Despite its shortcomings, GDP per capita is still the most commonly used indicator of living standards.

What GDP does actually measure may differ significantly across countries for several reasons, particularly the quality of public spending, and the government’s effectiveness in transforming resources into socially valuable outputs.

Everywhere around the world, non-market government accounts for a big share of GDP and yet it is poorly measured—namely the value to users is assumed to equal the producer’s cost. Such a framework is deficient because it does not allow for changes in the amount of output produced per unit of input, that is, changes in productivity. It also assumes that these inputs are fully used, when this is not the case, there is an overstatement of national production.

Moreover, in the national accounts, this attributed non-market (government and non-profit sectors) ‘value added’ is further allocated to the household sector as ‘actual consumption.’

In many countries around the world have inefficient health and education systems sometimes involving mass absenteeism by teachers and health workers. Such ‘actual’ consumption is anything but actual. To count the salaries of AWOL( absent without official leave) government employees as ‘actual’ benefits to consumers adds statistical insult to original injury.

This ‘statistical insult’ logically follows from the United Nations System of National Accounts (SNA) framework once ‘waste’ is classified as income—since national income must be either consumed or saved. Absent teachers and healthcare workers are all too common in many low-income countries. Beyond straight absenteeism, which is an extreme case, generally there are significant cross-country differences in the quality of public sector services. World Bank (2011) reports that in India, even though most children of primary school age are enrolled in school, 35 per cent of them cannot read a simple paragraph and 41 per cent cannot do a simple subtraction.

It must be acknowledged, nonetheless, that for many of government’s non-market services, the output is difficult to define, and without market prices the value of output is hard to measure. It is because of this that the practical solution adopted in the SNA is to equate output to input costs. This choice may be more adequate when using GDP to measure economic activity or factor employment than when using GDP to measure living standards.

Moving beyond this state of affairs, there are two alternative approaches. One is to try to find indicators for both output quantities and prices for direct measurement of some public outputs. The other is to correct the input costs to account for productive inefficiency, namely to purge from GDP the fraction of these inputs that is wasted. We focus here on the nature of this correction. As the differences in the quality of the public sector have a direct impact on citizens’ effective consumption of public and private goods and services, it seems natural to take them into account when computing a measure of living standards.

Atkinson and others (2005, page 12) state some of the reasons behind current SNA practice: “Wide use of the convention that (output = input) reflects the difficulties in making alternative estimates. Simply stated, there are two major problems: (a) in the case of collective services such as defense or public administration, it is hard to identify the exact nature of the output, and (b) in the case of services supplied to individuals, such as health or education, it is hard to place a value on these services, as there is no market transaction.”

Once it is recognised that the effectiveness of the government’s ‘production function’ varies significantly across countries, the simple convention of equating output value to input cost must be revisited. Thus, if we learn that the same output could be achieved with less inputs, it is more appropriate to credit GDP or GNI with the required inputs rather than with the actual inputs that include waste.

A natural way forward involves finding indicators for both output quantities and prices for direct measurement of some public outputs. This is recommended in SNA 93 but has yet to be implemented in most countries. Moreover, in recent times there has been an increased interest in outcomes-based performance monitoring and evaluation of government activities.

As argued also in Atkinson (2005), it will be important to measure not only public sector outputs but also outcomes, as the latter are what ultimately affect welfare.

A step in this direction is suggested by Abraham and Mackie (2006) for the US, with the creation of ‘satellite’accounts in specific areas as education and health. These extend the accounting of the nation’s productive inputs and outputs, thereby taking into account specific aspects of non-market activities.

Edited extracts from IMF working paper on ‘Quality of government and living standards: adjusting for efficiency of public spending’.

Edited extracts from IMF working paper on ‘Quality of governance and living standards’