A plenary paper to the Second National Ecological Economics Conference
Melbourne, 20th November 1997

Clive Hamilton
Executive Director, The Australia Institute and
Visiting Fellow, Australian National University [1]

Over the last twenty years or so, some far-reaching changes have been made to our economy in the pursuit of more economic growth. Trade barriers have been dismantled, our financial markets have been opened up to global investors, a large proportion of our publicly owned assets have been sold, we have sought to become part of Asia, our foreign policy has been reoriented to emphasise trade and investment as never before, the labour market has been deregulated, the public sector has been cut, and taxes on the wealthy have fallen. The changes to the economy have transformed Australian society in ways that many people find deeply unsettling.

This transformation has all been aimed at increasing the growth rate. Economic growth is the touchstone of policy success. The release of the quarterly national accounts unfailingly receives extensive coverage. Picking out growth in gross domestic product or GDP, journalists write as if they have a technical barometer of how we are doing as a nation. Produced by some of our best statisticians using the internationally agreed system of national accounts, GDP appears to provide a measure of progress that is immune to argument.

If GDP reaches or exceeds expectations, government leaders seize on it to crow about their achievements. If it falls below expectations, the Opposition seizes on it to attack the Government's poor performance. The fetish with the national accounts reached its zenith with Prime Minister Keating's comment on one quarter's figures: "This is a beautiful set of numbers". Few were persuaded that the reality was as beautiful as the numbers.

In the presence of sustained economic growth throughout the 1970s, 1980s and 1990s, Australians have been strangely restive. They are disgruntled, fractious and suspicious of the claims by politicians that the economy is doing well. There is a widespread perception, confirmed by social researchers such as Hugh Mackay, that life in Australia is not improving, but is in fact declining. If growth is so good for us, how come it seems that things are getting worse?

People do not experience the growth rate, but a complex set of economic and social changes that affect their daily lives. While the economy grows inexorably, people have found that they must work harder and longer just to keep up, they feel more insecure about their jobs and their futures than ever, they no longer believe in the post-war dream that everyone can make a better future for their children, and they feel less connected to their communities than ever before. While the fear of nuclear annihilation has subsided, they worry about new social epidemics: family breakdown, youth suicide, drug addiction and drug-related crime, the gambling culture, and a pervasive fear about the destruction of the natural world.

Undoubtedly, one reason for this divergence between the performance of the economy and the perceptions of ordinary people is the fact that the growth of income has been skewed towards the wealthy. But the problem runs much deeper than the age-old one of maldistribution of income. The problem lies in how we define and measure prosperity in Australia. Our official statistics provide a profoundly misleading picture of changes in national well-being. The national accounts which generate GDP fail to recognise that the economy produces ill-being in addition to well-being, 'bads' as well as goods.

Our measure national progress has been defined solely in relation to the market economy. An activity is taken to contribute to our national well-being by virtue of the fact that, and solely to the extent that, it is produced for sale. The defining feature of prosperity is monetary exchange.

This way of measuring national well-being omits two large realms: the contributions of family and community on the one hand, and of the natural environment on the other. Both of these are vital to our well-being but because their contributions lie outside of the marketplace, they simply do not count. Years ago this may have been justified. The dynamic, changing part of the world was the market for goods and services. The social structure seemed largely immune from the market, although in a famous and extraordinarily prescient passage Karl Marx and Friedrich Engels wrote in ringing terms about the power of market relationships to sweep all before them.

It also seemed reasonable to ignore the natural world as long as it continued to provide an endless supply of resources and bottomless 'sinks' to absorb the waste products of industrial society.

But in the twentieth century these presuppositions have become manifestly insupportable. Our society has been penetrated at every level by market relationships. Increasingly, couples prepare for marriage by signing a financial contract. We buy our social identities through brand names and personal styles created by advertising agencies. Our leisure time is increasingly the preserve of commercial entertainment rather than family and community activity. Sporting competitions developed to provide weekend excitement for players and magnets for community loyalty are now big business, with teams for sale to the highest bidder and loyalty packaged and sold. The images that surround us everywhere in our daily lives are created to sell products.

Moreover, we have been dismayed by the discovery that the natural world is decidedly finite, and that we have exceeded its ability to absorb human impacts. Vast expanses of forests are gone, or transformed into sterile monocultures. Many of the fish stocks that teemed the oceans have vanished. The soils are being washed into the seas. Wars are now fought over precious water supplies. Everywhere the natural world is in decline; we now even threaten the most basic life-support system of them all, the atmosphere.

