Money Illusion

By Ghassan Karam, Special to Ya Libnan

The level of welfare of societies and even individuals should not be measured in purely monetary terms.  This is not a proposition to be questioned since there are many other aspects that play a major role in determining the level of welfare. Income distribution, access to healthcare, quality and level of educational services provided in addition to strong protection of the right to associate and dissent are a few examples. That is in essence why the Sarkozy commission headed by Joseph Stiglitz and Amartya Sen recommended steps to avoid what it called “GDP fetishism”.

Old ideas die hard. Despite all the criticism of GDP per capita as an indicator of the level of progress in an economy regrettably the idea is still prevalent all over the world and even more so among the less advantaged countries.  Besides the numerous shortcomings , some referred to above, there is still a common mistake that is committed when the metric of GDP per capita is used.

Economists of all political persuasions stress the fact that when monetary comparisons are to be made across a time horizon then it is crucial to adjust the nominal unit of currency used so as to make sure that the comparisons are fair. The problem arises from the universal tendency for units of currency to loose purchasing power over time. As a result a comparison of a stream of income during one year cannot be compared  to the stream of income during another year, say ten years earlier, because both streams are measured in terms of a particular currency whose ability to acquire goods and services has changed over time. In such circumstances the only way that comparisons can be meaningful and productive will be after an adjustment is made so that both incomes will be measured in terms of the same unit of currency. Please allow me to give a simple example of what the above means : If the wages of a person double but the prices of all items also double then that particular person whose nominal income has increased by a factor of 2 still enjoys the exact same level of welfare. This individuals income is still the same when measured in constant units of currency.

Many in Lebanon, both in and outside the government speak glowingly at times in the increase in the Lebanese GDP over the years. In nominal terms that is undeniable since the population has increased and since the value of the currency has shrunk over time. That is why two adjustments need to be made: the first adjustment is  look at GDP per capita and not the aggregate GDP since over the years the number of residents has increased and the second adjustment is that of transforming the nominal GDP per capita into one expressed in constant purchasing power units of currency.

The above exercise , in the case of Lebanon, turns out to be very instructive as the accompanying table reveals:

GDP per Capita

Year                     Nominal $             Constant $2000

1998                       4594                                4805

1999                       4565                                4663

2000                      4421                                 4421

2001                       4505                                4416

2002                      4836                                4606

2003                       5054                               4776

2004                       5414                                4905

2005                       5375                                4768

2006                       5603                                4797

2007                       6011                                 5009

Note that the per caipta income of $5603 nominal dollars for the year 2006 is 22% larger than the 1998 GDP per capita of $4594 when measured in nominal dollars. But as soon as both of 1998 and the year 2006 are measured in terms of the year 2000 dollars then the typical Lebanese citizen in the year 2006 turns out to be 46 poorer than the 1998 counter part. The implications of this are huge. The typical Lebanese has spent 9 years running on the spot when our political leaders would argue that Lebanon has made tremendous gains.

The last three years have been slightly better for Lebanon. Note that if 1998 is to be compared to 2007 then the GDP per capita in real terms would have shown an increase of 4.27 % over a period of ten years. That is nothing to write home about.

Note: Both of 2008 and 2009 promise to show net real growth but this observer did not have access to the constant $ and so decided not to use these figures for this post. All the above is based on my own estimates since such figures are not readily available in the case of Lebanon.