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1 OVERVIEW v
a Correcting the G, D and P of GDP ............................................................ vi
b Correcting NNI for changes in the total capital stock: human and natural capital .............vii
c Leisure and voluntary caring and community action ............................................viii
d Congestion .................................................................................. viii
e The distribution of income .................................................................. viii
f Non-economic aspects of wellbeing ............................................................x
f1 Environment ..........................................................................x
f2 Political capital ....................................................................xi
f3 Zero weighted dimensions of our index ................................................xi
f4 Social capital .......................................................................xi
g Gross National Suffering .....................................................................xii
g1 Health ...............................................................................xii
g2 Employment-related satisfaction ......................................................xiii
OVERVIEW
In the first three decades of the 20th century as economists debated the
scientific criteria by which one might conclude that one state was better than
another in economics, the emerging practice of national accounting provided
another means of assessing the state of an economy.
Though the shortcomings of Gross Domestic Product (GDP) were well understood
as a yardstick of economic welfare at the time and are well understood by
economists today, by processes not dissimilar to the one in which the poorer
VHS standard beat out BetaMax, GDP has become the standard shorthand
means of assessing economic welfare.
Yet GDP captures production within the market but not outside the market -
counting the labour used to make sandwiches sold at milk bars but not of those
made at home.
Leisure contributes to wellbeing, but not to GDP.
GDP measures production but not consumption, which is the point of production.
And running down our natural or social capital or building our knowhow or
‘human capital’ does not register in GDP, though it may impoverish future
generations.
But even if some or all of these inadequacies with the way GDP measures
wellbeing were corrected, by building a new measure of economic wellbeing,
man does not live by bread alone.
Since at least the late ’60s, increasing interest has been shown in how we might
go beyond the measurement of human wellbeing in dollars and cents.
Interest has intensified again in the last half decade with major initiatives to
measure national wellbeing in France, the UK and Canada.
Indeed, as this report was being written the OECD launched a major initiative
to measure wellbeing across its member countries.
Central Finding: There is significant interest globally in establishing a
better indicator of economic progress and wellbeing than GDP. However,
there is no consensus or an ‘off-the-shelf’ methodology than can easily
be replicated in Australia with existing data sources.
The Herald/Age - Lateral Economics HALE Index of wellbeing has been built
against the following criteria. It should, within the bounds of practicality, be:
* intellectually rigorous and comprehensive;
* commonsensical;
* responsive to emerging developments;
* politically and ideologically nonpartisan
Broadly speaking, five strategies are typically employed in building an index of
wellbeing:
* National accounting data can be augmented to address the
weaknesses of GDP as a measure - as occurred, for instance with the
so called ‘Genuine Progress Indicator’ constructed to address left
leaning concerns about the inadequacies of GDP.
* An index can measure subjective wellbeing by aggregating people’s
answers to surveys on how they feel and how their society is faring.
This is the methodology behind the Australian Unity Wellbeing Index.
* A composite index can be constructed that aggregates measures over
a wide number of domains into a single number - as is the case with
the Canadian Index of Wellbeing.
* The same approach can be taken with users invited to vary the
weightings given to the index according to their own values - as with
the recently released OECD Better Life Index.
* Finally, a ‘dashboard’ approach can collect data over a range of
dimensions while discouraging any definitive aggregation of the
information therein into a summary index.
The index set out in this report is a hybrid of the first four of these approaches.
A composite index was initially considered, but as we constructed it we became
aware of the costs of moving away from the logic of national accounting.
Though money is far from the measure of all things, as we proceeded we saw
that it provided a yardstick by which we might get some approximate bearings
on the relative importance of each domain and sub-domain within the index.
As a consequence we took the first approach of correcting and augmenting
GDP as far as we could take it, and then topped and tailed the index with some
adjustments to bring in considerations that national accounting measures
cannot.