Despite this, if we look only at the official figures, our lives should be getting better. The decline of family and community life and the deterioration of the natural world are not independent of the economy. Commerce, industry and consumerism are inseparable from their decline. We need new measures of national progress, measures that better reflect the complexity of human well-being and take account of the costs as well as the benefits of the growth process.
 

While some economists recognise that changes in GDP are not a good indicator of changes in national well-being, in almost every case the practice belies the formal acknowledgement. In the words of Cobb and Cobb, who have been heavily involved in developing alternative indexes for the USA, the 'normative usage of GNP is the central dogma of the economic faith' (Cobb and Cobb 1994: 251).

It has long been recognised that GDP growth does not correlate well with changes in social welfare, i.e. national well-being. The principal shortcomings of GDP as a measure of changes in national well-being are:

• the failure to account for the way in which increases in output are distributed within the community;
• the failure to account for the contribution of household work to our well-being;
• the incorrect counting of defensive expenditures (such as spending on pollution clean-ups) as positive contributions to GDP; and
• the failure to account for changes in the value of stocks of both built and natural capital.

There have been several attempts to construct an indicator of changes in well-being that is more comprehensive than GDP. A well-known earlier index was built by Nordhaus and Tobin (1972). In more recent years Daly and Cobb have constructed the Index of Sustainable Economic Welfare (ISEW) in an influential appendix to their book, For the Common Good (1990). Daly and Cobb's index has led to a lively debate on a series of methodological and measurement issues (much of which is presented in Cobb and Cobb 1994), and construction of similar indexes for several other countries including the UK (Jackson and Marks 1994), Germany (Diefenbacher 1994) and Sweden (Jackson and Stymne 1996). These later efforts have placed a particular emphasis on accounting for environmental costs in the new measure of welfare. Daly and Cobb's initial index for the USA has been refined and developed by Cobb, Halstead and Rowe (1995) and renamed the Genuine Progress Indicator (GPI).

Construction of the GPI is based on the recognition that we do not live in an economy but in a society, and that the society itself is embedded in a natural environment. The GPI does not claim to be a perfect, or even an adequate, measure of changes in national well-being; it claims only to be a better (and possibly a much better) indicator than changes in GDP. We now explore some of the more important methodological issues in the Australian GPI.
 

The key to understanding the attempts to develop the GPI lies in the notion of sustainability. The best starting point is John Hicks' 1939 definition of income. What is now known as 'Hicksian income' is defined as the maximum amount that a person or a nation could consume over some time period and still be as well off at the end of the period as at the beginning (Hicks 1946: 172). Thus income is maximum sustainable consumption. Sustaining consumption over a given period depends on maintaining the productive potential of the capital stocks that are needed to generate the flow of goods and services that are consumed.

The GPI takes this idea and sets itself two tasks:

• to define and measure 'consumption' in a way that provides a better approximation of actual well-being than the simple measure of marketed goods and services that appears in the national accounts; and
• to account for the sustainability of consumption by incorporating measures of changes in the value of capital stocks.

Taking account of these two classes of influence on welfare over time, we may end up with a situation in which GDP is increasing while consumption (more broadly defined) is rising or falling, and while capital stocks are growing or declining.

Consistent with the definition of Hicksian income, capital stocks perform two functions in the GPI method of measuring changes in welfare (they yield an annual flow of services and they contribute to the sustainability or otherwise of levels of consumption in the future. Depreciation or depletion of capital stocks can be thought of as requiring an amount of current consumption to be 'set aside' to maintain the ability to generate income in the future. The implication of this is that, unlike the way in which changes in GDP are used, year-on-year changes in the GPI are not very meaningful. The purpose of the GPI is to illustrate trends over time.
 

For individuals or households, consumption may be defined as annual flows of marketed and non-marketed goods and services. Perhaps the biggest category of non-marketed goods and services are those produced in the home by unpaid household work. Non-marketed goods and services also include services provided by the natural environment such as the aesthetic and recreational services of old-growth forests and the health-sustaining properties of clean air.

A more comprehensive definition of consumption that takes account of non-marketed goods and services is particularly important because measured GDP growth may reflect nothing more than the transfer of activity from the non-market to the market sector, a problem long recognised in the development literature. This is most apparent in the case of household work, but applies equally to any other 'free' service. Just as, in the well-known observation, GDP declines 'if a man marries his housekeeper', GDP rises if an entrance fee is levied on visits to a national park or a family decides to eat out more often.

Some monetary expenditures by final consumers ( which are therefore included as expenditures in GDP ( represent not additions to welfare but attempts to offset some change in social, environmental or individual circumstances which is causing a decline in welfare. These are known as defensive expenditures and are deducted from the value of personal consumption expenditure which provides the starting point of the GPI.

