Measuring The Standard of Living

Introduction

• The standard of living is a measure of material welfare.
• The baseline measure is real national output per head of population or real GDP per capita
• Real income per capita is an inaccurate and insufficient indicator of living standards

National income data can be used to make cross-country comparisons. This requires

• Converting GDP data into a common currency
• Making an adjustment to reflect differences in the cost of products in each country to produce data expressed at ‘purchasing power parity’ standard.

The chart below tracks changes in real per capita national income adjusted for PPP for a selection of African countries. Note: not all countries have seen their absolute position improve.

Problems in using national income statistics to measure living standards

Official data on GDP understates the growth of real national income per capita over time due to theshadow economy and the value of unpaid work by volunteers and people caring for their family.

The "shadow economy" includes illegal activities such as drug production and distribution, prostitution, theft, fraud and concealed legal activities such as tax evasion on otherwise-legitimate business activities such as un-reported self-employment income.

The scale of the “shadow economy” varies across countries at different stages of their development.

According to the IMF, in developing countries it may be as high as 40% of GDP; in transition countries of central and Eastern Europe it may be up to 30% of GDP and in the countries of the OECD, the shadow economy may be in the region of 15% of GDP. 

Here are some reasons why GDP data may give a distorted picture of living standards in a country:

1. Regional variations in income and spending: National GDP data can hide regional variations in output, employment and income per head of the population.
2. Inequalities in income and wealth: Average (mean) incomes might be rising but inequality could grow at the same time
3. Leisure and working hours and working conditions: An increase in real GDP might have been achieved at the expense of leisure time if workers are working longer hours or if working conditions have deteriorated.
4. Imbalances between consumption and investment: High levels of investment as a share of GDP might be superb for creating extra capacity to produce but at the expense of consumer goods and services for the current generation.
5. Changes in life expectancy: Improvements in life expectancy don’t always show through in the GDP accounts. Putting a monetary value on the benefits of increased longevity is difficult.
6. The value of non-marketed output: Much useful and valuable work is not produced and sold in markets at market prices. The value of the output of people working unpaid for charities, self-help groups and of housework might reasonably be added to national income statistics.
7. Innovation and the development of new products: New goods and services become available because of invention and innovation that simply would not have been available to the richest person on earth less than fifty years ago. About half of what we spend our money on now was not invented in 1870. Examples include air travel, cars, computers, antibiotics, hip replacements, insulin and many other life-enhancing and life-saving drugs
8. Environmental considerations: Rising output might have been accompanied by an increase in air and noise pollution and other externality effects that have a negative effect on our social welfare.
9. Defensive expenditures: Much spending is to protect against an “economic or social bad” e.g. crime, or spending to clean up the effects of pollution and waste