# Unit 1 Prosperity, inequality, and planetary limits

## 1.2 History’s hockey stick

Living standards throughout the world have risen dramatically since the time of Ibn Battuta—but much more in some countries than in others.

Listen to Diane Coyle talking about the benefits and limitations of measuring GDP. You can learn about how GDP is calculated in The Economy 2.0: Macroeconomics. In order to compare average living standards across countries and over time, economists use the concept of purchasing power parity (PPP) to account for the differences in prices of goods and services. PPPs are price indices that measure how much it costs to purchase a basket of goods and services compared to how much it costs to purchase the same basket in a reference country in a particular year, such as the United States in 2011.

gross domestic product (GDP)
A measure of the total output of goods and services in the economy in a given period. GDP combines in a single number, and with no double counting, all the output (or production) carried out by the firms, non-profit institutions, and government bodies within a government’s territory. Household production is part of GDP if it is sold. GDP is measured monthly, quarterly, and annually.

Figure 1.1 tells only a part of the story. To compare living standards in each country, we start from a measure called gross domestic product (GDP). GDP is a measure of how much is produced in a particular country in a year. We refer to GDP as the ‘output’ of a country. Diane Coyle, an economist, says it ‘adds up everything from nails to toothbrushes, tractors, shoes, haircuts, management consultancy, street cleaning, yoga teaching, plates, bandages, books, and the millions of other services and products in the economy’.1 These are all added together using their market values, which gives us total output, which also corresponds to the total income of everyone in the country. Then we divide GDP by the total population, and use the resulting number—GDP per capita—to measure average income, or ‘living standards’. (Some important things have been left out here. We discuss them in the extension of this section.)

In Figure 1.1, the height of each line is an estimate of average living standards at the date on the horizontal axis. You can see, for example, that in the fourteenth century, living standards were higher in Italy than in any of the other countries for which we have data.

History’s hockey stick

Figure 1.1 History’s hockey stick: gross domestic product per capita in five countries (1000–2018).

Stephen Broadberry. 2021. ‘Accounting for the great divergence: recent findings from historical national accounting’.; Total Economy Database.; S. N. Broadberry, B. Campbell, A. Klein, M. Overton, and B. van Leeuwen, B. 2015. British Economic Growth, 1270–1870. Cambridge: Cambridge University Press.; S. Broadberry, H. Guan, and D. Li. 2018. ‘China, Europe and the Great Divergence: A Study in Historical National Accounting’ Journal of Economic History 78: pp. 955–1000.; J. P. Bassino, S. Broadberry, K. Fukao, B. Gupta, and M. Takashima, M. 2019. ‘Japan and the Great Divergence, 730–1874’ Explorations in Economic History 72: pp. 1–22.; S. Broadberry, J. Custodis, and B. Gupta, B. 2015. ‘India and the Great Divergence: An Anglo-Indian Comparison of GDP per Capita, 1600–1871’ Explorations in Economic History 55: pp. 58–75.; P. Malanima. 2011. ‘The Long Decline of a Leading Economy: GDP in Central and Northern Italy, 1300–1913’. European Review of Economic History 15: pp. 169–219.; S. Broadberry and L. Gardner. 2022. ‘Economic Growth in Sub-Saharan Africa, 1885–2008: Evidence From Eight Countries’. Explorations in Economic History 83: 101424.
Note: The historical data is being improved continuously and the best data is provided in Figure 1.1 for the six countries shown. An alternative source of data is available for many more countries in the interactive chart.

We call these figures ‘hockey stick curves’ because of their resemblance to the shape of an ice hockey stick.

By 2018, according to this measure, people were six times better off, on average, in Japan than in India. People in Japan were nearly as rich as those in Britain, just as they were in the fourteenth century, but people in the US (not shown) were even better off, and people in Norway (also not shown) are better off still.

Before 1300, we have very few data points. For example, we have estimates of Chinese GDP only in 1000, 1090, and 1120, so the graph is drawn by joining these points with straight lines.

We can draw the graph in Figure 1.1 because of the work of Angus Maddison, who dedicated his working life to finding the scarce data needed to make useful comparisons of how people lived across more than 1,000 years. More recent estimates by economic historians are shown in the figure. This book will show you that the starting point of all economics is data like this about regions of the world, and the people in it.

History’s hockey stick does not appear in all countries and, where it does, it is shaped differently for different countries. The hockey stick kink is less abrupt in Britain, where growth began around 1650, while in Japan the kink is sharper, occurring around 1870. In China and India, living standards declined during the period when growth was taking off for countries in western Europe, and the kinks happened much later—in the second half of the twentieth century.

