Friday, December 10, 2010

Maximizing the Human Development Index

We all recognize GDP per capita is far from a perfect measure of wellbeing in an economy, hence the Human Development Index (HDI) was developed. It aggregates indicators of health, education and income. The idea is to evaluate how well an individual can function in such an economy. But the elaboration of the HDI did not follow any formal theory in the selection of the precise indicators and their weighting. So what about doing the reverse: take the HDI seriously in theory?

Merwan Engineer and Ian King use a standard growth model, calibrated following Mankiw, Romer and Weil, and look for what it takes to maximize the HDI. And they find massive overinvestment into physical and human capital, which saving rates so much higher than what the Golden Rule would call for that consumption is almost reduced to zero. Because consumption is not part of HDI! That looks a crass oversight, as we generally assume, correctly I think, that people care about consumption for their standard of living.

1 comment:

mOOm said...

I presume that the creators of the HDI just assumed that consumption would be some reasonable proportion of GDP per capita. This exercise seems rather silly to me. Instead, replace GDP per capita with consumption per capita in the HDI and redo the exercise.