a more meaningful measure of development, is now quite well-established Its value, importance and relevance are also recognized Does it mean that its imperfections are to be overlooked? Of course not It shares the shortcomings of other composite indices But the point is that the GDP is also a major composite indicator If we can live with GDP for about 75 years, the HDI, which is only 22 years old, deserves a chance All the human development composite indices and indicators, including the HDI, are in the process of evolution With regard to the HDI, as has been pointed out, refinements have been made over the years both with regard to methodological issues as well as statistical sophistication Monitoring human development is important for assessment, policy making and enhancing lives of millions Research is going on – both within the Human Development Report Office and in academic and research institutions We have advanced quite a lot, but we have miles to go BIBLIOGRAPHY Commission on the Measurement of Economic Performance and Social Progress 2008, Survey of existing approaches to measuring socio-economic progress, viewed 23 October 2012, Dickinson, E 2011, ‘GDP: a brief history’, Foreign Policy, viewed 22 October 2012, Haq, Khadija 2007, Human development index and its relevance for developing countries, speech at the Foreign Service Academy, Pakistan, viewed 21 October 2012, Jahan, S 2000, Measuring human development: evolution of the human development index, viewed 23 October 2012, Mankiw, NG 2003, Principles of macroeconomics, 3rd edn, South-Western College Pub, Nashville Pagliani, P 2011, The human development approach and people with disabilities, PowerPoint slides, United Nation Development Program, New York, viewed 23 October 2012, Perkins, DH, Radelet, S & Lindauer, DL 2006, Economics of development, 6th edn, W W Norton & Company, New York Stanton, EA 2007, The human development index: a history, viewed 24 October 2012, United Nation Development Program (UNDP) 1990, Human Development Report 1990, New York Oxford, New York, viewed 21 October 2012, United Nation Development Program (UNDP) 2011, Human Development Report 2011, Palgrave Macmillan, New York, viewed 22 October 2012, ... notable disparity between HDI and GDP/ N, as highlighted in the HDR, vanishes Indeed, log GDP/ N appears to represent a reasonable approximation to the HDI. ” Figure - HDI versus GDP/ N Rankings (2001)... of HDI around the GDP/ N -HDI trend line, especially in countries with low income per capita It means that all of the information in HDI could not be expressed only with GDP per capita, and HDI. .. differences between HDI to GDP per capita and (see Figure 3, which reproduces a graph of the HDI versus GDP per capita from HDR 1990 updated with 2001 data from HDR 2003), but then plots HDI against