New Estimates of the Index of Economic Well-Being for Canada

Lars Osberg

- Dalhousie University

Andrew Sharpe

- Center for the Study of Living Standards

Canadian Economics Association

May 27, 2006

"Are you better off today than you were four years ago?"

1980 Ronald Reagan 1976-80 actual increase in per capita disposable

income in USA = 8.8% Audiences answered “NO!” – WHY ?

Widespread dissatisfaction with GDP as a measure of Economic Well-Being BUT: Alternative measures also aggregate to a single

index, burying value judgments

Is the nation “better off” ? As voters or bureaucrats, individuals do

make decisions re: collectivity Vote index I = α1 (own utility) + α2 (society’s well-

being)

Economic Well-Being is multi-dimensional Index should respect heterogeneity

Values / Preferences of Analysts Life Circumstances of Population

Objective of Index construction: to assist democratic discourse & summative subjective judgments

Outline of Paper

Index of Economic Well Being Consumption flows Sustainability / Accumulation of Productive Resources Distribution: inequality & poverty Economic Security

Present new estimates of trends in the index for Canada and provinces Compare to GDP per capita trends

Discuss methodological changes Linear Scaling Economic Security from Risk of Unemployment

Dimensions of Economic Well BeingConcept Present

Representative Agent / “Typical Citizen”

Average Flow of Current Income

Per Capita GDP or “Adjusted” Average Income Flow

Issues: Market transactions only, heterogeneity, stocks

Dimensions of Economic Well BeingConcept Present

Representative Agent / “Typical Citizen”

Average Flow of Current Income

Diversity of Population Experiences

Distribution of Current Income- Poverty and Inequality

Social Welfare Function literature SWF = f ( µ, σ )

Dimensions of Economic Well BeingConcept Present Future

Representative Agent / “Typical Citizen”

Average Flow of Effective Current Consumption

Aggregate Accumulation of Productive Stocks (broadly defined)

Issues: Average Income does not reveal savings rate- assets include environment, Human Capital, R&D, etc.

Aggregate Savings – not automatically optimal, sustainable–preferences for social saving differ among individuals

Dimensions of Economic Well BeingConcept Present Future

Representative Agent

Average Flow of Effective Current Consumption

Aggregate Accumulation of Productive Stocks

Diversity of Population Experiences

Distribution of Current Income:- Poverty and Inequality

Insecurity of Future Income

Values matter – and differ ECONOMIC WELL-BEING=

α1 [ CONSUMPTION ]+ α 2 [ STOCKS OF WEALTH ]+ α 3 [ EQUALITY ]+ α 4 [ ECONOMIC SECURITY ]

DIFFERENT VALUES WILL IMPLY DIFFERENT WEIGHTS Useful to know whether (& how much)

aggregate trend depends on weighting α = 0 is a (strong) value choice

80.0

90.0

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Index of GDP per Capita

Index of Overall Economic Well-being

(1981 =100 )

Source: Table 1.

Chart 1: Trends in the Overall Index of Economic Well-being and GDP per Capita, Canada, 1981-2005

Why an Additively Separable Social Welfare Function ?

Key theoretical assumptions: Constant relative risk/inequality aversion Imperfect Insurance & Capital Markets Additively Separable Lifetime Utility

Risk Averse Representative Agent choosing from behind Veil of Ignorance ?

Communication is key to actual usage Sensitivity to alternative weightings easy

Methodology Variables now scaled linearly

Consistent with other indices (e.g. HDI) Solves “Directionality Problem”

(Max – value)/(Max – Min) OR (Value – Min)/(Max-Min)

Problems: Reporting trends as % change or % points Scaling removes base – sensitive to comparison group

“Base Case” assigns equal weight to all dimensions Excel data sheet available for experimentation

Chart 2: Trends in the Index of Economic Well-being for Four Components, Canada, 1981-2005

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300.0

350.0

400.0Index of Scaled Total Consumption per Capita

Index of Scaled Total Wealth per Capita

Index of Scaled Equality

Index of Scaled Economic Security

Index of GDP per Capita

(1981=100 )

Source: Table 2.

Average Consumption Flows $

Marketed real consumption per capita from SNA

Adjustments value of increased longevity of life /

consumption reduced economies of scale in household

consumption Unpaid work – @ generalist replacement wage Government services @ cost “Regrettable Necessities”

Commuting, costs of crime & divorce, household pollution abatement spending

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Index of Personal Consumption per Capita

Index of Government Expenditure per Capita

Index of Unpaid Work per Capita

Index of Regrettable Expenditure per Capita

Index of Total Consumption Flows per Capita

Source: Table 3.

( 1981=100 )

Chart 3: Trends in the Index of Total Consumption per Capita and its Components, Canada, 1981-2005

Chart 5: Trends in the Index of Family Size and Index of Life Expectancy, Canada, 1981-2005

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Index of Square root of Family Size

Index of Life Expectancy

Source: Table 3.

