Grossly Distorted Performance: Accounting & Business

Posted on December 29, 2009 · Posted in Accounting & Business

 

Did you hear the joke about the French President who suggested replacing GDP with a measure of national happiness? If you read the British press, you probably did. Around much of the world, though, no one is laughing.

 

Nicholas Sarkozy was certainly deadly serious setting-up the Commission on the Measurement of Economic Performance and Social Progress and in launching its report. And the report’s authors are not people to dismiss as comedians.

 

Joseph Stiglitz, a Nobel winning economist and senior economic advisor to President Bill Clinton, chaired the commission. Another Nobel economist – Amartya Sen, of Harvard University – was its advisor. Nick Stern of the London School of Economics – given the job by the UK’s Treasury of quantifying the economic impact of climate change – was another panel member.

 

For Sarkozy, challenging GDP as an economic measure is not only nothing to snigger about, it is also a very important priority – going to the heart of what he sees as the Anglo-Saxon domination of economic thinking. “GDP has increasingly become used as a measure of societal well-being and changes in the structure of the economy and our society have made it an increasingly poor one,” said Sarkozy at the report’s launch.

 

Behind the cult of figures, behind all these statistical and accounting structures, there is also the cult of the market that is always right.”

 

But the commission’s report goes far beyond considering whether we have become fixated with materialism. It also asserts that as a measure of economic value, GDP is a pretty poor system of assessment. For example, GDP only measures goods and services bought within the market economy. Consequently, healthcare, social services, schools and childcare that are provided by the state and paid for through taxation are not measured – whereas those same services when supplied by the private sector count as part of GDP.

 

This, inevitably, boosts US GDP, while downplaying the economic performance of a country such as France whose public sector plays a more significant role. The effect, concluded the commission, is that using the GDP measure, France has only 73% of the wealth per person of the US. Yet the figure is actually 87% when adjusted for public sector supplies.

 

There are other weaknesses of GDP as a measure of economic output. It is a measure of commercial output, rather than the wealth of a country’s citizens. It fails to take into account the financial cost of GDP, nor the accumulated debt. In the period 2000 to 2008, GDP in the US increased strongly. Yet household income fell by about 4%. If more attention had been paid to this, and less to GDP, there might have been a strong (and healthy) sense of impending doom, suggests the report.

 

Stiglitz and colleagues make another important point. GDP, they argue, is like looking at only the assets side of a balance sheet. There is no sense of the liabilities that are being created. Specifically, environmental pollution and destruction generate long-term social and financial costs. A massive open cast mine will be seen positively in GDP, but may be a massive burden on future generations in terms of repairing the physical damage and in caring for people made ill by contact with harmful minerals.

 

A firm would look at its assets and liabilities if it wanted to see if it was better or worse off,” explained Stiglitz. “Yet we don’t look at any of these things when we talk about the balance sheet of society.”

 

In fact, the report has many more arguments than this in claiming that GDP is generally a rather poor measure for assessing national or global wealth. At nearly 300 pages long, and containing the collective wisdom of five Nobel prize winning economists and another 25 of the world’s most renowned social scientists, it is inevitably a long and detailed study.

 

Yet it might be very wrong to assume this is merely a worthy document that will go nowhere. Sarkozy has said he will now use alternative economic measures as proposed in the report to measure France’s social and economic progress.

 

And the question of whether more countries follow France’s lead may become an indicator of Sarkozy’s international influence. The president has promised (or threatened) to raise the report at every international conference he attends until other leaders accept its recommendations. Despite this individualistic approach to diplomatic relations, he has made a very good start.

 

Both the OECD and the European Commission strongly support the project. Angel Gurría, the OECD’s Secretary-General, said: “Economic resources are not all that matter in people’s lives. We need better measures of people’s expectations and levels of satisfaction, of how they spend their time, of their relations with other people in their community. We need to focus on stocks as much as on flows, and we need to broaden the range of assets that we consider important to sustain our well-being.”

At present, he observed, there is a growing gap between what official statistics say about nations’ economies and how people regard their living conditions. “This gap can be clearly damaging both to the credibility of political debate and action and to the very functioning of democracy in our countries,” he warned.

 

Both the OECD and the European Commission are working on their own proposals for how best to assess national wealth and outputs. European Environment Commissioner Stavros Dimas explained: “To meet the challenges of the 21st Century we need more integrated and transparent policies. To design these policies we need to better assess where we are now, where we want to go and how we can get there. To change the world we need to change the way that we understand the world and to do this we need to go beyond GDP.”

 

But there is a warning in the report about systems of measurement that has an echo of the row over the use of fair value in accounting standards. In the end, says the commission, no single measure can provide all that is needed to know about economic output or value. There is no alternative, they suggest, to using more than one measure. Accounting standards setters, please note.

 

 

Recommendations:

 

* Income and consumption, not production, should be measured when evaluating material well-being.

* Household perspectives should be emphasised.

* Income and consumption should be considered jointly with wealth.

* Prominence should be given to distribution of income, consumption and wealth.

* Non-market activities should be taken into account.

* Quality of life indicators should comprehensively consider inequalities.

* Relationships between quality of life factors should be considered.

* Measurements should include objective and subjective well-being factors.

* A basket of sustainability indicators, not just monetary, should be used.

* A further report is needed to provide an indicator of dangerous levels of environmental damage.