Why GDP Per Capita Can Start A Bar Fight

January 10, 2012

In his latest New York Times Magazine column, “The Other Reason Europe Is Going Broke,” Adam Davidson writes, “One great way to start a bar fight during an American Economic Association conference is to claim that the U.S. economy is preferable to Europe’s. Someone will undoubtedly start quarreling about how GDP per capita doesn’t measure a person’s happiness.”

NPR’s Planet Money blog asked Dean Baker, co-director of the Center for Economic Policy Research, to explain why GDP per capita, the total GDP of a country divided by the number of people in the country, is such a controversial measure. This post originally appeared there.

The gap in per capita income between the United States and Europe is striking, but these numbers do not tell the whole story in comparing living standards There are three important issues to keep in mind.

First, there are some very big measurement issues in international comparisons of GDP. At the top of this list, I would put our spending on health care. We spend 17 percent of GDP on health care, whereas the average across Europe is less than 10 percent GDP. What do we get for this extra 7 percentage points of GDP? That is not obvious to say the least. The U.S. ranks behind every West European country in life expectancy and does not stand out in most other outcome measures.

There are also important areas of spending that don’t directly improve living standards. The United States spends more than 4.0 percent of GDP on the military as opposed to less than 1.0 percent across Western Europe. One can argue whether this spending is necessary, but this is another 3.0 percent of GDP that is not improving living standards. The same applies to spending on criminal justice, which is more than 1.5 percent of GDP in the United States and perhaps one-tenth this amount across Western Europe.

There are some other measurement issues that individually may not be that large, but could add up to be big. For example, we spend more money on things like administering pension funds and 401(k)s, which are needed here because Social Security provides a lower replacement rate than most public pension systems across Europe. Tax preparation is another example of wasted spending. In many European countries the government prepares tax returns for people. They need only file if they believe the return is incorrect. Depreciation is a larger share of our economy than is the case in Europe. (Much of this is a measurement issue.) If we used net national product rather than gross national product it would get rid of 2-3 percentage points of the difference between the United States and Europe.

The second point is that Europeans have made a conscious policy decision to take much of the benefits of productivity growth in leisure. Across Western Europe, 4-6 weeks of vacation is standard. Also, all of these countries have paid sick leave and family leave. Average hours worked for a full-time worker is around 20 percent less in West Europe than the U.S. It is difficult to say that they are poorer if they choose to work less but then have less money.

The final point is that every country in West Europe has much less inequality than in the United States. This means that the typical worker may enjoy a comparable living standard to workers in the U.S. even if per capita income is lower. The big difference in living standards, or at least incomes, is at the high end.

In short, if we want to compare living standards between the United States and Western Europe, per capita GDP is just a starting point. There are many other items that must be factored in to get a real sense of the well-being of the typical person.

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