Download Extension: GNI and living standards

Volume 32, Number 1, September 2014
Extension
GNI and living standards
Peter Smith
The indicators of GDP and GNI were introduced in the Vital statistics column in this issue of
ECONOMIC REVIEW (pp. 23–25). This resource discusses the issues involved in using such
indicators to make international comparisons of living standards.
GDP and GNI are key ways in which we can calculate the rate of economic growth, which is seen as
the percentage rate of change of GDP (or GNI) from year to year.
One way in which these data are used is to make international comparisons. For example, we may
wish to know how GDP, GNI or economic growth in the UK compares with that for France or
Germany. This may then help us to interpret the performance of the UK, either in terms of the
standard of living, or the progress being made through economic growth.
But to what extent can GDP or GNI provide a relative measure of living standards in different
countries? When we look at this carefully, we realise that there are several issues that need to be
addressed if such a comparison is to be valid.
GDP or GNI?
First, we need to decide whether to use GDP or GNI. GDP measures the output produced in the
domestic economy during a period. GNI also takes into account movements of income between
countries. For example, if residents in the home country receive income from abroad, this would be
added to GDP to calculate GNI. For some countries this is very important — for example, countries
like Pakistan or the Philippines, where significant numbers of workers overseas send income back to
their families in the home countries. If we are trying to measure living standards in the home country,
we would want to recognise these income flows, so we should use GNI — which is what the World
Bank does in providing comparative data across countries.
Population size
One issue was mentioned in the Vital statistics column, namely that we need to compare the average
level of GDP or GNI, taking into account the size of population. The reason for this is clear. For
example, China in 2012 had a GNI of $7,749 billion, compared with Singapore’s figure of only $251
billion. If we are thinking about living standards of typical residents of the two countries, we need to be
aware that while China has 1.3 billion people, Singapore has only 5 million, so on average,
Singaporeans receive a much higher share of total GNI. Indeed, GNI per capita (per head) is $5,740 in
China, but $47,210 in Singapore.
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Purchasing power
To compare living standards, we do not only need to know about the level of income received by
residents. What we really want to know is what people can buy with their income. In other words, we
want to measure the relative purchasing power of income in different countries. When we translate
from local currency into US dollars using official exchange rates, we do not necessarily learn about
purchasing power.
This is because official exchange rates do not necessarily reflect the relative purchasing power of
income. There are several reasons for this. Exchange rates may reflect the prices of goods that are
traded between countries (which may be very different from the goods and services that the average
citizen buys). Or exchange rates may reflect the interest rate policies of governments. In some cases,
governments intervene to influence the exchange rate in pursuit of their macroeconomic policies. For
all these reasons, official exchange rates may not give a true representation of relative living
standards when we use them to calculate GNI per capita in US$.
This has been the subject of much research, and the International Comparisons Program now
regularly produces data on GNI per capita that have been converted from local currency using
purchasing power parity rates (PPP). Using these data, China has GNI per capita of PPP$9,210, while
the estimate for Singapore is PPP$61,100. Figure 1 shows the data for GNI per capita in both US$
and PPP$ for a selected group of countries.
You can see that using PPP conversion rates makes quite a difference. The countries in the figure
have been ranked in descending order of GNI per capita in US$ from top to bottom. Notice that for the
advanced countries shown in the figure, the PPP estimates are lower than those in US$, whereas the
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reverse is the case for the less developed countries. This suggests that the US$ estimates
overestimate the purchasing power of local incomes in the advanced countries, but underestimate it
for the less developed countries.
Does GNI per capita measure what we want it to?
A further question is whether GNI per capita is the appropriate indicator if we want to compare living
standards across countries. We might well argue that it is too narrow a measure. After all, living
standards do not only depend upon the resources available to people, but also upon the extent to
which people use those resources wisely and whether they have the capability of enjoying the
consumption of resources. From this angle, we might argue that GNI per capita will not capture all the
dimensions of the standard of living. We might suggest that having a good education is important if
people are to make good use of resources, or that people need to be in good health and to live long
enough to enjoy the resources available.
In response to this argument, the United Nations have devised an alternative indicator known as the
Human Development Index (HDI), which brings together indicators of resources (GNI per capita in
PPP$), education (mean and expected years of schooling) and longevity (life expectancy). This is
intended to capture more dimensions of human development than are reflected just in the level of
resources measured by GNI per capita. Values of the index for our selected countries are depicted in
Figure 2.
This shows an interesting pattern. Remember that the countries are shown in descending order of GNI
per capita measured in US$, so the rather jagged pattern of the graph shows that some countries rank
more highly using the HDI than GNI per capita, whereas others show the reverse characteristic. For
example, compare South Africa with Sri Lanka. South Africa has a much higher GNI per capita than
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Sri Lanka, but Sri Lanka fares much better than South Africa on the basis of the HDI. This may reflect
the fact that Sri Lanka places greater emphasis on human development than on economic growth. It
may also reflect the impact that HIV/AIDS had on human development in South Africa.
Other indicators
It is also important to recognise that there are other things that contribute to living standards. For
example, the quality of the environment may contribute to the quality of life. Furthermore, if people
have to spend long hours commuting to work, this may detract from the quality of life, but would be
reflected in a higher GNI per capita, given the expenditure of transport services.
This resource is part of ECONOMIC REVIEW, a magazine written for A-level students by subject experts.
To subscribe to the full magazine go to www.hoddereducation.co.uk/economicreview
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