(1981=100)

Accumulation, Sustainability and Intergenerational Bequest $

Physical capital stock Plant & Equipment + Residential

Research and Development – as capital stock Value of natural resource stocks

price + quantity change Stocks of human capital (@ cost education) Net change in foreign indebtedness Net Change in state of environment &

national heritage (cost of CO2 emissions ) NOTE: Real productive assets only

0.0

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300.0Index of Total per capita Net Capital StockIndex of Per Capita R&D StockIndex of Per Capita Stock of Natural ResourcesIndex of Per Capita Net International Investment PositionIndex of Per Capita Stock of Human CapitalIndex of Per Capita Greenhouse Gas Social CostIndex of Total per Capita Wealth

( 1981=100 )

Source: Table 4.

Chart 6: Trends in the Index of Wealth per Capita and its Components, Canada, 1981-2005

Distribution

Same average income if all get $500 or if ½ get $999 & ½ get $1 – but well-being differs

How to summarize “Distribution”? Simplicity desirable if index to be used Poverty & Inequality differ, but both matter

Inequality - Gini coefficient After-tax & transfer household income Equivalence scale =

Poverty - Sen-Shorrocks-Thon measure Rate (Poverty Line = ½ Median) Average poverty gap ratio Intensity = rate x gap

familysize

Chart 8: Trends in the Index of Gini Coefficient in Canada, 1981-2005

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1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

( 1981=100)

Source: Table 5.

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1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Index of Poverty RateIndex of Poverty Gap RatioIndex of Poverty Intensity

( 1981=100)

Source: Table 5.

Chart 9: Trends in the Index of Poverty Rate and Poverty Gap in Canada, 1981-2005

Economic Security.

[25] “Everyone has the right to a standard of living adequate for the health and well being of himself and of his family, including food, clothing, housing and medical care and necessary social services, and the right to security in the event of unemployment, sickness, disability, widowhood, old age or other lack of livelihood in circumstances beyond his control.”

Universal Declaration of Human Rights - United Nations: 1948 “Named Risks” – conditional probability of

financial loss approach

“Economic Security”

Risk of loss due to unemployment Risk of Unemployment + E(financial loss|unemployment)

Financial Risk of Illness Unreimbursed private medical expenses as share of disposable

income Risk of single parent poverty

Divorce rate x poverty rate x poverty gap of single parents Risk of poverty in old age

chance x depth of elderly (>65) poverty Security risks weighted by relevant population size

Security from Unemployment

Original method – financial loss implied by compound probability =P(U)*P(B|U)*(E(B/W)

Assumes components matter equally Decline UI/EI coverage has big impact on trends

New literature on self-reported happiness Di Tella, MacCulloch, Oswald (2003) “The Macro Economics of Happiness” RESTAT

Ordered Probit life satisfaction – n= 271,224

Recover Implicit weights on Unemployment Rate and Unemployment Benefits

This paper: Unemployment rate = 4x UIBen = .8*(scaled Unemp) + .2*(scaled P(B|U)*(E(B/W))

Chart 10: Trends in the Index of Unemployment Rate in Canada, 1981-2005

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1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

( 1981=100)

Source: Table 6.

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1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Index of Proportion of Unemployed receiving Benefits (coverage)

Index of Proportion of Earnings replaced by Benefits

( 1981=100)

Source: Table 6.

Chart 11: Trends in the Index of EI Financial Assistance in Canada, 1981-2005

Chart 1A: Relationship Between Trends in the Index of Overall Economic Well-being and GDP per Capita, Canada

1.30

2.10

0.64

1.46

1.681.77

1.63 1.64

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2.50

1981-2005 1981-1989 1989-2000 2000-2005

Ave

rage

Ann

ual G

row

th R

ate,

per

cen

t

Index of Overall Economic Well-being

Index of GDP per Capita

Source: Table 1.

Chart 2: Trends in the Index of Economic Well-being for Four Components, Canada, 1981-2005

0.0

50.0

100.0

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250.0

300.0

350.0

400.0Index of Scaled Total Consumption per Capita

Index of Scaled Total Wealth per Capita

Index of Scaled Equality

Index of Scaled Economic Security

Index of GDP per Capita

(1981=100 )

Source: Table 2.

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Index of GDP per Capita

Index of Overall Economic Well-being

(1981 =100 )

Source: Table 1.

Chart 1: Trends in the Overall Index of Economic Well-being and GDP per Capita, Canada, 1981-2005

Conclusion growth rate 1981 – 2005

GDP per capita = 1.68 % Index of Economic Well-being = 1.30 %

Average Consumption flows & Wealth Stocks grew

Equality & Security declined

Equality & Security Focus of Welfare State Crucial to personal well-being

The Non-Linear (log) Functional Form of the Value of GDP per Capita in the HDI vs. The linear functional form

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100 2,400 4,700 7,000 9,300 11,600 13,900 16,200 18,500 20,800 23,100 25,400 27,700 30,000 32,300 34,600 36,900 39,200

GDP per capita (PPP US$)

HD

I G

DP

per

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ita

ind

ex

At $10,000 GDP per capita, the HDI GDP per capita index value is 0.7686

HDI GDP per capita index = (log(GDP per capita)-log(100))/(log(40,000)-log(100)).Source: Human Development Report 2001, p. 240, United Nations.

Linear Scale: 0.25Log Scale: 0.78

Linear Scale: 0.5Log Scale: 0.88