Although, some subjective assessments of wellbeing cannot be
avoided, we have used what information is available to calibrate the relative
importance of the various components of national accounts to wellbeing.
a Correcting the G, D and P of GDP
As John Quiggin comments, the problem with Gross National Product as an
index of wellbeing is that it is:
* Gross - and so does not make allowances for the depreciation of
capital;
* Domestic - and so does not take into account income from production
activities offshore that might nevertheless earn a return for Australians
- as, for instance, do the offshore operations of Australian-owned
firms; and
* Production based - when the ultimate point of production is to
consume.
All these problems can be relatively straightforwardly finessed by moving from
GDP to NNI, or Net National Income, which measures income paid to nationals
(what they can consume) net of the depreciation of physical or produced
capital.
b Correcting NNI for changes in the total capital stock: human and
natural capital
In fact, except for unusual circumstances, the growth of NNI tends to track GDP
quite closely.
The largest inadequacies in using GDP as a measure of welfare
also apply to the use of NNI as a measure.
Neither GDP nor NNI take into account two of the most important forms of capital
at our disposal.
These are natural capital and human capital.
Natural capital includes the positive value of renewable and non-renewable
resources such as land and minerals as well as the value of the environment as
a public good - not just for our enjoyment, but also as a sink for our wastes.
As carbon emissions increase, the scientific evidence suggests that they
degrade our environment in ways that detract from our wellbeing.
As our society and economy have become more dependent on ideas and
technology, knowhow or ‘human capital’ has grown more important.
Today it represents between 60 and 80 per cent of all capital.
Given this, it is quite obvious that a large part of the story is missing if we
do not account for human capital.
The Herald/Age - Lateral Economics (HALE) Index of Wellbeing includes
measures of the net effect of our activities on our natural capital by taking into
account rural land degradation (1) and both the depletion of natural resources
through mining and the discovery of new assets (and the changing profile of
viable mines given the current price of minerals and the state of mining
technology).
***Footnote (1)
Ideally we would have included augmentation of the economic value of land,
which may offset the detrimental impacts of land degradation.
However current ABS statistics do not allow us to
do this in a robust way.
We have removed changes in urban land values from this calculation
as they do not measure changes in natural capital.
Indeed, it is not clear how to handle changes in urban land values.
On the one hand, land values measure the economic utility of the land, but one
might also look upon them as measuring the economic disutility of urban
development, with the highest land values measuring the limit of people’s
preparedness to pay to avoid the disutility of the city’s congestion costs.
***End Footnote (1)
We also add a risk-weighted Net present value (NPV) of the likely
negative value of climate change based on the assessed likelihood of three
scenarios from mild to extreme warming from now to 2100.
We also measure human capital accretion and destruction looking at early
childhood development, school performance and retention, post-secondary
schooling education and training as well as destruction of human capital
through longer-term unemployment.
c Leisure and voluntary caring and community action
Non-market activity - such as leisure when not working and voluntarily caring
for others and the community - are major sources of wellbeing and ultimately of
economic output.
Yet they are not captured in the national accounts.
However, we take the principle purpose of the index to reflect on changes
within Australia over time rather than between Australia and other countries.
Given substantial international differences in the working hours of the employed,
any reasonable summary accounting for differences in economic welfare
between countries would have to make allowance for these factors.
However, given that these factors would change only gradually in Australia over
time, given the practical difficulties of accounting for this aspect as well, and
given the state of our statistical collections, we have not measured these
aspects of Australian life in our index.
d Congestion
The Bureau of Transport and Communications Economics (2007) estimated
congestion costs in 2005 to have been around $10 billion and expected them to
double by 2020.
If they were captured in our measure it would likely reduce economic wellbeing
by about 1˝ to 2 per cent by 2020, a substantial but not massive effect.
Ideally we would like to include them in our index.
However, we have been unable to locate a satisfactory means of measuring them
with reasonable regularity.
