Limitations of GDP as an Indicator of Welfare

Gross Domestic Product is an indicator of total economic activity. This indicator is also used frequently to describe social welfare. This is because GDP tends to correlate closely with consumption, which is then often used as a proxy for welfare. The idea is that people are happier if they consume more.

This argument seems a little too simple. Insisting on causality as a simple correlation between welfare and GDP may lead to incorrect conclusions that can be very problematic, especially for policymakers. Therefore, we muste look at the limitations and potential alternatives to GDP as a welfare indicator.

Limitations to GDP

GDP is not a good indicator of welfare. There are many limitations to it. These limitations are due to the fact that GDP does not measure well-being. In addition, the concept fails to account for important factors that affect social welfare. These are the most important limitations.

GDP does NOT include any measures for the welfare

This is perhaps the most important issue. GDP, as mentioned above, is simply the total value of all final goods produced in an economy over a certain period. There are several ways to calculate or measure GDP. However, neither one of these methods includes any indicator of welfare or well-being. Although this doesn’t necessarily mean that GDP can’t be a good indicator for welfare, the fact it is used as to “proxy of proxy” significantly affects its validity.

GDP includes only market transactions

Therefore, GDP does not include domestic or voluntary work. These activities, however, have a substantial positive impact on social well-being as they complement and improve the standard of living. The GDP, on the other hand, does not include black-market transactions or any other illegal activities that might have a substantial impact on overall socio-economic well-being.

Read also: What is inflation? What are its effects?

GDP does not describe income distribution

The majority of people who are not able to afford the majority of goods and services will not benefit from an increase in economic output if there is high inequality. Therefore, to accurately assess social welfare, it is necessary to consider income distribution. (For more information, please see the Gini index).

GDP is not a description of what is being produced

GDP refers to the value of all final goods and services in an economy. This includes products that have negative impacts on social welfare. For example, consider a country with a large armaments industry, which represents the majority of its GDP. Overall social welfare is likely to decrease if arms are exported and used in the country. This holds true for all goods and services with adverse social effects.

GDP ignores externalities

Increased exploitation of both non-renewable and renewable resources is a common way to increase economic growth. Overuse can lead to negative externalities such as pollution and overfishing. Overfishing, pollution, and social welfare will all decrease as a consequence. This effect is not part of GDP.

When we consider all of these factors, it becomes clear that GDP is not a good indicator of welfare. It is clear that higher GDP means better social well-being. However, the positive effects of increased consumption opportunities may not outweigh any negative effects due to the limitations noted above. Although GDP can sometimes be used to measure social welfare, it can lead to biased conclusions that could make it unfavorable.

Alternate approaches

Due to the above shortcomings, there have been several attempts to develop better indicators that can measure social well-being. These alternatives include the Human Development Index (HDI), the Gross National Happiness Index (GNH), and the Social Progress Index (SPI).

Human Development Index

The Human Development Index focuses on individuals and their abilities to assess the development and well-being of a country. It measures three important dimensions: standard of living, health and life expectancy, education, and education. This latter measure is the gross national income per head. HDI is an indicator of economic activities. It also adds two dimensions to give a better picture of social welfare.

Gross National Happiness Index

The Gross National Happiness Index uses a psychology-based holistic approach to measuring social well-being. It was developed in Bhutan. It is built on four pillars: governance and socio-economic development. Cultural preservation and conservation are also important. These four pillars have been further broken down into nine areas that are measured with 33 specific indicators. This concept is very advanced because of the many different indicators.

Social Progress Index

The Social Progress Index offers a comprehensive framework that is based in part on three dimensions: basic human requirements, foundations of well-being, and opportunities. A variety of indicators are used to measure the social progress of each dimension. These include, among others, nutrition, medical care and safety (basic human requirements), education, well-being, and sustainability (foundations and foundations of well-being), as well as personal rights and freedom and tolerance (opportunity).

Each of these methods considers multiple dimensions to provide a comprehensive picture of social welfare. It is impossible to replace GDP as a social welfare indicator in the near future, but it could be used with these other approaches to give more detailed and accurate results.


Despite many flaws, the GDP is often used to indicate social welfare. Many of these limitations can be attributed to the fact that the concept is not meant to measure well being. Because GDP doesn’t account for nonmarket transactions, wealth distribution, and externalities, as well as the types of goods and services being produced within the economy, it is not able to measure well-being. These issues were addressed by a variety of measures of welfare, including the Human Development Index (HDI), Gross National Happiness Index (“GNH”), and Social Progress Index (SPI).



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