208 PllB.

T IV THE DATA OF MACROECONOMICS

'r···

..

grown on average about 3 percent per year. This continued growth in real GOP thE
enables most Americans to enjoy greater economic prosperity than their parents tell
and grandparents did. . G(
Asecond feature of the GOP data is that growth is not steady. The upward climb nol
of real GOP is occasionally interrupted by periods during which GOP declines, COl
called recessions. Figure 2 marks recessions with shaded vertical bars. (There is ho les:
ironclad rule for when the official business cycle dating committee will declare G[
that a recession has occurred, but an old rule of thumb is two consecutive quarters me
of falling real GOP.) Recessions are associated not only with lower incomes but I
also with other forms of economic distress: rising unemployment, falling profits, trit
increased bankruptcies, and so on. eVE
Much of macroeconomics is aimed at explaining the long-run growth and tha
. short-run fluctuations in real GOP. As we will see in the coming chapters, We an(
need different models for these two purposes. Because the short-run fluctuations eVE
represent deviations from the long-run trend, we first examine the behavior of frO]
key macroeconomic variables, including real GOp, in the long run. Then in later 1
chapters, we build on this analysis to explain .short-run fluctuations. ~ val
om
del
Quick Quiz Define real GOP and nominal GOP. Which is a better measure of eco­
But
nomic well-being? Why?
the
cen
wo
10-5 Is GOP aGood Measure of Econom'ic Well-Bei refl
i

Earlier in this chapter, GOP was called the best single measure of the economic tha
well-being of a society. Now that we know what GOP is, we can evaluate this pro
. claim. GD
As .we have seeI1J;pp measures both the economy's total income and the qua
economy's total expenditure on goods and' services. 'Thus, GOP per person tells us (

the income and expenditure of the average p~rson in the economy. Because most 100
people would prefer to receive higher income and enjoy higher expendihlre, GOP pri~
per person seems a natural measure of the economic well-being of the average $50
indIvidual. situ
Yet some people dispute the validity of GOP as a measure of well-being. When ave
Senator Robert Kennedy was running for president in 1968, he gave a moving I
critique of such economic measures: beir
inel
fGross domestic product] does not allow for the health of our children, the
quality of their education, or the joy of their play. It does not include the beauty
of our poetry or the strength of our marriages, the intelligence of our public de­
bate or the integrity of our public officials. It measures neither our courage, nor
our wisdom, nor our devotion to our country. It measures everything, in short,
except that which makes life worthwhile, and it can tell us everything about
America except why we are proud that we are Americans.
s
Much of what Robert Kennedy said is correct. Why, then, do we care about COP? vari
The answer is that a large GOP does in fact help us to lead good lives. GOP 1
does not measure the health of our children, but nations with larger GOP can of (
afford better healthcare for their children. GOP does not measure the quality of sch,
 CHAPTER 10 MEASURING ANATION'S INCOME 209

