Exercise 7.1:
Why do real GDP data understate the growth in U.S. living standards during the past century?

U.S. real GDP per person, one measure of the standard of living in the U.S., rose nearly 1000% from 1870 to 1998. That means that the average U.S. citizen earned nearly eleven times more income in 1998 than the average citizen in 1870 and could afford eleven times more goods and services. However, dramatic as that rise in income and spending appears, it likely understates the country's true increase in economic well-being during the past century and a half. Why have living standards grown faster during the past century than real GDP figures indicate?

As noted above, real GDP per person gives us one measure of the growth in living standards over time. However, while real GDP per person takes account of increases in the price level and growth of the population, this dollar-valued economic measure does not fully reflect the effect that advances in technology, agriculture, medicine, and computers have had on our economy during the past century. Indeed, some of these long-term improvements in our standard of living may defy measurement in pure economic terms.

Take for example, the dramatic increase in life expectancy during the 1900s due to improved nutrition, clothing, and medical care. From 1900 to 1996 the average U.S. life expectancy at birth increased by nearly 30 years, from 47 years to 76 years. Such increases in life expectancy directly increase a country's output, through healthier workers and longer working lives, but how much are thirty-years' of additional life worth for the average citizen worth? How much would you be willing to pay for 30 additional years of life? Can economists really put a price tag on that? Alternatively, could real GDP measures alone adequately measure the benefits resulting from finding a cure to the worldwide AIDS/HIV epidemic, which in some countries has reduced the average human lifespan by 5-10 years or more? Clearly not.

Not only are people living longer today than they were in the 1800s but they have access to thousands of goods and services that were unavailable then—because they did not exist! The availability of such items today—such as antibiotics, automobiles, and electric lights—make comparisons of current living standards to those of a century ago difficult or impossible. Goods we take for granted today—CDs, cell phones, computers, modern life-saving drugs—were simply beyond our imagination a hundred and fifty years ago. In this sense, the increase in U.S. living standards has been beyond measure.

Real GDP figures provide one measure of the tremendous economic growth and transformation that has occurred in market-based economies like the U.S. over the past century and a half, but almost certainly underestimate the true rate of growth in actual living standards. In particular, changes in real GDP figures over this time period understate the benefits from the dramatic increase in life expectancy and the availability of new goods and services brought about by new technologies. As a result, the increase in living standards for the average American—the real measure of economic growth—has been significantly higher than the standard economic measures reflect.

References:

National Vital Statistics Report, 1996

Delong, J. Bradford, "How Fast is Modern Economic Growth?," Federal Reserve Bank of San Francisco Economic Letter, Number 98-31 (October 16, 1998)
http://www.frbsf.org/econrsrch/wklyltr/wklyltr98/el98-31.html