Real GDP per head and the Human Development Index (HDI) are both commonly indicators of a country's standards of living. These measures are covered in this section of the website.

Real gross domestic product (GDP) per head

In Unit 4.6, it was stated that real GDP is used by economists to measure economic growth and to indicate standards of living in an economy. However, one limitation of this approach is that reporting GDP figures in this way does not account for the size of the population (see Table 1). For example, China is the second largest economy as measured by GDP. However, it also has the world's larger population. Hence, reporting GDP per capita (per person) can be a better indication of an economy's standards of living.

Real GDP refers to the monetary value of an economy's national income that is adjusted for inflation. This removes the impact of higher prices on an economy's national income over time. Real GDP per head (or real GDP per capita) refers to a country's gross domestic product divided by its population size. Economic growth does not necessarily increase GDP per capita, as this depends on the relative change in population size. However, for living standards to increase, there must be a rise in real GDP per head. In general, the higher the real GDP per head, the higher the living standards as individuals and households are more able to meet their needs and wants.

Economic growth that does not come at the expense of growth prospects for future generations is known as sustainable growth.

Table 1 - GDP and GDP per capita, selected countries (Dec 2021)

Source: adapted from Trading Economics

 To review your understanding of real GDP per capita, watch this informative video (play from 1 min 8 seconds).

Human Development Index (HDI)

An alternative indicator of living standards is the Human Development Index (HDI). This is a composite indicator created by the United Nations (UN) that acknowledges income is not the only indicator of living standards. The HDI captures three key dimensions of human development and hence people's quality of life: (i) a long and healthy life, (ii) access to knowledge, and (iii) a decent standard of living. The index uses a geometric mean average of each of these three dimensions of human development.

Source: UNDP

In calculating a country's HDI, each of the dimensions of human development must first be measured:

• Health - A long and healthy life is assessed by life expectancy at birth.

• Education - Access to knowledge is assessed by the expected years of schooling for school-aged children and by the mean average years of education for adults aged 25 years and above.

• Income - A decent standard of living is assessed by real GDP per head.

The HDI allows economists to make a better comparison of living standard for two countries with the same level of GDP per head but with different human development outcomes. This enables economists and policy makers to have more informed discussions about government policies and priorities.

 Advantages of real GDP as indicators of living standards

• It is relatively easy to calculate (the various components of GDP). Calculating the HDI is more complex.

• GDP gives information about the size of the economy, indicating the level of economic well-being. The higher the real GDP in a country, the higher the level of purchasing power and level of national output.

• Higher real GDP also means a growing economy and hence more people are likely to be in employment. This helps to show living standards are improving in the economy.

• Economists would argue that real GDP is the single best indicator of living standards. The average person in  Luxembourg, Ireland, Switzerland, and Norway (see Table 1) will have a better standard of living than the average person in countries that have a low real GDP per head, such as Burundi ($267), Malawi ($394), and Central African Republic ($411).

 Disadvantages of real GDP as indicators of living standards

• Income distribution is ignored in calculations of GDP, real GDP, and GDP per head. The calculations do not take account of the unequal distribution of income in an economy. For example, the GDP per capita in the USA was $61,280 in 2021, although there are plenty of people in America who experience poverty.

• Real GDP does not account for the environmental impacts of economic growth. For example, climate change, pollution, and resource depletion are direct consequences of economic activity, but these do not have a positive impact on people's living standards.

• Furthermore, there is consideration of qualitative factors that impact living standards, such as the threat of war, outbreak of highly infectious diseases, or access to clean drinking water.

• Two or more countries can have the same or similar value for their real GDP or real GDP per head, but still have contrasting standards of living.

 Advantages of HDI as indicators of living standards

• As a composite indicator, the HDI is a more comprehensive measure of living standards than real GDP. The HDI has the advantage of also accounting for education and healthcare as measures of the quality of life for the average person.

• Similarly, the HDI considers social aspects of human development (health and education) rather than just an economic aspect of living standards (real GDP). Hence, it is a more accurate measure of the average person's well-being and human development.

• It is the most widely used measure of living standards, making it easier for governments to make international comparisons and to set benchmarks.

 Disadvantages of HDI as indicators of living standards

• The components of the HDI are arbitrarily calculated as a geometric mean, with all three components having equal weighting in the calculation of the index.

• The HDI does not reflect on inequalities, poverty, human insecurities, and gender disparities - all of which have negative impacts on people's living standards.

• Qualitative factors that impact living standards are also ignored in the HDI, such as human rights, political freedoms, and work-life balance.

• Environmental issues are ignored by the HDI ignores environmental and resource depletion as a consequence of economic growth.
• Cultural differences and interpretations of the meaning of living standards are not accounted for. For example, whilst Hong Kong has a high HDI value (see Table 2), the very high cost of housing puts huge pressures on individuals and households. Stress and anxiety are clearly detrimental to people's well-being and human development.

The cost of housing is not included in the HDI as a measure of living standards

• The Human Development Index (HDI) is a composite indicator of human development by measuring three key dimensions: (i) a long and healthy life, (ii) access to knowledge, and (iii) a decent standard of living.

• Living standards (or the quality of life) refers to the economic, social, and physiological well-being of individuals in an economy at a particular point in time.

• Real GDP refers to the monetary value of an economy's national income that is adjusted for inflation.

• Real GDP per head (or real GDP per capita) refers to a country's gross domestic product divided by its population size.

To assess your understanding of this topic in the syllabus (Indicators of living standards), have a go at answering the following true or false questions.