p their education, but nations with larger GOP can afford better educational sys­
:s tems. GOP does not measure the beauty of our poetry, but nations with larger
GOP can afford to teach more of their citizens to read and enjoy poetry. GOP does
h not take account of our intelligence, integrity, courage, wisdom, or devotion to
s, country, but all of these laudable attributes are easier to foster when people are
10 less concerned about being able to afford the material necessities of life. In short,
;'E! GOP does not directly measure those things that make life worthwhile, but it does
rs measure our ability to obtain many of the inputs into a worthwhile life.
ut GOP is not, however, a perfec': measure of well-being. Some things that con­
:s, tribute to a good life are left out of GOP. One is leisure. Suppose, for instance, that
everyone in the economy suddenly started working every day of the week, rather
ld than enjoying leisure on weekends. More goods and services would be produced,
ve and GOP would rise. Yet despite the increase in GOP, we should not conclude that
ns everyone would be better off. The loss from reduced leisure would offset the gain
of from producing and consuming a greater quantity of goods and services.
:er Because GOP uses market prices to value goods and services, it excludes the
value of almost all activitY. that takes place outside markets. In particular, GOP
omits the value of goods and services produced at home. When a chef prepares a
delicious meal and sellsit at her restaurant, the value of that meal is part of GOP.
co­ But if the chef prepares the same meal for her family, the value she has added to
the raw ingredients is left out of GOP. Similarly, child care provided in day-care
centers is part of GOP, whereas child care by parents at home is not. Volunteer
work also contributes.to the well-being of those in society, but GOP does not
reflect these contributions.
Another' thing that GOP excludes is the quality of the environment. Imagine
nic that the government eliminated all environmental regulations. Firms could then
his produce goods and services w:lthout considering the pollution they create, and
GOP might rise. Yet well-being would most likely fall. The deterioration in the
the qu~l~ty of air and water would more than offset the gains from greater production.
iUS GOP also says nothing about the distribution of income. A society in which
lOst 100 people have annual incomes of $50,000 has GOP of $5 million and, not sur·
;D1' prisingly, GOP per person' of $50,000. So does a society in which 10 people earn
age $500,000 and 90 suffer with nothing at all. Few people would look at those tWI)
situations and call them equivalent. GOP per person tells us what happens to the
hen average person, but behind the average lies a large variety of personal experience:;,
'ing fn the end, we can conclud.e that GOP is a good measure of economic wel­ GDP r~flects thefactory'S
being for most-but not all-purposes. It is important to keep in mind what GOP production, but not the harm it
includes and what it leaves out. i1~flicts on the environment.
the
mty
:de­
International Differences in GOP and the Quality of life
nor
lort, One way to gaugE the usefulness of GOP as a measure of economic
)out well-being is to examine international data. Rich and poor countries ha'le
vastly different levels of GOP per person. ff a large GOP leads to a higher
standard of living, then we should observe GOP to be strongly correlated with
DP? various measures of the quality of life. And, in fact, we do.
:;OP Table 3 shows twelve of the world's most populous countries ranked in oreer
'can of GOP per person. The table also shows life expectancy, the average years of
tyof schooling among adults, and the percentage of the population that reports
210 PART IV THE DATA OF MACROECONOMICS

The Underground
Economy
The gross domestic product misses many transactions·that take place
in the underground economy.

Searching for the

iilegal. And, of course, it's the sort of thing
Hidden Economy
that happens all the time.
~~-

By Doug Campbell International Differences in the

Underground Economy
.The size of the official U.S. economY,as
measured by Gross Domestic Product{GDP),
ere is the brief, unremarkable story of Underground .
H how I recently came to participate in the
underground economy: Country
Economy as a
Percentage of GDP
was almost $12 trillion in 2004. Measurements
of the unofficial economy--not including illegal
activities like drug dealing and prostitution­
Midafternoon on the iciest day this past Bolivia 68 percent differ substantially. But it's generally agreed to
winter, a man knocked at my front door. Zimbabwe 63 be significant, somewhere between 6percent
"Shovelyour walk?" he asked. "Only $5." Peru 61 and 20 percent of GDP. At the midpoint, this
Outside, it wasa bone-chilling 15 Thailand 54 would be about $1.5 trillion ayear.
degrees. "Sold," I said. Ahalf-hour later I Mexico 33 Broadly defined, the underground, gray,
handed over a five-dollar bill and thanked Argentina 29 informal, or shadow economy involves oth­
him for saving me the trouble. Sweden 18 erwise legal transactions that go unreported
Officia lIy, th is was a11 unoffiCia I Australia 13 or unrecorded. That's awide net, capturing
transaction-off the books, with no taxes Un'ited Kingdom 12 everything from babysitting fees, to bartering
paid or safety regulations followed. (At least, Japan 11 home repairs with aneighbor, to failing to re­
I assume this hired hand didn't bother to Switzerland 9 port paY,from moonlighting gigs. The "under­
report that income or register with the proper United States 8 ground" label tends to make it sound much
authorities.) As such, it was technically Source: friedriCh Schne;der, figures are for 2002, more sinister than it really is.