In some economies, including those of China and India, substantial improvements in people’s living standards did not occur before they gained independence from colonial rule or interference by European nations.

• India: GDP per capita fell by one-third between 1600 and 1870, as India increasingly came under British colonial rule.
• China: China suffered a similar decline in the eighteenth and nineteenth centuries, when European nations dominated its politics and economics. It had once been richer than Britain but, by the middle of the twentieth century, GDP per capita in China was one-fourteenth that of Britain.
• Latin America: Neither Spanish colonial rule, nor its aftermath following the independence of most Latin American nations early in the nineteenth century, saw anything resembling the hockey stick upturn in living standards experienced by the countries in Figure 1.1.
• Nigeria: Nigeria illustrates a case (one of many) in which there was little if any growth in output per capita prior to independence from colonial rule in 1960, and limited growth thereafter.

Figure 1.1 also illustrates that for much of history, living standards did not grow in any sustained way. When sustained growth occurred, it began at different times in different countries, leading to vast differences in living standards between countries around the world. Since late in the twentieth century, ‘latecomers’ such as India and China have been catching up with the richer nations, but in some countries the hockey stick has not yet tipped upwards.

An entertaining video by Hans Rosling, a statistician, shows how some countries got richer—and healthier—much earlier than others.

Understanding why over the past three centuries some countries have prospered and others have not has been one of the most important questions that economists have asked, starting with a founder of the field, Adam Smith. He gave his most important book the title An Inquiry Into the Nature and Causes of the Wealth of Nations.2 Read more in the ‘Great economist’ feature on Adam Smith.

Adam Smith (1723–1790) is considered by many to be the founder of modern economics. Raised by a widowed mother in Scotland, he went on to study philosophy at the University of Glasgow, which was an important centre of Enlightenment thought as well as of colonial trade—both of which influenced his understanding of the economy. He travelled throughout Europe, and while in Toulouse, France, he claimed to have ‘very little to do’ and so began ‘to write a book in order to pass away the time’. This was to become the most famous book in economics.

In An Inquiry Into the Nature and Causes of the Wealth of Nations, published in 1776, Smith asked: How can society coordinate the independent activities of large numbers of economic actors—producers, transporters, sellers, consumers—often unknown to each other and widely scattered across the world? His radical claim was that coordination among all of these actors might spontaneously arise, without any person or institution consciously attempting to create or maintain it. This challenged previous notions of political and economic organization, in which rulers imposed order on their subjects.

Even more radical was his idea that this could take place as a result of individuals pursuing their self-interest: ‘It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest,’ he wrote.

Elsewhere in The Wealth of Nations, Smith introduced one of the most enduring metaphors in the history of economics: that of the invisible hand. The businessman, he wrote, ‘intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.’ And he added: ‘Nobody but a beggar chooses to depend chiefly upon the benevolence of his fellow-citizens.’

Among Smith’s insights is the idea that a significant source of prosperity is the division of labour, or specialization, and that this in turn is constrained by the ‘extent of the market’. Smith illustrated this idea in a famous passage on the pin factory by reporting that ten men, each fully specialized in one or two of 18 distinct operations, could produce close to 50,000 pins a day. But ‘if they had all wrought [pins] separately and independently … they certainly could not each of them have made twenty, perhaps not one pin in a day.’

But such an enormous number of pins could only find buyers if they were sold far from their point of production. Hence specialization was fostered by the construction of navigable canals and the expansion of foreign trade. And the resulting prosperity itself expanded the ‘extent of the market’, in a virtuous cycle of economic expansion.

Smith did not think that people were guided entirely by self-interest. Seventeen years before The Wealth of Nations, he had published a book about ethical behaviour called The Theory of Moral Sentiments.3

He also understood that the market system had some failings, especially if sellers banded together so as to avoid competing with each other. ‘People in the same trade seldom meet together,’ he wrote, ‘even for merriment and diversion, but the conversation ends in a conspiracy against the public; or in some contrivance to raise prices.’

He specifically targeted monopolies that were protected by governments, such as the British East India Company, that not only controlled trade between India and Britain, but also administered much of the British colony there.

He agreed with his contemporaries that a government should protect its nation from external enemies, and ensure justice through the police and the court system. He also advocated government investment in education, and in public works such as bridges, roads, and canals.

