What is a Standard of Living?

A standard of living is like a shopping basket…

When you have a high standard of living, you have a large shopping basket and the ability to put lots of goods into it – And maybe you can even afford to shop for all of the luxury goods at Whole Foods. But when your standard of living is low, you have a much smaller basket and more limited choice of what to buy – You have to stick to only the necessities, and likely have to shop at a budget store.

The standard of living and quality of life are not the same thing – though they are frequently confused with each other and closely related. While the standard of living focuses on quantifiable metrics of an economy, quality of life is a bit more nebulous, intangible, and harder to measure.

Quality of life includes less concrete factors like leisure, economic and political stability, cultural resources, freedom of speech and religion, privacy, and safety. It attempts to take a more complex and holistic approach to answer whether a group of people has the living conditions conducive to happiness and a good life. As such, these judgments can often be political and controversial.

You’ll often see standard of living and quality of life used interchangeably and, in many cases, they affect each other. A country with a high standard of living likely offers a good quality of life to its citizens. People who have a good quality of life may, in turn, be more productive, which then betters their standard of living – and, thus, the two influence each other.

However, while a higher standard of living is frequently correlated with a higher quality of life, that’s not always the case. For example, two countries might have a very similar quantifiable standard of living but, due to quality of life factors like freedom of religion or speech, one place may be more attractive than the other to live for a given individual — a high standard of living isn’t likely to make up for being persecuted over your beliefs.

Standards of living can affect multiple factors of a population, including happiness and productivity. This is important because the greater productivity and happiness are, the better off an economy tends to be as a whole. According to research by a professor at the University of Virginia, happy people are often healthier, better workers, and greater contributors to society than those who are not. And productivity means greater profits for companies, higher salaries for workers, and more total money available for societal and government initiatives.

Economists link high standards of living with high levels of productivity in a population, and vice versa. Communities that increase their level of productivity tend to increase their standard of living. The reverse is also true – populations that improve their standards of living tend to enhance their productivity. It can become a virtuous cycle that reinforces each other.

In fact, productivity is the single most important factor in determining standard of living. The generally agreed upon measure for standard of living is the real gross domestic product (GDP) per capita of a country. Because GDP is the total value of goods and services produced by a country, when overall productivity increases, GDP per capita also increases –- This results in a standard of living boost.

While quality of life encompasses many more intangible factors contributing to happiness, the quantifiable standard of living is often one of the most significant determinants of happiness. Things that correlate to a low standard of living, such as poverty, food insecurity, and lack of access to necessities, all also detract from a group’s happiness.

Economists have historically measured a country’s standard of living by its real gross domestic product (GDP) per capita.

Let’s break this down a bit. GDP refers to the total value of all goods and services that a country produces in a set period of time, usually annually. Real GDP adjusts for inflation (i.e. the increase in the price of goods and services over time). Per capita essentially means per person.

So, in summary, the real GDP per capita seeks to measure the average economic output of each resident in a country.

Real GDP per capita can be calculated as follows:

Real GDP Per Capita = (Nominal GDP / (1 + Deflator)) / Population

Real GDP Per Capita = Real GDP / Population

The nominal GDP simply refers to GDP without factoring in inflation. The deflator – aka the change in the value of the currency between the years you’re comparing – is an economic tool used to adjust for inflation. You can typically find the deflator for a country listed online, often published by a country’s government. For example, the Bureau of Economic Analysis publishes annual deflator information for the US. Taking nominal GDP / (1 + deflator) will result in a country’s real GDP. The last step is then dividing this real GDP by population to determine the real GDP per capita.

If the real GDP per capita of a country is on the rise, then, by this definition, the standard of living of that country is also rising. It indicates that there are likely more goods and services available to consumers and that they’re in a better position to buy them. This definition of standard of living is purely material and quantifiable – It doesn’t factor in quality of life components like privacy, safety, and freedom as religion, as discussed earlier.

While real GDP per capita is traditionally the most popular metric used to measure standard of living, it fails to account for many factors that profoundly impact both an economy and an individual’s life.