bei
TABLE Satisfied with
de
pe,
Real GDP per life Average Years Water Quality
GDP and the Quality 9c
Country Person Expectancy of Schooling (% of population)
of Life In
The table shows GOP United States $43,017 79 years 12 years 90 dit
per person and three Germany 35,854 80 12 95 thi
other measures of Japan 32,295 83 12 88 av(
the quality of life Russia 14, 561 69 10 53
for twelve major
Mexico 13,245 77 9 68 10Vl
countries.
Brazil 10,162 74 7 83 ofj
China 7,746 74 8 73 rna
Indonesia 3,716 69 6 87 are
India 3,468 65 4 63 stu
Pakistan 2,550 65 5 55 to l
Nigeria 2,069 52 5 47 wit
Bangladesh 1,529 69 5 70 lea'
Source, Human Oeveiopl):enl Repnl! ;ro 11, Un,ted Nat,ons. Real GOP IS for 2011. c,p(med '" 2005 dollars Avera" Yea,s 01 sch",,:mg is amo"g adulls 15 yeats zen
and oltler

QU

 CB.ilPTER 10 MEASURING ANATION'S INCOME 211

),
:s hand". theory that men pursuing
II t.hpjr6wn~lf~jriterest will generatebenefHs
~or~iety a:i awllole. This inv;siblehand has
to 'pfoddteilil (alrlysizable ondergroundcecon­
It "~n whannot understalld our.entire
;\(:/-t:!;;.<,-,'~_;%;t -_~:_-'~-ic-'v-,:_ _,'__
.:>_; ,­ -::,_ --':_""~
_"Y

"'~,cS)stef!twithout 'understaodfllg how

" '" .... tions; iOll!l­
grouM is @good'meas~n10f . . . . . .
... aodthe hea~h~IR~tionS,·~ch'losser;Wntes.
'Wtien mUch;sWrong, much nee<Js'f~1khid­
de.n. • Schklsse(simplic~ti~n was thaimuch
·s.lfM
~r­
some econo­
ch entire careers'to Source: "Region focus," Federal Reserve Bank of Rich­
An'lWllrina questions about the underground mond, Spring 2005.

being satisfied with the quality of water they have available. These data show a
clear pattern. In rich countries, such as the United States, Germany, and Japan,
people can expect to live to' about 80 and have 12 years of schooling; about
9 out of 10 people are satisfied with the quality of water they have to drink.
In poor countries, such as Bangladesh, Nigeria, and Pakistan, people typically
die 10 to 20 years earlier and have less than half as much scho5lling; about a
third to a half of the population is unsatisfied with the quality of water locally
available.
Data on other aspects of the quality of life ten a similar story. Countries with
low GOP per person tend to have more infants with low birth weight, higher rates
of infant mortality, higher rates of maternal mortality, and higher rates of child
malnutrition. In countries with low CDP per person, fewer school-age children
are actually in school, those 'Who are in school must learn with fewer teachers per
student, and illiteracy among adults is more common. These countries also te'1d
to have fewer televisions, fewer telephones, fewer paved roads, fewer households
with electricity, and fewer opportunities to access the Internet. International data
leave no doubt that a nation's GOP per person is closely associated with its clti­
zens' standard of living....

Quick Quiz Why should poficymakers care about GOP?