### Question 1.1 Choose the correct answer(s)

• Adam Smith believed in the role of the government to improve societal welfare.
• Adam Smith believed that all markets were characterized by perfect competition.
• Adam Smith argued that economic agents were guided entirely by self-interest.
• Adam Smith claimed that coordination among a large number of economic actors (producers, transporters, sellers, consumers), often unknown to one another, might spontaneously arise without any person or institution consciously attempting to create or maintain it.
• He agreed with his contemporaries that the government should protect the nation from external enemies and ensure justice through the police and the court system, and also advocated government investment in education and public works.
• Adam Smith understood that the market system had some failings, especially when sellers colluded (‘banded together’) to create market power.
• He didn’t believe that self-interest was the sole motivation of economic agents, and he wrote about ethical behaviour in The Theory of Moral Sentiments, published in 1759.
• This statement expresses Adam Smith’s idea of the ‘invisible hand’: ‘It is not from the benevolence of butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest, led by an invisible hand to promote an end which was no part of his intention.’

### Extension 1.2 GDP per capita and living standards

In this extension we explore the reasons why GDP is not always a satisfactory measure of living standards. Not only does GDP leave out some things that are important for our daily lives, it also fails to take account of differences between people, and of the depletion of environmental resources.

You can explore GDP per capita data for various countries in the world, by visiting Our World in Data’s GDP per capita webpage.

correlation
A statistical association observed between two variables in a sample of data. If high values of one variable (e.g. people’s earnings) commonly occur along with high values of another variable (e.g. years of education) the variables are positively correlated. When high values of one variable (e.g. air pollution) are associated with low values of the other variable (e.g. life expectancy) there is a negative correlation. If variables are correlated, it doesn’t mean that there is a causal relationship between them: air pollution may not have caused the lower life expectancy we observed. See also: causality.

We have used GDP per capita as an indicator of living standards because total output is what makes possible the goods and services that we need or enjoy, whether it be haircuts or toothbrushes or education or other needed goods and services. Though GDP per capita does not measure directly how well off people are, it is highly correlated with other measures of wellbeing, such as life expectancy and what people report about their degree of satisfaction with their life.

But many aspects of our wellbeing are not measured by GDP per capita.4

Our measure of output leaves out things that directly affect how ‘well off’ we feel, including:

• the quality of our social and physical environment, such as friendships, clean air, and personal safety
• the amount of free time we have to relax or spend time with friends and family
• goods and services that are produced within the household, such as meals or childcare.

Two further problems with the GDP per capita measure come up when we use this concept to measure what we call ‘average living standards’:

• GDP measures output but does not take account of how the output is distributed among the members of a population.
• Producing output often involves ‘using up’ or destroying our natural environment and these costs of output are not included.

#### Output, income inequality, and ‘average living standards’

There is no such person as the average member of a population, so to talk about how well off a nation or group is, we have to sum up the experiences of the many individual members of a population and averaging them. What GDP tells us is how big is the total pie (the total output to be divided among the members of the group). GDP per capita tells us how large each person’s slice of the pie could be if everyone received the same amount.

But of course that is not how the ‘pie’ of GDP is actually divided up. To see why this matters, if output were equally divided and sufficient for everyone to have enough to satisfy their needs, we might say that the group was at least moderately well off. But if the same total output were enjoyed by just a single person, and the rest had nothing, GDP per capita would be unchanged, but it would not make sense to say that the ‘group’ was well off. All but one of the population would be miserable, and perhaps not even likely to survive.

Some people get much more than others because most of the output is for sale, and to get it for your own use you have to buy it. How much you can buy depends on your income, that is, the wages, salaries, rents, profits, transfers from governments, or other payments that you receive. To see why this matters, consider a group in which each person initially has an income of $5,000 per month, and imagine that, with no change in prices, income were to rise for every individual in the group. Then we would say that living standards had risen, because everyone would have had an increase in the goods and services they could enjoy. But now think about a different change. Suppose that the income of half the population rises to$9,000, while the income of the other half falls to $1,000. The average monthly income is unchanged (it is still$5,000) but would we say that living standards were unchanged after the group’s income became unequal? The additional income of the lucky (now-)rich half is unlikely to matter as much to the rich people (because they have so much already), as the loss in income suffered by the unlucky (now-)poor half. Taking this into account, we could say that while average income has not changed, people are less well off on average than before.

Since income distribution affects wellbeing, and because the same average income may result from very different distributions of income between rich and poor within a group, average income or GDP per capita may fail to reflect how well off a group of people is by comparison to some other group.

