Chapter 2: The Money Metrics Problem in Dynamic Welfare Analysis
2 The money metrics problem in dynamic welfare analysis Karl-Gustaf Löfgren 1 INTRODUCTION It has long been known that traditional GDP (Gross Domestic Product), or for that matter traditional NNP (Net National Product), are not exact money metrics welfare indicators. The textbook arguments behind this view contain some obvious reasons. One is related to the definition of net investments: the only information about net investments in the conventional NNP refers to physical, ‘man made’ capital. This means that changes in other important stocks, such as natural resource stocks, environmental stocks and the stock of human capital are not included. Another – although related – flaw in NNP is that external effects are not handled in an appropriate manner. When present, the market data on which NNP is based are flawed because prices do not reflect the true underlying scarcities. A third example is that traditional NNP, because it is an aggregate number, does not reveal how consumption opportunities are distributed between individuals or generations.1 However, all three of the above reasons can be assumed away by moving to an ideal situation, where it is assumed that all types of capital stocks are correctly priced and included in NNP. We can also assume that all consumption services produced by capital goods are included in the consumption vector, and that the corresponding correct rental prices are available. Moreover, we can exclude externalities, and duck distributional issues by assuming that an intertemporal welfare function supports the efficient market solution. Now, in what sense will...
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