Limitations of National Income as a Measure of Welfare

National Income is a measure of the money value of goods and services becoming available to a nation from economic activities. It can also be defined as the total money value of all final goods and services produced by the nationals of a country during some specific period of time – usually a year – and to the total of all incomes earned over the same period of time by the nationals. National income is a good way of measuring the level of economic growth in a country, but there are several limitations of its use as measure of welfare.

Per Capita Income is the item that is usually used to measure standards of living by dividing national income by the population size to get the income per head in the country. But does the amount of income per head really determine the welfare of a person? What if the person has a lot of income but goods and services are extremely expensive due to inflation in the country? Here is a list of reasons why using per capita income to measure welfare can be problematic.

1) Inaccurate Estimates of Population

The first statistical problem in calculating income per head particularly in less developed countries is that we do not have very accurate population figures with which to divide total income.

2) Specific items which are difficult to estimate

Another data problem, as already mentioned, is that data for depreciation and for net factor income from abroad are generally unreliable.  Hence although we should prefer figures for “the’ national income, we are likely to fall back on GDP, which is much less meaningful figure for measuring income per head.  Inventory investment and work-in progress are also difficult items to calculate.

3) Non-marketed subsistence output and output of government

Some output like subsistence farming and output of government are not sold in the market. These are measured by taking the cost of the inputs. In one country, however, salary of doctors for instance, might be higher and their quality low compared to another country. Although the medical wage bill will be high, the “real consumption” of medical care in the former might be lower. Since “public consumption” is an important element in national income, this could affect comparisons considerably. Also in making international comparisons it is assumed that the complied national income figures of the countries being compared are equally accurate. This is not necessarily the case. If, for example, in one country there is a large subsistence sector, a lot of estimates have to be made for self-provided commodities. The national figures of such a country will, therefore, be less accurate than those of a country whose economy is largely monetary or cash economy.

4) Different degrees of income distribution

Another limitation of using national income to measure welfare is that a large population may be contributing a small proportion of national output while a few contribute a higher percentage. The many people who share only a small proportion will have a low standard of living.

5) Different Types of Production

The type of production affects the effectiveness of using national income to measure welfare. If one country devotes a large proportion of its resources in producing non-consumer goods e.g. military hardware, its per capita income may be higher than that of another country producing largely consumer goods, but the standard of living of its people will not necessarily be higher.

6) Different forms of Published National Income figures

The per capita income figures used in international comparisons are calculated using the published figures of national income and population by each country. For meaningful comparisons, both sets of national income figures should be in the same form i.e. both in real terms or both in money terms, the latter may give higher per capita income figures due to inflation, and thus give the wrong picture of a higher living standard. On the other hand, if both sets are in money terms the countries being compared should have the same level of inflation. In practice, this is not necessarily the case.

7) Exchange Rates

Per capita income or national income may not be a reliable method of measuring welfare if exchange rates are not stable. Every country records its national income figures in its own currency. To make international comparisons, therefore, the national income figures of different countries must have been converted into one uniform currency. Using the official exchange rates does this. Strictly speaking, these apply to internationally traded commodities, which normally form a small proportion of the national production.  The difficulty is that these values may not be equivalent in terms of the goods they buy in their respective commodities i.e. the purchasing power of the currencies may not be the same as those reflected in the exchange rate.

8) Difference in Price Structures

Differences in the relative prices of different kinds of goods, due to differences in their availability, mean that people can increase their welfare if they are willing to alter their consumption in the direction of cheaper goods. The people in poor countries probably are not nearly as badly off as national income statistics would suggest, because the basic foodstuffs, which form an important part of their total consumption, are actually priced very low.

9) Income in relation to Effort

Increased gross national output may have resulted from an increase in the number of hours worked. G.N.P is a measure of production and consumption not necessarily indicating an improvement in people’s welfare. The citizens may be working in unhealthy conditions and leisure time denial thus G.N.P does not take into account people’s welfare.

10) Differences in size

A problem which is both conceptual and statistical about using national income to measure standards of living and welfare is due to the transport factor. If two countries are of different sizes, the large country may devote a large proportion of its resources in developing transport and communication facilities to connect the different parts of the country. This will be reflected in its national income, but the standard of living of its people will not necessarily be higher than that of smaller country, which does not need these facilities to the same extent.

11) Differences in Taste

Another formidable difficulty in measuring people’s welfare using national income is that tastes are not the same in all countries. Also in different countries the society and the culture may be completely different thus complicating comparisons of material welfare in two countries. Expensive tastes are to some extent artificial and their absence in poor countries need not mean a corresponding lack of welfare. Tastes also differ as regards the emphasis on leisure as against the employment of the fruit of labour.

12) Different climatic zones

If one country is in a cold climate, it will devote a substantial proportion of its resources to providing warming facilities, e.g. warm clothing and central heating. These will be reflected in its national income, but this does not necessarily mean that its people are better off than those in a country with a warm climate.

13) Income per head as index of economic welfare

We cannot measure material welfare on an arithmetic scale in the same way as we measure real income per head. For instance, if per capita income increases, material welfare will increase; but we cannot say by how much it has increased, and certainly that it has increased in proportion.

14) It does not take into consideration the effects of production activities on environment, e.g. environmental degradation and pollution.

15) Quality of Life

National income figures do not reflect the quality of life. An increase in national income may be the result of linger working houses, inferior working condition, increase in housewives (which means less comfort). Generally national income has no provision for leisure time.

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