Even if we were able to include them, the likelihood is that they would shave a
little under 0.1 per cent of growth of our index each year in a relatively steady way,
so that their absence is unlikely to substantially undermine the information our index
captures.
e The distribution of income
It was a commonplace in early 20th-century economics that economic
resources and the money to command them were a means to an end rather
than an end in themselves and that that end was a good life - though of course
people would differ on what that comprised.
As a consequence, like other commodities, the efficacy of money in facilitating
the good life suffered from ‘diminishing returns’.
Thus leading economists in the English tradition at the time (such as Marshall
and Pigou) agreed that dollar satisfying the urgent need of a poor person achieved
more - which is to say generated more ‘utility’ - than the same dollar in the hands
of a wealthy person who would use it to meet less urgent needs.
Though from the mid-20th century on, this idea fell out of favour as somehow
‘unscientific’, it has recently received some validation from surveys of self-reported
subjective wellbeing.
The subjective wellbeing literature provides us with a way of observing the
diminishing marginal utility of income and thus of calibrating it.
The survey of subjective wellbeing behind the Australian Unity Wellbeing Index
shows that, on average, it takes $6,000 of additional annual income to improve
the self-reported wellbeing of a household earning less than $15,000 per year
by one percentage point.
By contrast the same increment in happiness would require more than $100,000
for a household already earning over $100,000 a year.
TABLE 1: The marginal utility of income in Australia
Gross H’hold $ for additional Relative value of
Income ($’000) 1ppt wellbeing additional $
< 15 6,000 4.2
15-30 20,000 1.3
30-60 25,000 1.0
61-100 33,333 0.8
101-150 111,111 0.2
151-250 178,571 0.1
251+ 1,250,000 0.0
Source: The Australian Unity Wellbeing Index
In order to use this information to adjust income for its usefulness in promoting
people’s subjective wellbeing, we must also know the extent to which people
gain in subjective wellbeing from the things that money can buy as opposed to
the extent to which they value its ability to improve their status relative to
others.
The latter effect is a zero-sum game - with any gains enjoyed by one being offset
by losses from another moving down (2).
Both the common sense of the diminishing marginal utility of money and cross-country
studies suggest that material needs are more urgent at lower levels on the income
scale, suggesting that relative income considerations are less powerful lower on
the income scale than they are higher up.
***Footnote (2)
Indeed, given evidence of ‘loss aversion’, downward movements have a disproportionate
effect on welfare by imparting more detriment to wellbeing than upward movements impart
wellbeing.
***End Footnote (2)
This insight, together with information on any changes in distribution of income
over some period, enables us to adjust the aggregate income growth for its
efficacy in improving the subjective wellbeing of the population.
When lower-income households expand their share of national income the adjustment
is up, whereas where the movement is in the other direction the adjustment is down.
f Non-economic aspects of wellbeing
f1 Environment
f2 Political capital
f3 Zero weighted dimensions of our index
f4 Social capital
It is no surprise that there are non-economic aspects of wellbeing.
However, as explained, the anchoring of our index in the national accounts does
provide us with some non-arbitrary base upon which to calibrate the relative
importance of different aspects of wellbeing.
This is an imperfect - indeed biased - way to calibrate these weightings, but the
alternative, it seems to us, is no alternative at all.
For, as we have seen, pure composite indices appear to have made
negligible progress in dealing with the incommensurability of the various
aspects of wellbeing, leading most of them to simply posit that each aspect is
equally important.
But given the difficulty of making any progress at all on such a difficult problem,
it is not arbitrary to assume that the amount of resources a democratic polity
expends in various domains - say, in health or education - by way of its own
private and public democratic choices offers some clue as to its relative
importance to that population in providing for its wellbeing.
We can then go beyond this as an assumption and make adjustments to the
pure national accounting measures reflecting our own investigations into their
relative importance and/or our values.
This is effectively what we have done above with regard to the distribution of
national income.
Beyond this, where we came to the conclusion that there are good measures of
various aspects of our wellbeing that are poorly captured in our framework, we
added them to our index of wellbeing.