The GPI assumes that personal consumption spending by individuals on marketed goods and services is the major component of welfare and that an increase in this spending represents, ceteris paribus, a corresponding increase in welfare. There is a large literature critical of the assumption that there is a close relationship between changes in consumption spending and changes in individual welfare (see eg. Dodds 1997). But the purpose of the GPI is to demonstrate that even using conventional economic methods, a more comprehensive attempt to account for changes in welfare may show large deviations from GDP over time.
 

Sustaining levels of consumption requires that the productive potential of capital stocks be maintained. Capital stocks can be divided into five forms which we discuss in turn. While GDP accounts for changes in none of them, the GPI attempts to incorporate changes in the value of the first three.

Built capital This covers the stocks of physical machinery, buildings and infrastructure that are essential to sustaining levels of GDP. These stocks deteriorate and a portion of income must be set aside each year to invest in them to maintain and improve their productive potential. The GPI adjusts consumption spending to take account of net capital growth which, if positive, adds to sustainable economic welfare.

Financial assets A nation's ability to sustain investment in built capital assets is diminished if it is accumulating foreign debts since some part of future income must be devoted to repaying the debts. If those loans are being invested productively then future income will be higher and it will be possible to repay the debts without additional burden. To the extent that foreign debt has been invested productively in the past, current consumption will be higher. The GPI adjusts consumption spending to account for net foreign liabilities.

Natural capital Maintaining the stocks of natural capital is essential to sustaining consumption in the future, especially when consumption is defined more broadly. These stocks take two forms. The first are stocks of renewable and non-renewable resources used as inputs in production, such as minerals, fossil fuels and soils. The second take the form of waste sinks provided by the natural environment which are essential for dissipating waste products so that they do not represent a danger to humans. The GPI takes account of the depletion of natural capital. However there are some difficult methodological issues concerning the substitutability of built for natural capital.

Human capital This represents the accumulation of health, skills, knowledge and experience in humans that makes them more productive than brute labourers. Technology is partly embodied in humans. The GPI does not account for human capital because of the conceptual and measurement difficulties involved.
 

A nation that possesses sound and stable political, legal and commercial institutions, and cohesive, supportive and trusting communities, will be in a better position to generate flows of goods and services than one that does not. However, this form of 'capital' is difficult to define precisely and to measure, and is thus excluded from the GPI.
 

The depletion of one form of capital does not represent a decline in sustainable consumption if other forms of capital are accumulating and can be substituted for the disappearing asset. Thus the issue of substitutability within and between these classes of assets is critical.

More controversially, the run down of one type of natural asset will not necessarily impose a cost if built capital or another type of natural asset can perform, at the same or similar cost, the same functions. The question of the degree of substitutability of built for natural capital is perhaps the most strongly contested issue in the economics of the environment. We have taken the view that, for three classes of natural assets, perfect substitutability between built and natural assets is not a valid assumption. They are:

• certain natural resources that are irreplaceable and form essential inputs to continued productive activity ( soils and supplies of fresh water are examples;
• waste sinks, i.e. those aspects of the natural environment which absorb and process wastes rendering them benign, including the atmosphere (covering the climate system and the ozone layer) and the oceans; and
• assets whose services are consumed directly by final consumers and which are valuable because of their unique natural features ( old-growth forests and the Great Barrier Reef are examples.

From an environmental point of view, depletion of non-renewable natural resources is a crucial issue and estimates of the value of this depletion are dominating factors in previous GPIs. However, in estimating the likely economic costs of depletion of non-renewables it matters a great deal which non-renewables we have in mind. We need to distinguish between 'critical capital', that is, assets that are irreplaceable, and assets for which substitutes are likely to be found at similar cost to the one being depleted.
 

The Australian GPI attempts a more systematic approach to valuing time than previous GPIs. The value of time is a very important aspect of various components of the GPI, including the value of household and community work and the costs of unemployment and of overwork. In the Australian GPI we have adopted the principle that the value of time devoted to voluntary activities counts as a positive in the GPI and the value of time engaged in involuntary activities counts as a negative. The following activities contribute to our welfare. They all have the characteristic that they are 'voluntary', that is, we could choose not to do them or to devote less time to them:

• paid work, except the involuntary component referred to below as 'overwork';
• household work;
• community work; and
• leisure activities.

The following activities diminish welfare and, as such, impose costs on the community:

• involuntary leisure, i.e. the times when we are unemployed but want to be employed; and
• involuntary work, i.e. the times when we are doing paid work but would prefer not to be.