#### Growing output and depleting natural resources

When we think of how well off a person is, we think about the goods and services that they are able to enjoy in the course of a year. But beyond the things a person can get, we also take into account the things that they have, like a comfortable house or living in a beautiful natural setting. When we add up the ‘haircuts’ and ‘toothbrushes’ that make up GDP we include the value of the house by counting how much the house could have been rented for if the owner did not live there. But we do not count the enjoyment of the natural setting.

To see why this matters, consider a person who lives surrounded by a beautiful forest and enjoys the natural environment for the diverse species that it supports. In order to make a living, they decide to cut down the part of the forest that they own, and to sell the resulting wood for others to use.

The wood that is sold is counted in GDP but the fact that there is no longer a forest there is not counted. The person gets the goods that they can buy with the income from the wood that they have sold. But they no longer have a forest to live in. Are they better off? Probably. They decided that having the goods they could buy with the income from selling the wood is worth giving up the forest. But they are not as much better off as the income from selling the wood indicates.

If we think of an entire nation in the same way, the failure to count the depletion of our natural surroundings can make a big difference in our assessment of average living standards. A study of Indonesia measured the value of the depleted forests due to commercial logging, deforestation, and other causes. In 1983, for example, the value of Indonesia’s remaining forests fell by such an amount that, had it been subtracted from GDP, it would have reduced that measure of the country’s output by eight per cent.

In the same year, oil companies pumped 521 million barrels from the country’s known petroleum reserves. When account is taken of the 71 million barrels of new reserves that were discovered, the known reserves were reduced by 4 per cent. If the reduction in petroleum reserves due to pumping and selling oil had been included in the calculation of output, along with the erosion of the soil used for farming, the reduction in GDP for the year 1983 would have been 22 per cent.

Between 1971 and 1984 (the period covered by the study) the annual rate of growth of Indonesian GDP (adjusted for inflation) as conventionally calculated by economists was 7.1 per cent. Had account been taken of depleted petroleum reserves, forests, and soil, it would have been just 4.0 per cent.

In order to count output in such a way that it can inform us about how well off the people of a nation like Indonesia are, we have to include not only what has been used up in the process of producing the output (such as the wear and tear on machinery) but also the depletion of natural resources.

### Question E1.1 Choose the correct answer(s)

Read the following statements about GDP per capita, and choose the correct option(s).

• GDP per capita measures the average wellbeing of a country’s residents.
• If we adjusted GDP per capita to account for natural resource depletion, economic growth rates would generally be negative.
• It is possible for GDP per capita to rise while average living standards fall.
• It is possible for countries to have the same GDP per capita but very different levels of income inequality.
• GDP per capita does not measure many aspects of wellbeing, such as the quality of our social and physical environment.
• The growth rate of GDP per capita would still be positive, but smaller than if we only looked at the income generated from depleting the natural resources.
• For example, if incomes of the richest residents rise substantially while incomes of all other residents fall, GDP per capita may increase but the average living standards would have fallen. The additional income for the richest matters less to their wellbeing than the fall in income for everyone else.
• GDP per capita is an average, so it does not take income distribution into account. The same average income may result from very different distributions of income—for example, one person enjoying all of the output, compared to everyone enjoying the same total output in equal amounts.

### Exercise E1.1 What should we measure?

While campaigning for the US presidency on 18 March 1968, Senator Robert Kennedy gave a famous speech questioning ‘the mere accumulation of material things’ in American society, and why, among other things, air pollution, cigarette advertising, and jails were counted when the US measured its living standards, but health, education, or devotion to your country were not. He argued that ‘it measures everything, in short, except that which makes life worthwhile.’

1. In the full text, which goods does he list as being included in a measure of GDP?
2. Do you think these should be included in such a measure, and why?
3. Which goods does he list in the full text as missing from the measure?
4. Do you think they should be included, and why?
1. Diane Coyle. 2014. GDP: A Brief but Affectionate History. Princeton, NJ: Princeton University Press.

2. Adam Smith. (1776) 2003. An Inquiry into the Nature and Causes of the Wealth of Nations. New York, NY: Random House Publishing Group.

3. Smith, Adam. 1759. The Theory of Moral Sentiments. London: Printed for A. Millar, and A. Kincaid and J. Bell.

4. Jennifer Robison. 2011. ‘Happiness Is Love – and \$75,000’. Gallup Business Journal. Updated 17 November 2011.