Notably we have not added an adjustment for education, because education is
represented strongly firstly in NNI and then again in our measures of the most
important capital item in the index - human capital.
f1 Environment
The biggest environmental challenge we face - climate change - figures in our
economic measures.
Likewise democratic political processes tend to internalise environmental costs
where those costs are direct human health impacts.
Given this, if we included indicators for air pollution, for instance, they would make
negligible difference to the index over time.
However, this is less true of degradation of the eco-system, which does not
have direct impacts on human health.
The Yale Environmental Performance index (EPI) is a reasonable summary
index for this area.
Accordingly, if it were desired to give a larger representation to environmental
issues than our index has so far, we would choose including that index.
However, if the index were to be included, it would be difficult to justify giving it
a very high weight.
Thus it would have negligible impact on the overall index.
Further, there is no evidence we can find that the state of eco-system vitality
has a direct impact on human wellbeing as measured for instance in wellbeing
surveys.
f2 Political capital
A number of composite measures of wellbeing, like the recently released
OECD Better Life Index, include measures of the quality of governance.
Yet it is not easy to find strong and simple indicators.
Voter turnout as used in that index may be a reasonable proxy for community
engagement in other countries but not in countries like Australia, which make
voting compulsory.
A better measure may be to ask people directly about them as is already done
as part of the Australian Unity Wellbeing Index [AUWI].
Unlike other aspects of the AUWI, this domain exhibits significant variability over
time, especially in recent years.
Another alternative would be to supplement existing political polling with
questions that ask whether people think their voice is heard by governments.
However, as in the case of the previously mentioned category, we know of no
evidence of this affecting people’s self-reported subjective wellbeing.
f3 Zero weighted dimensions of our index
This section was missing from the report
f4 Social capital
There is a strong correlation between unhappiness and a lack of social
connections.
The OECD Better Life Index tracks social capital and quality of support
networks using the Gallup World Poll, which asks people questions
such as whether they know someone they could rely on in a time of need.
95 per cent of Australians answered yes to this question, one of the highest
rankings in the OECD.
A forthcoming AUWI survey on loneliness found a similar correlation - each
1-point increase in self-reported loneliness (on a scale of 1 to 10) was associated
with a 1.9-point drop in subjective wellbeing.
We have been unable to access a ‘back-cast’ of this data going back from this
year.
Further presuming changes to the index are relatively minor, they will relate to a
sufficiently small proportion of the population that changes in this metric are
likely to be swamped by other developments in the index.
Given this we have not included the measurement in our index.
g Gross National Suffering
g1 Health
g2 Employment-related satisfaction
Once a country has achieved a reasonable standard of living, we believe one of
the main tasks of policy should be the task described by Denis Healey as
"eroding by inches the conditions which produce avoidable suffering" (Healey,
1989).
To our surprise we have found this idea poorly represented in the literature or
existing indices of wellbeing, even in the composite indices where the
methodology would easily allow for this to be included.
On the other hand, when we looked directly at the problem we found that many
causes of what is clearly suffering of a high order - for instance suicide or road
deaths - were sufficiently rare in our community that for them to make much
difference to our index would require weighting that would be highly
contentious.
At the same time, there is a range of other areas that are widespread in our
society, have a powerful impact on wellbeing and also recognised as sources
of community concern.
In each case we had intended to include them in what had begun as a composite
index.
But as we developed our means of weighting, we thought that a unifying theme
for most if not all of these areas was their relationship to issues that can cause
avoidable suffering.
g1 Health
The community spends about nine per cent of its economic resources on its
health, which means that this expenditure is already captured (as income to
health providers) in NNI.
However, this is a poor proxy for the quality of our health system or for wider
aspects of our society that contribute to health.
Accordingly, we use two measures of the outputs of the health system to
capture the overall health of our society: life expectancy at birth and
hospitalisations from preventable diseases.
