John Gascoigne: NZ needs new economic compass

Disasters such as the Deepwater Horizon oil spill in the Gulf of Mexico actually boosted GDP.

There is a growing awareness that the Gross Domestic Product or GDP economic metric by itself has become increasingly obsolete as an indicator of national economic performance. For example, politicians extol New Zealand's "strong economy" but our low-wage status remains unchanged. While our GDP has risen - the "rockstar economy" - median incomes have fallen. Something's amiss.

The explanation is straightforward. The marked divergence between hype and reality is largely due to reliance on flawed economic measures, chiefly the GDP.

Despite its obsolescence, the GDP remains the summary statistic of choice. But incomplete, skewed or asymmetrical economic information can result in public-policy decisions hugely detrimental to the national interest.

The GDP was the brainchild of Simon Kuznets in the US in the 1930s. Before it, no national-scale economic metrics existed. The GDP, defined as the total market value of all final goods and services produced by a nation in a year, allowed economists to measure total national economic output.

The GDP, ideal for measuring physical production, was indispensable for hauling the US out of the Great Depression. And it made possible its transformation from a mixed economy to an amazingly powerful wartime command economy in World War II. But that was a different age, when manufacturing dominated. No longer.

Services, rather than physical production, can now dominate a modern economy. New Zealand is the prime example. Unlike the tiny, high-income nations, our manufacturing and high-technology sectors are relatively small components of our GDP while our agricultural and service sectors, notably tourism, are proportionately much larger.

The GDP's downside is that it includes "bads" as well as goods. For example, alcohol and cigarette sales, crime, sickness, resource depletion, financial speculation and toxic financial products such as derivatives and credit default swaps all add to the GDP. Conversely, women's huge, unpaid contribution does not count, nor does invaluable voluntary work, all foundational to social cohesion, economic wellbeing and quality of life.

More perversely, environmental damage and heritage destruction can boost GDP. For example, Alaska's Exxon Valdez disaster, the Gulf of Mexico Deepwater Horizon catastrophe and the February 2011 Christchurch earthquake all boosted respective GDPs through huge salvage, clean-up and reconstruction costs. Hence its obsolescence as a barometer of success.

A new set of national economic performance indicators is needed. The GDP, restricted to aggregates and averages, conceals far more than it discloses. For example, while we are assured our economic growth rate, partially due to the Christchurch quake, is one of the fastest in the developed world, we are not told our per capita economic growth rate is almost nil.

No single statistic can give an accurate, comprehensive measure of national economic performance. But four metrics taken together can give a far more accurate fix on our economic wellbeing than GDP alone. These include real per capita income growth, the median (not average) wage, household disposable income and national income distribution or income equality.

About 20 years ago I advocated a new set of economic indicators to redress the over-reliance on the GDP. The aim of the Economic Transparency Act (ETA) was to create a comprehensive, accessible set of all critical economic and social indicators, a "one stop shop". The idea was to enable the public, independent of politicians and the commentariat, to access and determine our overall performance. But people scoffed.

Elsewhere, however, GDP scepticism is now widespread. For example, the EU has explored alternatives. In 2009, French president Nicolas Sarkozy declared the GDP obsolete and ordered the creation of the Commission on the Measurement of Economic and Social Progress.

America has now achieved full economic disclosure with its Key National Indicator System (KNIS), administered by the National Science Foundation.

Derek Bok, President Emeritus of Harvard University, lauded the KNIS, saying "understanding our nation's progress toward widely accepted goals is imperative in an age when most of us know far too little about the problems and opportunities we face".

That applies to us. We need a new economic compass. Critics of this imperative should note Kuznets' warning that a nation's wellbeing can't be inferred from measuring its national income.

• John Gascoigne is a Cambridge-based economics commentator.