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What is the best way to measure economic welfare?


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Economics 101



The nation's level of prosperity, and economic welfare, must be measured to help governments determine future policies and the effectiveness of previous policies. Without quantifying economic welfare, it would be impossible to prevent costly and irreversible policy decisions, so it is vital to use the best possible measure. In my discussion, I will explain the shortcomings of popular measures, explore the three inputs of the Human Development Index and why each one is necessary. I will then conclude that although the HDI is flawed, it is the best method as it is well-balanced and allows a straightforward comparison of economic welfare between countries.


Economic welfare can be assessed with various methods, each concentrating on different factors – GDP per capita is more quantitative and often used to measure average income. However, it could be misleading without considering income inequality. A bracket of hyper-wealthy individuals in an impoverished society can skew the value to create false conclusions, misrepresenting the nation's financial health [1]. Alternatively, qualitative methods, such as the happiness index [2], are very subjective, as people have different interpretations of happiness. It uses normative judgements on whether people are happy and does not include tangible indicators of prosperity. Therefore, it is crucial when selecting the optimum measure of economic welfare to ensure that it is well-grounded while maintaining accuracy and validity.


The HDI [3] combines education, health and income to provide a holistic view [4] of a population's economic welfare and allows comparison of countries based on development. It produces a clearer image of economic welfare than individual measures due to its multivariate aspect, taking into account different perspectives.


Firstly, education shows potential economic growth - with a high education rate, more skilled labourers will be available in the future. This means it is an essential indicator of economic welfare; thus, it is measured using the mean and expected years of schooling, allowing the HDI to assess economic welfare from a skills-based perspective accurately. Furthermore, differentiating between less and more developed countries is possible, as the latter are more likely to have expensive, publicly-funded mandatory schooling programs. One caveat to this is that years of education does not necessarily show the quality of education, which may skew figures for economic welfare in countries with a lack of skilled teachers.


Economic welfare also relies on people working and interacting, so health [5] becomes a key factor. Frequently ill employees cannot work as often or as productively - as evidenced recently – negatively impacting economic welfare, but other measures often overlook this. However, the HDI accounts for this using life expectancy, allowing us to assess the country's healthcare system from early deaths and the availability of care to live longer.


The final element is income, represented by GNI per capita [6]. Economic welfare is essentially the general standard of living, and it relies on people being able to buy goods and services to enrich their lives. Consequently, an indicator of purchasing power is essential in the index, and GNI per capita fits this role perfectly, showing the average income based on purchasing power parity [7]. However, as mentioned initially, this is a measure prone to income inequality - the reason why it works in the HDI is because it is used alongside the two other measures, and so if a country has a high GNI per capita but poor education and life expectancy, the overall low economic welfare is still conveyed.


As its inputs are not substantial individually, HDI can be flawed like other measures; however, using three crucial variables prevents the discrepancies caused by using only one. Combining them provides a well-grounded and accurate overview of an economy and the standard of living of its citizens, enabling us to rank countries from high to low development better than in other measures, and generally, this is a valid indicator of economic welfare.


References:

[1] Mark Thoma, ‘Why GDP fails as a measure of well-being’, CBS News, 2016 https://www.cbsnews.com/news/why-gdp-fails-as-a-measure-of-well-being/


[2] World Happiness Report, ‘World Happiness Report 2021’, World Happiness Report, 2021


[3] United Nations Development Programme, ‘Human Development Reports’, United Nations, 2021 http://hdr.undp.org/en/content/human-development-index-hdi


[4]Jude Jordan, ‘Human Development Index: The New GDP?’, Medium, 2017 https://medium.com/4thought-studios/human-development-index-the-new-gdp-34ce23fc8bd1#_ftn1


[5] McKinsey Global Institute, ‘Prioritizing health: A prescription for prosperity’, McKinsey & Company, 2020 https://www.mckinsey.com/industries/healthcare-systems-and-services/our-insights/prioritizing-health-a-prescription-for-prosperity


[6] Investopedia Team, ‘Gross National Income (GNI)’, Investopedia, 2021 https://www.investopedia.com/terms/g/gross-national-income-gni.asp


[7] Tutor2u, ‘Human Development Index (HDI)’, tutor2u, 2021 https://www.tutor2u.net/business/reference/human-development-index-hdi


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