The distribution of these activities varies between different groups in and outside of the labour force, partly by choice and partly involuntarily. A notional distribution of activities among these groups is illustrated in Figure 1. It represents the allocation of time between activities for the 14 hours of an average weekday when we are not occupied by sleep or personal care.

How is each of these treated in the GPI? The value of household work and community work are assessed directly while the value of paid work is included in the GPI by way of the starting point of the index ( consumer spending (Column A). Unlike the US GPI, the Australian GPI excludes the value of leisure. It does, however, include the obverse ( an estimate of the costs of overwork. The costs of overwork are discussed below (Column H). This leaves us with the costs of unemployment and underemployment which are included in the Australian GPI (Columns F and G).

Components of the Australian GPI

The full list of components of the Australian GPI appears in Table 1, along with an indication of which components are added to, and which are deducted from, the index, and a brief description of the component. A full description of the GPI, methods and data can be found in Hamilton (1997).

The index has been calculated for the period 1949/50-1995/96, but for simplicity of presentation the years are identified only by a single date. Thus for the financial year 1995/96 we simply write 1996. All components of the GPI are converted to 1989-90 constant prices using appropriate deflators.

Table 1 Components of the Australian GPI

Column nameDescription of indicatorAPersonal consumption+Private final consumption expenditure from the national accounts.BIncome distribution+/

(Share of lowest quintile in total income. A new index constructed from taxation statistics.CWeighted personal consumption+/

(Personal consumption weighted by index of changing income distributionDPublic consumption expenditure (non-defensive)+Value of non-defensive government consumption spending. Includes portions of spending on defence, public order, social security, education, health and general government.EValue of household and community work+Hours of household and community work performed each year valued by the housekeeper replacement method. Some components of household work (including some childcare, gardening & shopping) are valued for the process rather than the product.FCosts of unemployment(Value of hours of idleness of the unemployed.GCosts of underemployment(Value of hours of idleness of part-time employees who want to work full-time.HCosts of overwork(Value of hours of work done involuntarily.IPrivate defensive spending on health and education(Health and education spending that offsets declining conditions (assessed as half of health spending and half of tertiary education costs)JServices of public capital+Contribution of public investment in non-defensive works (eg. roads), valued annually by depreciation rate.KCosts of commuting(Time spent commuting valued at opportunity cost.LCosts of noise pollution(Excess noise levels valued by cost of reducing noise to acceptable level.MCosts of transport accidents(Costs of repairs and pain and suffering (but excluding medical costs and lost earnings counted elsewhere).NCosts of industrial accidents(Costs of pain and suffering (but excluding medical costs and lost earnings counted elsewhere).OCosts of irrigation water use(Damage to environment estimated by the opportunity cost of environmental flows (30% of current diversions in the Murray-Darling).PCosts of urban water pollution(Damage to environment estimated by the control cost of improving water quality.

QCosts of air pollution(Damage to humans and environment from noxious emissions measured mainly by health costs.RCosts of land degradation(Costs to current and future generations from soil erosion etc. measured by forgone output and ecological damage.SCosts of loss of old-growth forests(Environmental values denied to future generations measured by willingness to pay to retain environmental values.TCosts of depletion of non-renewable energy resources(Costs of shifting from petroleum and natural gas to renewables using US replacement cost estimate.UCosts of climate change(Annual greenhouse gas emissions valued by the expected cost of emission abatement using taxes or permits.VCosts of ozone depletion(Annual emissions valued by future impacts on human health and environment.WCosts of crime(Measured by property losses and household spending on crime preventionXNet capital growth+Growth in value of stock of built capital net of depreciation adjusted for growth in the labour forceYNet foreign lending(Change in net foreign liabilities (the current account deficit)
 

The results of the calculation of the GPI per capita are shown in Figure 3 where the trend can be compared with the growth of per capita GDP. The absolute levels of the GPI index and GDP are not comparable because GDP measures economic activity while the GPI is a measure of well-being. The fact that they begin at around the same level of $9,000 is a convenient accident.

The GPI calculations show that between 1950 and 1996, real GDP per person in Australia increased from a little over $9,000 to over $23,000 reflecting steady economic growth over the period. This is usually interpreted as showing that Australians have become progressively better off.

Using the much broader accounting framework of the GPI reveals a very different picture of the changing levels of well-being of the Australian people. Starting at a little under $9,000 in 1950, the GPI rises over the period by an average of 1.3 per cent each year, compared to 2.1 per cent for GDP, reaching approximately $16,000 in 1996.

