Measuring GDP in the PWT from a Social Welfare Perspective

Our project aims to develop a new methodology for measuring income and living standard differences across countries, utilising recent advancements in macroeconomics, the economic theory of index numbers, and social welfare theory. Existing measures, such as Gross Domestic Product (GDP) per capita at Purchasing Power Parity (PPP) from the Penn World Table (PWT) and Gross National Income (GNI) per capita from the World Bank, are vital for policy analysis and research. Policymakers rely on these measures to design policies for growth and development, poverty reduction, and reducing regional inequality, while international organisations use them for critical decisions, such as foreign aid allocation. In this context, the project’s main objective is to improve how GDP is measured in the PWT and extend this to Gross National Product (GNP), addressing limitations in current methods. This initiative has two key goals: first, to strengthen the theoretical basis of cross-country GDP measurement by adopting a dynamic approach that better captures the welfare impact of economic activities; and second, to design a methodology that aligns with the current workings of the PWT while offering a more comprehensive assessment of income differences through a global social welfare perspective. The proposal is based on recognising a key limitation of the current PWT methodology. Currently, it measures income differences using static models, which treat trade balances as simple transfers between countries. This approach can create biases, especially when significant trade imbalances exist. Our project will address this by refining the methodology to treat trade balances as investments between countries, better capturing the flow of goods and capital and giving a more accurate picture of economic well-being. By adjusting for these biases, we aim to provide more precise comparisons of living standards and prosperity across nations. In the new approach, bilateral income gaps between countries will measure welfare gains by accounting for the trade-offs countries face between increasing current consumption through a trade deficit or investment abroad, opening opportunities for future consumption. This dynamic perspective, merging macroeconomic theory with the theory of index numbers, will produce bilateral indices that better reflect welfare differences. In contrast to the current method, which views net exports as transfers, our method interprets them as investments abroad, providing a clearer understanding of global economic interactions. Additionally, we will aggregate income gaps between all pairs of countries into a global social welfare function, producing a single, PPP-adjusted GDP per capita figure for each country. This approach incorporates recent developments in social choice theory, such as Eden's (2022) aggregating welfare gains method and Maskin's (2023) cumulative voting system based on the Borda count. These innovations promise a more accurate and insightful representation of economic differences across countries, contributing to better-informed policymaking, advancing research in economics and the social sciences, and having a critical impact on the study of development issues. Overall, this proposal seeks to redefine how GDP and GNP are measured in the PWT, advocating for a shift towards a more dynamic and welfare-focused approach. By addressing current biases and improving measurement techniques, we aim to enhance our understanding of global economic differences and contribute to a more equitable discussion on development and prosperity.