Comparing living standards

The seven issues that must be taken into account when using NI figures to measure the standard of living

  1. Monetary value: The statistics are measured in a given currency at a given time. This causes problems when comparing output between different periods or countries as inflationary pressures eroding the real value of money can mask the real change in national output. GDP at constant prices is obtained by dividing the current price by a deflator.
  2. Change in population: An increase in output will not improve the standard of living if there is an equal increase in population the standard of living of citizens in the economy will not increase. Therefore GDP or national income figures must be expressed as per capita.
  3. Type of goods and services: During the communist era in Russia lots of capital goods were produced and there was high spending on the military. This does not generally have such a great improvement on citizens standard of living as spending on consumer goods. High capital investment may have future rewards for an economy and allow a higher standard of living in the future.
  4. The role of the government: If the government spends large sums of money on the military this could arguably not improve the standard of living of citizens. Government spending on services such as free health care is thought to improve the standard of living of citizens within an economy, however often this spending is not very efficient and arguably a greater increase in the standard of living could be arrived at if the money were spent by private firms.
  5. Income distribution: A very unfair distribution of income may exist in some economies, so a per capita figure including the highest earners in an economy may suggest a much higher standard of living than most citizens in an economy actually experience. Lorenz curves and Gini coefficients can be used to analyse the distribution of income in an economy. Many developed economies suffer from poor income distribution and within the UK there are large north/south divides. Perhaps surprisingly many poorer nations have a more equal distribution of income.
  6. Environmental concerns: Considering sustainable development and abuse of the environment in interpreting economic growth figures is important. All developed economies are fuelled by oil, a non-renewable resource.
  7. Lower welfare: What may appear statistically as a better standard of living many be due to longer working hours, poor working conditions. It is hard to measure this, but government legislation aims to enforce a lower limit on working conditions by banning some practises, setting a minimum wage and maximum working hours.

The six issues involved in using NI statistics as a measure of standard of living

  1. Valuation: Each economy measures it's GDP in it's own currency so to compare two countries they must be converted into a common currency. US dollars are the standard currency, but market exchange rates are not appropriate for this conversion as these rates change on a daily basis, whereas it is unlikely that citizen's standard of living fluctuates so much. Purchasing Power Parity (PPP) rates are used which are calculated using a "basket of goods" in a similar way to the RPI. This aims to take into account the relative cost of living in different economies and the spending power of one dollar.
  2. Self provision: In economies such as India and many developing nations DIY activities, more prevalent in "time rich, money poor" economies, mainly developing economies instead of the "money rich, time poor" developed nations, goes unrecorded. Some economies aim to include this in their GNP or GDP statistics, such as food that farmers will have grown and eaten themselves. This means that, particularly in developing nations, the standard of living may be higher than suggested by national income statistics. This contributes to a hidden economy, not measured in statistics. The black economy - illegal trade - is also part of the hidden economy as is the direct sale of a second hand car where cash is paid.
  3. Defence: A high spending on capital goods such as military goods that will not yield more consumer goods in the future will reduce the standard of living in an economy. Israel is an example of an economy with a high defence budget.
  4. Working hours: Long hours and poor conditions can give a high GDP figure and suggest a high standard of living. This high income is at the expense of leisure time and safe conditions which also contribute to the standard of living.
  5. Population: A high GDP for an economy can be deceptive if the economy has a very large population, therefore GDP or GNP per capita figures are used when comparing economies. The GDP per capita represents the average income in the economy; it is the GNP divided by the population.
  6. Unreliable statistics: Data collection in less developed nations is not always accurate, often large rural areas are estimated or not sampled at all. Even in more developed nations data is collectively reasonably infrequently, often every 10 years in a census.

Wealth as a measure of standard of living

The wealth of a nation or economy is it's stock of assets consisting of natural resources (or factors of production), rather than the economies annual national income. The wealth of an economy as measured by the World Bank can be thought of in four categories.

  1. Natural assets such as timber and oil.
  2. Produced assets such as machinery and infrastructure.
  3. Human assets within the economy, how skilled a workforce is and how productive they are.
  4. Social capital such as families and communities

Currently the Human Development Index is calculated using only the first three criteria as no measure has been decided upon for the fourth criteria. The sustainability of an economy can be evaluated by looking at the figures for wealth and considering future depletion.

Measuring the value of natural, produced and human assets is also a very difficult task. Natural resources are only valuable if there is demand. Coal for example is not as valuable as it once was as it is no longer used for domestic heating. Produced assets such as a machine to manufacture a particular product are only useful if there is demand for that product. It is also questionable how the value of human capital is measured as the World Bank's figures suggest that a citizen in Luxembourg is worth three times that of one in Australia, for example.

These notes form a homework given in a lesson on 06/09/2004 and are compiled from an article by Dr John Richards "How Difficult is it to Compare Standards of Living between Different Countries?" Economics today January 2002 and "Do National Income statistics Measure a Country's Standard of Living?" by Dr John Richards in Economics Today November 2001.

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