212 PDT IV THE DATA OF MACROECONOMICS

M~~~lJringMacroeconomic
WeU"Seing
Can we do better than usinggross domestic product?
Nations Seek Success
BeyondGDP
By Mark Whitehouse
oney isn't everything. But in measuring
M the success of nations, it isn't easy to
find asubstitute.
Political leaders are increasinglyexpress­
ing dissatisfaction with gross domestic
product-a monetary measure of all the
goods and services acountry produces-as a
gauge of anation's success in raisiflg living
standards.
In November, British Prime Minister David
Cameron announced plans to build measures
of national well-being that would take into
account factors such as peoples' life satis­
faction, following asimilar effort by French
President Nicolas Sarkozy.
Their efforts cut to the core of what eco­
nomics is supposed to be about: What makes
us better off? How can we all have more of it?
Anyone hoping for aclear-cut answer, though.
is likely to be disappointed.
"There is more to life than GOP, but it will
be hard to come up with asingle measure to
replace it and we are not sure that asingle
measure is the answer," said Paul Allin, director
of the Measuring National Well-Being Project at
the U.K.'s Office of National Statistics. "Maybe
we live in a multidimensional world and
we h~ve to get used to handling areasonable
number of bits of information."
After a session on creating anational
success indicator at the annual meeting
of the American Economic Association on
Friday, Carol Graham, fell~w at the Brookings
Institution, summed up the situation thus:
"It's like anew science. There's still alot of
work to be done."
For much of the past four decades, econo­
mists have puzzled ov~r a paradox that cast
doubt on GOP as the w.orld's main indicator
of success.
People in richer countries didn't appear
to be any ha ppier than people in poor coun­
tries. In research beginning in the 1970s,
University of Pennsylvania economist Richard
Easterlin found no evidence of alink between
countries' income-as measured by GOP
per person-~and peoples' reported levels of
happiness.
More recent research suggests GOP isn't
quite so bad. Using more data and differ­
ent statistical techniques, three economists
at the University of Pennsylvania's Wharton
School-Daniel Sacks, Betsey Stevenson
and Justin Wolfers-~found that agiven per­
centage increase in GDP per person tends to
coincide With asimilar increase in reported
well-being. The correlation held across differ­
ent countries and over time.
Still, for measuring the succeSs of pol­
icy, GOP is far from ideal. Making everybody
work 120 hours aweek could radically boost .
acountry's GOP per capita, but it wouldn't
make people happier. Removing pollution
limits could boost GOP per hour wO'rked, but
wouldn't flecessafily lead to a world we'd
want to live in.
One approach is to enhance GOP with
other objective factors such as inequality,
leisure and life expectancy. In apaper pre­
sented Saturday at the American Economic
Association meeting, Stanford econom./sts.
Peter Klenow and Charles Jones found·that
doing so can make abig difference. .
By their calculation, accounting for longer'
life expectancy. additional leisure time and
lower levels of inequality makes living stan­
dards in France and Germany look almost the
same as those in the U.S., which otherwise
leads the pack by alarge margin.
Mr. Klenow points out that the calcula­
tion is fraught with difficulties. For one, many

10-6 the se,

upsho
This chapte'r has discussed how economists measure the total income of a nation. Att
Measurement is! of course, only a starting point. Much of macroeconomics ingG[
is aimed at revealing the long-run and short-run determinants of a nation!s lives. E
GOP. Why, for example, is GOP higher in the .United States and Japan than in erswh
India and Nigeria? What can the governments of the poorest countries do to Concrel
promote more rapid GOP growth? Why does GOP in the united States rise rap­ econon
idly in some years and fall in others? What can U.s. policymakcrs do to reduce science
 CHAPTER 11) MEASURING ANATION'S INCOME 213

ever after
wealth doesn't always translate into greater quality of rife, when factors such as
and length of life are included.
Well-being Index Per capita GDPindex
~{~;~';~;._
_ _• _•
_ •_ 100~ ;'1 ~·.·:+1:::[.Y"':::I01]1 ;l,\Oo.n;
•98,(

!/ '"'~)47:f
_25.9
'.12.2' _'21.8
.8.6 "20.9
just pphil!SS,"
.7.1 _18.4 measuTlljust onepartof'whatmakes for a
.6.6 .10.8
full life you're going to end upl1armirlg the
• 5.3 .11.3
other parts."
for the time being, that leaves policy
"21.6
makers to (hoose the measures of success
16.6
that seem most appropriate for the task at
_17.9
hand. That'5 not ideal, but it's the best eco­
12.9
nomics has to offer. ,.4

Source: 1/Je WJ/I Street Joumal,January 10, 201l.

the severity of these fluctuations in GDP? These are the questions we will take
up shortly.
on. At this point, it is important to acknowledge the significance of just measur­
.ic~
ing GDP. We all get some sense of how the economy is doing as we go about our
,n's
lives. But the economists who study changes in the economy and the policymak­
tin ers who formulate economic policies need more than this vague sense-they need
>to concrete data on which to base their judgments. Quantifying the behavior of the
ap­ economy with statistics such as GOP is, therefore, the first step to developing a
lice science of macroeconomics.