However, from the late 1970s, the pattern changes markedly. The GPI shows effectively no increase from the late 1970s to 1996. Figure 4 shows the GPI both with and without weighting for changes in income distribution. The decline since the late 1970s would have started sooner except for the impact of a measured substantial improvement in income distribution in the 1970s. Thus the measured improvement in income distribution in the 1970s masked the divergence of the GPI from GDP that began around 1972.

This improving trend in the GPI in the 1970s was reversed at the end of the decade and the result has been a sharp divergence between GDP and the GPI. These results suggest that for the last two decades the benefits to society of economic growth have been offset by the costs. The main factors explaining the failure of measured well-being in Australia to continue rising since the late 1970s have been as follows:

• unsustainable levels of foreign debt;
• the growing costs of unemployment and overwork;
• the combined impact of a number of environmental problems;
• the escalating costs of energy resource depletion and greenhouse gas emissions
• a failure to maintain investments in the national capital stock.

The first three factors listed above are numerically the most important overall. However, the significant dip in the GPI in the years 1987-89 was due to the sudden decline in net capital growth and a jump in net foreign liabilities as a result of policies that saw a sharp fall in public investment and an expansion of the current account deficit. Together these changes represent a significant set-back in the value of capital.

The GPI results indicate that continued growth in Australia is relying ever more heavily on the run-down of stocks of built, social and natural capital. They suggest that the living conditions of Australians may not be improving and we are borrowing from the future to prevent our living standards falling further.

The divergence of the Australian GPI from GDP in the 1970s is mirrored by the indexes calculated for Britain, the USA and some European countries. The 1970s saw some historic changes in the world economy and economic policies in the leading economies, including the floating of major currencies, the development of often unstable international capital markets, the emergence of stagflation and persistent high unemployment in OECD countries, the oil shocks, and a range of policies based on a belief in the virtue of 'small government'. These are summarised in the term 'globalisation', a process which explains the divergence between continued GDP growth and perceived declines in living standards reflected in the GPI.

Cobb, C. and Cobb, J. 1994, The Green National Product: A Proposed Index of Sustainable Economic Welfare (University Press of America: Maryland)

Cobb, C., Halstead, T. and Rowe, J. 1995 The Genuine Progress Indicator: Summary of Data and Methodology (Redefining Progress)

Daly, H. and Cobb, J 1990, For the Common Good (Beacon Press: Boston)

Diefenbacher, H. 1994, 'The Index of Sustainable Economic Welfare in Germany', in C. Cobb and J. Cobb (eds), The Green National Product (University of Americas Press)

Dodds, S. 1997, 'Economic Growth and Human Well-being' in M. Diesendorf and C. Hamilton, Human Ecology, Human Economy: Ideas for an ecologically sustainable future (Allen & Unwin, Sydney)

Hamilton, C. 1997, The Genuine Progress Indicator: A new index of changes in well-being in Australia, Discussion Paper No. 14 (The Australia Institute: Canberra) (with contributions from Hugh Saddler)

Hamilton, C., Quiggin, J., and Hundloe, T., 1997 Ecological Tax Reform in Australia, Discussion Paper No. 10 (The Australia Institute: Canberra)

Hicks, J. 1946, Value and Capital, 2nd edition (Oxford University Press: London)

Ironmonger, D. 1994, 'The Value of Care and Nurture Provided by Unpaid Household Work', Family Matters No. 37 April (Australian Institute of Family Studies)

Jackson, T. and Marks, N. 1994, Measuring Sustainable Economic Welfare ( A Pilot Index: 1950-1990 (Stockholm Environment Institute)

Jackson, T. and Stymne, S. 1996, Sustainable Economic Welfare in Sweden: A Pilot Index 1950-1992 (Stockholm Environment Institute)

Nordhaus, W. and Tobin, J. 1972, 'Is Growth Obsolete?', in National Bureau of Economic Research, Economic Growth: Fifth Anniversary Colloquium, NBER, New York
 

1. This paper is based on a longer paper (Hamilton 1997) detailing the methods and data sources used in constructing the Genuine Progress Indicator (also known as the Index of Sustainable Economic Welfare). Dr Hugh Saddler of Energy Strategies Pty Ltd made a major contribution to this work by constructing the data sets for several components. We would like to thank John Nevile and Max Neutze for valuable comments on a draft version and Phan Dinh The for excellent research assistance. Financial support for this work has been provided by the Oikoumene Foundation, the CSIRO's Division of Wildlife and Ecology and the National Citizenship Project. Officers of the Australian Bureau of Statistics have been very helpful in providing advice on data.
    

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