Does GDP growth reflect changes in social welfare after all?

Individuals realise consumer benefits in a variety of ways. They use part of their income to buy consumer goods and services, and part of it to pay “voluntary” taxes and contributions to the state to cover community services. The remainder of their income is saved, put aside, invested and used to finance future consumption. It is important to emphasise that consumer benefit is not measured by the amount of expenditure or cost for any of the uses, but by the extent to which the consumer values the goods and services available for consumption.

GDP is made up of three parts of domestic final consumption according to how consumers realise the benefits.

1. In the case of purchased consumption, the free market, equilibrium price of the product directly expresses the degree of consumer utility.
2. Community services do not have a market price, so the “value” of community services can only be quantified indirectly by statistics. It relies on the assumption that consumers/voters have entrusted the government they elect and control with the task of shaping the level and structure of community services in such a way that they provide the greatest benefit to consumers. Although the public budget sets the cost of community services, the aim is in fact to increase the benefits to consumers from using the services. It is also a community service when the state buys a product or service from others and passes it on to consumers.
3. Investment is the third component of the consumption side of GDP. According to a widely accepted economic theory, investment is a sacrifice for the sake of future surplus consumption. A person saves because he expects to consume more of the return on the fixed capital created by the capital investment in the future than he could consume today with the amount saved. Even if we always consider the enjoyment of the present to be more than what we have to wait for. It follows that an investment contributes to social welfare by the present value of the expected return/profit from the operation of the fixed asset created. The expected return cannot be quantified by statistical methods. Therefore, when GDP is compiled, the expected return is proxied by the investment costs. Applying the well-known theorem that, in a market equilibrium, the cost of investment is equal to the present value of the expected return over the life of the fixed asset. It is not the case that the higher the cost of an investment, the higher the expected welfare increase. The theorem states that a rational decision maker is willing to invest only as much as the expected return, the consumption surplus, including the so-called time preference, is expected to result from the investment.

It also follows from the above that public support for business investment distorts the market equilibrium, whether directly or through interest rate relief. It puts the chosen investor in a more favourable position by requiring him/her to calculate a return only on his/her own capital, the subsidy or interest-rate subsidy being a free source. State aid to enterprises actually reduces the expected specific return on investment and thus the expected increase in consumer benefits. State aid is only justified if it helps to achieve a social preference, such as reducing unemployment. The congruence of costs and expected consumer benefits also applies to government investment, even if the expected return on government investment is usually not expressed in monetary terms. However,

the choice between publicly financed investment alternatives should be based primarily on the interests of consumers/citizens.

The timeline of Hungarian government investment illustrates the preferences that have influenced development policy over the past decade and a half. A table compiled from the Hungarian Central Statistical Office (KSH) database shows the sectoral ranking of government investment expenditure for the period 2010-2022. At 2010 price levels, the total value of government investment was around HUF 20,600 billion[1], of which more than half was allocated to the public administration and defence sector. The amount of defence investments and arms purchases is not known separately, but it is certain that, apart from that, investments for public administration purposes dominate. It is hardly credible that this reflects the preference ranking of the Hungarian population. It is certain that the vast majority of consumers/voters would prefer to spend on healthcare improvements rather than on administrative luxuries. It is also telling that the amount of investment in recreation and sports (e.g. stadiums and canopy walks) is more than a quarter higher than what the state spends on health care development.

To assess the extent to which government investment has contributed to social welfare, we need to know the costs of individual projects. For example, since 2010 the Hungarian state invested a significant amount in education. The aggregate figures do not show the extent to which the projects implemented have contributed to raising the overall quality of public and higher education.

Unlike market investment, government investment is never loss-making, according to statistical accounts (the macroeconomic importance of the topic is indicated by the fact that between 2010 and 2022, an average of around 5% of GDP was spent on government investment per year). More precisely, in the absence of market prices, statistics cannot show if an asset created or acquired by government investment is surplus, unused or unusable. In fact, the more costly the investment, the more the fixed asset created appears to increase welfare over its lifetime. The depreciation of the fixed asset and the cost of maintaining it are included in the value of public services, and this, according to the GDP statement, constitutes a consumer benefit for consumers even when the facility is vacant.

The investment figures illustrate the pitfalls of valuing public services. In reality, all public services are only worth what they deliver in terms of consumer benefits to users. However, since statistics cannot quantify the benefits of public services, only their costs,

this gives rise to the illusion that social welfare increases as the costs of public services increase.

GDP is an indicator of both production and welfare. As an indicator of production, it is primarily suitable for examining short-term economic processes. It measures production from the cost side, with value added being the sum of the cost of capital (including depreciation and profit) and wages. Statistics can estimate both components with sufficient precision and reliability. GDP is a relevant indicator of the cost of production and of changes in the volume of production. In the longer term, however, it is pointless to expand production for its own sake. This paper aims to draw attention to the fact that GDP, as a production-side, cost-based indicator, and its change, can only reflect changes in social welfare from consumption if it can be shown that governments, through democratic consultation, are shaping the level and structure of public services in a way that best suits the individual preferences of their citizens.

Between 2010 and 2022, Hungary's GDP grew by just over 2.5% on average per year. Based on the above, it can be assumed that the welfare of Hungarian society has increased by a more modest amount.

[1] Between 2010 and 2023, the Hungarian government spent a total of nearly HUF 26,000 billion on public administration and defence investments at 2023 annual prices.

Cover photo (for illustration purposes only): Getty Images