Relation between GDP and welfare and its limitations
GDP and Welfare
Real GDP is considered as an index of welfare of the people. Welfare of the people is measured in terms of the availability of goods and services per person. Increase in real GDP means increase in the level of output in the economy. Other things remaining constant, this means greater availability of goods per person. This leads to higher level of welfare (popularly known as (Social Welfare). It because of this reason that the planners and politicians in a country always lay emphasis on the growth rate of GDP. Higher the growth of GDP, greater is the flow of goods and services. Greater is the availability of goods and services per person. Also, higher level of output is often associated with higher level of employment. It is also associated with higher level of efficiency and productivity in the economy. Purchasing of the people tends to rise. Aggregate demand rises. This leads to higher investment. Higher investment leads to yet another cycle of GDP growth. And, another cycle of increase in welfare of the people. Thus, there is a strong relationship between GDP growth and increase in the level of welfare of the people. This relationship sets in motion a virtuous circle of economic prosperity, as under:
Limitations
But there are certain limitations related to the positive relationship between GDP and welfare. These are as under:
(1) Distribution of Income: If distribution of income turns unequal, GDP growth fails to reflect a rise in social welfare. India is facing this situation at present. While per capita GDP is rising, starvation deaths are hitting the headlines more often than ever before. Reason: Distribution of income is becoming increasingly unequal.
(2) Composition of GDP: Composition of GDP may not be welfare oriented Example: Increase in the production of defence goods does not lead to any direct increase in welfare of the people [Of course, strong defence offers a peaceful environment in the country. But, it contributes to social welfare only indirectly.]
(3) Non-monetary Exchanges: In rural economic, barter system of exchange still prevails to some extent. Payments for farm labour are often made in kind rather than in cash. All such transactions remain unrecorded. This causes underestimation of GDP. To the extent GDP remains underestimated, it remains an inappropriate index of welfare.
(4) Externalities: Externalities refer to good and bad impact of an economic activity without paying the price or penalty for that. There are both positive and negative externalities. Positive externalities occur when, for example, Mr. X maintains a beautiful garden and Mr. Y (neighbour of Mr. X) enjoys it. It adds to welfare of Mr. Y but the does not pay for it. Negative externalities occur when, for example, stubble burning by the farmers lead to air pollution. It causes a loss of social welfare. But, most farmers do not pay the penalty. GDP fails to account for the impact of positive and negative externalities on social welfare. Hence, it is an inappropriate index of welfare.
Thus, there are serious limitations of GDP as in index of welfare. These limitations reduce the significance of GDP as an index of welfare.
