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It's the distribution that matters

The size of the economy matters a whole lot less than how it is distributed

Gross Domestic Product (GDP) estimates present a nice neatly packaged way for politicians to see if they have done a good or bad job. If it goes up, hooray if it goes down oh no. Given that the economy typically expands considering how people and productions operate it is pretty easy to see demonstrate success by this measure.

There are several ways of measuring GDP. These include measuring:

1) The value of all goods and services

2) Total income

3) Total expenditure

Politicians and policymakers have for years used GDP as their key measure of success. Conceptually people understand what GDP is and how it operates but typically don't dig too deeply into understanding how it is useful for the average person on the street.

Top-line GDP numbers don't tell you very much

Let's break it down.

In New Zealand GDP sits at around about $300 billion, the average per person is about $61,000. Of course this doesn't necessarily mean that you sitting at home reading this are receiving $61,000 in income or spending that much on services, it is merely the average.

Summary numbers like these disguise all manner of sins.

First off, it is not clear from these numbers who has received the money and who has not. The lions share of the $300 billion could only be received by the top 10% of the population with the rest receiving very little. Once split cross the five million people in NZ we would still get an average of $61,000. Of course, it wouldn't be very fair but you don't know this without context.

Secondly, when GDP grows or shrinks it is not clear who it has actually grown or shrunk for. When we sign trade deals, have large events that bring tourists, or some new transport link is built we are often told that there are economic benefits that make it worthwhile. But who actually gets those economic benefits? It's not everyone. The average person on the street typically isn't going to be better off. Does that mean we shouldn't do whatever it is? No. But there needs to be a fair way of distributing the benefits.

Truth be told for many people it may not matter a great deal if consumption or income drops in one year. I know that sounds unusual but hear me out. If you typically consume $61,000 worth of goods in a year and then the next year you consume $60,000 then roughly you have lost the equivalent of 250 coffees. If you decided to stop drinking coffee this is a good thing but this isn't recognised when measuring GDP. You would still have a roof over your head and food on the table. From a measurement perspective, GDP has fallen by 1.7% in this scenario, but your life hasn't changed an awful lot.

When does a fall in GDP matter?

If GDP fell by that sort of margin across the country odds are the Government of the day would be voted out. Of course, the example above is an extremely naive assessment because if there is a drop in GDP of that magnitude the pain will not be shared equally. There is likely a vulnerable group of people who lose their jobs or suffer in some other way. Similarly when we see the economy grows the majority of the gains are captured by a group who is able to take advantage. Here is where the distribution element kicks in.

The absolute amount of GDP and whether it goes up or down doesn't matter anywhere near as much as who it goes up and down for. If income increases by $10,000 for someone on the poverty line then this increase can be game-changing. For a wealthy person? Not so much. This is the crux of the issue. Why does it even matter if GDP grows? What matters most is who captures this increase. If GDP grows for people who already have a lot then society isn't meaningfully better off. There are literally studies on this stuff, after a certain level of income happiness doesn't really improve as income increases.

Equality measures should be reported alongside GDP

Measures like the Gini coefficient or the 80/20 distribution that report equality are useful and it makes sense to report them regularly alongside typical economic measures like GDP and employment. That which is measured matters. The 80/20 income ratio reports the difference in income between the top. For example, a ratio of 3 shows that the top 20% earn three times the bottom 20%. The graph below created using data from Stats NZ reports the 80/20 income ratio between 1982 and 2015. Data wasn't available for all years so I used the average of the previous and next year where that was the case. The picture isn't flattering with income inequality being stubbornly stable and even increasing, particularly after housing costs are included.

income inequality 80/20 ratio new zealand

Economic policymakers should take purposeful steps to see that inequality measures improve year-on-year in the same way GDP does. Redistribution policies are low hanging fruit from a societal welfare perspective reflecting that for someone who is going without, that extra little bit can make a world of difference.


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