We have included two other measures as negative adjustments to our index
relating to two health conditions that are sufficiently prevalent and make a
sufficient impact on self-reported wellbeing that their inclusion can make a
substantial difference to the accuracy with which our index tracks wellbeing.
They are mental health treatment rates (assuming that treatment has some
efficacy) and the level of obesity in the community.
g2 Employment-related satisfaction
There is robust evidence that a serious mismatch between the amount of work
someone does, the amount they want to do (whether they are over or under
employed), and, at the greatest extreme, unemployed altogether have a
substantial impact on wellbeing.
Accordingly we include ABS measures of rates of unemployment,
underemployment and overwork in our index, weighting them according to
evidence from HILDA on the extent to which they affect
subjective wellbeing.
Table 2 below summarises the components of the HALE Index.
Table 2: The Herald/Age - Lateral Economics Index of Wellbeing
Dimension Indicators
A Economic Wellbeing
1. Economic * Real net national disposable income. This is
(recurrent plus a manipulation of GDP that
physical capital) o Focuses on income not production
o Focuses on income to Australians not
just those living here
o Nets out changes in physical capital
(buildings, plant and equipment)
2. Education (human * Early childhood risk
capital) * School performance
* Tertiary education
* Innovation (multi-factor productivity)
* Skills atrophy from long-term unemployment
3. Environment * Depletions and accretions to natural capital
(natural capital) o Land and sub-soil assets
o Climate change
4. Adjustment for the * Captures the differential benefit of NNI,
distribution of adjusted for human and natural capital
economic wellbeing growth, on people of different income levels
B Non-Economic Wellbeing
5. Environmental The Yale Environmental Performance Index of
amenity ecosystem vitality (excluding climate change)
6. Health Life expectancy
Hospitalisations from preventable diseases
Mental health treatment rates
Obesity
7. Employment-related Non-economic harm of unemployment,
satisfaction underemployment and overwork
8. Political capital Satisfaction with government (AUWI)
9. Social capital Social capital (Gallup Worldwide)
For ease of reference, we refer to that part of the index comprising item 1 as
NNI, that part of the index comprising items 1, 2 and 3 as capital-augmented NNI
and that part of the index comprising items 1, 2, 3 and 4 as distribution adjusted,
capital-augmented NNI. Fields 1 to 9 comprise the whole index.
The index is tracked from June 2005 until June 2010 in the chart below.
Figure 1: The Herald/Age - Lateral Economics Index (HALE) ($ billions)
As will be seen, the HALE Index of Wellbeing is more volatile than either GDP or
NNI. This reflects three factors:
* the volatility of some of its constituents (particularly human capital and
to a lesser extent unemployment and underemployment);
* the lower frequency of important updates in the raw data; and
* some of the more volatile constituents are large, particularly the
elements of human capital.
Over the five year period plotted above, the main driver of the HALE Index’s
deviations from NNI from which it is built is the growth of human capital.
This is not surprising since our methodology suggests that this is the biggest
aspect of our wellbeing that NNI fails to capture.
The period charted in Figure 1 above is characterised by an unusually low
human capital contribution from schooling at the beginning of the period and
this artificially depresses the 2005 HALE Index and similarly exaggerates the
growth in human capital over the period.
Nevertheless the proportion of tertiary qualified people in the workforce rises,
particularly in the middle of the period driving the surge from below NNI to a
figure that almost matches GDP.
Put another way, the surge in human capital over the course of these five years
adds almost as much capital to our economy as the depreciation of the physical
capital stock of plant and equipment, which is the principal difference between
NNI and GDP except where there are strong movements in the terms of trade.
Thereafter the HALE Index broadly tracks NNI though at a higher level
reflecting continuing higher growth of human capital.
Because it is built on NNI, the HALE Index captures the terms of trade ‘whipsaw’
at the time of the GFC and in fact accentuates it slightly because the HALE
Index responds more to changes in unemployment and underemployment
than NNI or GDP.
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