Measuring Social Welfare
GDP is not really a measure of well-being, or even of economic activity. It is a measure of economic activity mediated by the formal marketplace. (Or the not-so-formal marketplace: Italy recently made waves when it announced that it would include black-market activity in its GDP calculations.) In the classic example from introductory economics, if I hire a babysitter, then the monetary compensation I pay counts toward GDP. But if I arrange for a family member to babysit my child, for no monetary compensation, then it doesn't count toward GDP. This may be seen as a limitation of the metric, but for now let's just note that GDP is not all-inclusive.
Various efforts have been made to find a more direct measure of the thing we are actually trying to maximize, but as far as I know none of them has really taken off. I think this is probably because there is a fair degree of squishiness and value judgment involved. For instance, the per-capita GDP of the United States is considerably higher than that of Japan (according to the CIA, Japan is at $37,100 while the U.S. is at $52,800). But Japan is undoubtedly better off in a lot of ways. Its life expectancy at birth is 84.46 years, while in the U.S. it is 79.56 years. Infant mortality is 2.13 deaths/1,000 live births in Japan, vs. 6.17 in the U.S. Adult obesity is 5% in Japan, 33% in the U.S. The unemployment rate was 4.1% in Japan in 2013, while it was 7.3% in the U.S. (now it is 6.2%). (As far as I can tell, the CIA World Factbook does not report countries' incarceration rates. A puzzling omission. Anyway I would bet a substantial amount of money that it is lower in Japan than in the U.S.)
And you can draw similar comparisons between the U.S. and the social democracies of northern Europe, which have substantially lower GDPs than the U.S. but which enjoy better outcomes on a number of dimensions. But you can't really say who is doing better unless you have a way of adjudicating the relative importance of those dimensions. And it's worth noting that in a big-picture sense GDP is highly correlated with good outcomes on many of the most important dimensions (though perhaps obesity is not among them).
So just as an intuitive matter, I think the right way to think about it is to postulate some kind of hard-to-measure "gross domestic capacity," which is meant to reflect a society's ability to meet whatever goals it might embrace. GDP would be a major component of (and therefore a rough proxy for) GDC, which would explain why higher GDP is generally correlated with good outcomes. But it would be a mistake to take GDP too seriously as a measure of social welfare. If researchers developed a new sex position that improves pleasure by 50%, it would have almost no direct effect on GDP, but it would mark a huge step forward in human flourishing. [150% of zero is still zero, you fucking loser. - ed. What the hell, man?]
I bring all of this up because to some extent a society can choose how to "spend" its GDC. If you choose to "spend" it on market goods and services (cars, houses, restaurant meals), then it will appear in GDP numbers and your country will be demonstrably wealthy. But you can also choose to "spend" it on non-market things like long vacations, short work hours, preparing meals for yourself, exercising, having good sex. [Is there such a thing as bad sex? - ed. I wouldn't have thought so, but my girlfriend takes another view of the cathedral. Also, weren't you just mocking me for being bad at sex? I was implying you don't have any sex, but obviously the one thing causes the other. -ed.] This is essentially what northern Europe has done.
And I want to emphasize, this is to some degree a collective decision. A market-oriented society will punish people who engage heavily in non-market pursuits (I will have some vituperative things to say about this in a separate post), while a society that taxes itself more heavily can provide public goods and non-market protections that enable non-market activity. And it's not just political: a society that venerates wealth will confer status on people who orient themselves towards wealth-acquisition, thus punishing those who don't (status being a positional good). So there are limits on the degree to which an individual can simply "opt out" of his society's choices about how to allocate GDC. We are engaged in both a political struggle and a culture war, and sadly I think the capitalists/libertarians are winning (though there have been some positive developments on the political front).
In future posts I will take this thought in two directions: first, I will (as I mentioned) have some negative things to say about the U.S.'s brand of capitalism. Second, though, I want to return to my earlier posts about macroeconomics and monetary policy, in examining the concept of potential output.