GDP measures the value of output produced within the domestic boundaries of a country over a year. Welfare is the health, happiness, and fortunes of a person. A sustained increase in real GDP means there is a sustained increase in the output of goods and services, and growth in the countries economy. However, Though there are three possible limitations of using GDP as a measure of welfare between countries. The three limitations are that it ignores the quality of life, it underestimates informal markets, and overestimates negative externalities.
GDP ignores to measure the quality of life. The quality of life is used to evaluate the general well-being of individuals and societies. Quality of life should not be confused with standard of living, which is based primarily on income. Instead, the quality of life includes wealth, employment, physical and mental health, education, etc. For example, while South Africa is in the top 40 countries for highest GDP, over 50% of its people live in poverty, meaning they have a low quality of life because they lack basic human needs such as food, shelter, and access to education and healthcare, etc. Since GDP does not reflect upon the quality of life, it is limited as a measure of welfare.
GDP underestimates informal markets. GDP does not take into account black market activities, where the money spent isn’t registered. An example is if someone sells $1 million worth of illegal goods to someone else, it will not be counted in the GDP. Though the United States has a very high GDP, it has 10~20% of illegal market activities. Since GDP does take this into account, it is limited as a measure of welfare between countries.
GDP overestimates negative externalities. Negative Externalities are the bad effects that are suffered by a third party when a good or service is produced or consumed. When GDP (production) increases, negative externalities (air and water pollution) also increase. For example, China’s GDP is one of the highest in the world, but it emits more carbon dioxide emissions per year than any other country. High CO2 emissions does not equal to a country with high welfare. Since GDP does take this into account, it overestimates negative externalities, limiting it as a measure of welfare between countries.
As you can see, GDP alone is a fairly inadequate measure of welfare – other factors need to be considered. Other ways to measure domestic output and income, as well as health, happiness, and fortunes of a person can be through the gross happiness index, the genuine progress index, and the human development index.