There are four oft-cited downfalls of this measure of standard of living. According to the Federal Reserve Bank of Boston, they are:

• Unpaid work: Real GDP per capita fails to account for unpaid work. Things like volunteer work, community service, or work performed in the home don’t contribute to GDP. However, they can improve people’s lives.
• Distribution of wealth: Real GDP per capita does not take inequality or the distribution of wealth into account. Consider an imaginary country with 20 residents. If ten residents produce $1M in economic output each year and the other ten produce no output at all, then that country’s real GDP per capita is $500,000. However, half of the country produces no output, meaning that those people probably have both a low standard of living and quality of life, even if the standard of living for the country overall is high.
• Changes in quality of life: Non-economic factors also affect people’s standard of living. Someone who lives in an area with clean air and water likely has a better livelihood than someone who lives in a heavily polluted region.
• Changes in quality of goods: The measure for real GDP per capita does not accurately reflect the improvement in quality that many goods experience over time. While GDP figures try to adjust for significant quality upgrades of large items, such as cars and computers, they ignore other aspects of your life like energy efficiency upgrades around your home.

Despite these pitfalls, economists continue to use real GDP per capita to measure standards of living because it is easy to quantify and most nations already track and report this metric. On the other hand, quantifying the impact of factors like clean air, inequality, and privacy – things that contribute to quality of life – are more difficult.

Given that real gross domestic product (GDP) per capita is the most traditionally used metric for standard of living, the same factors that affect GDP affect standard of living.

GDP is a snapshot of a country’s economic health. While it’s almost impossible to produce a comprehensive list of the things that are included in GDP, there are four key determinants that can be used to calculate a nation’s GDP. They are personal consumption, business investment, government spending, and net exports. As an equation, this can be written as:

GDP = (Value of Exports - Value of Imports) + Investment + Consumption + Government Spending

GDP = Net Exports + Investment + Consumption + Government Spending

Consumer spending – aka what you and I buy – alone accounted for 68% of GDP in the US in 2019, according to the Federal Reserve Bank of St. Louis.

Real GDP per capita remains one of the most popular ways to measure a country’s standard of living, but some alternative measures have been devised in more recent years that aim to capture the effects of non-economic factors.

Human Development Index (HDI)

Another measure is the Human Development Index (HDI), which the United Nations (UN) created in the 1990s. HDI bases its standard of living measure on three key dimensions: life expectancy at birth, education (based on a mix of school enrollment and adult literacy), and Gross National Income (GNI) per capita adjusted for purchasing power parity (PPP).

GNI is a slightly broader alternative to GDP, while PPP evaluates the cost of a basket of similar goods in different countries to assess the relative value of each currency.

__Gross National Happiness (GNH) Index __

The Gross National Happiness (GNH) Index measures nine factors to determine an area’s standards of living:

• Psychological health
• Physical health
• Education
• How residents use their time
• Cultural diversity and resilience
• Governance
• Community vitality
• Ecological diversity and resilience
• Living standards

GNH was first developed in 1972 by King Jigme Singye Wangchuck, who was the 4th King of Bhutan, and has subsequently been popularized in some policy circles. The Genuine Progress Indicator (GPI)

One such measure is the Genuine Progress Indicator (GPI). It was created by Redefining Progress, a US nonprofit public policy organization. GPI uses GDP as the baseline for its test but then subtracts the costs of crime, family breakdowns (e.g., through a divorce), and pollution – both the damage it inflicts and cost to clean up. GPI then adds household and volunteer contributions – which GDP ignores – at the approximate amount it would cost to hire someone to perform the tasks.

GPI also seeks to adjust for income inequality. GPI rises and falls when poor people’s share of income increases and decreases, respectively.

Countries measure their standard of living so they can gauge whether life is improving for the average citizen. They also want to track how their standard of living compares to other countries.

Since measures of standard of living can vary, as discussed earlier, direct comparisons between two or more nations can yield different results based on the exact measure used.

Each year, the United Nations Development Programme (UNDP) publishes its Human Development Report, which includes the Human Development Index (HDI) scores for most countries in the world.

In 2019, the UNDP ranked the following countries as having the highest standards of living:

1. Norway
2. Switzerland
3. Ireland
4. Germany
5. Hong Kong
6. Australia
7. Iceland
8. Sweden
9. Singapore
10. Netherlands

The United States tied with the United Kingdom for having the 15th highest standard of living in the world, according to the HDI. If we measure by 2019 real GDP per capita, as reported by the International Monetary Fund (IMF), then the US has the 10th highest standard of living amongst countries. Qatar tops the list, followed in order by Luxembourg, Singapore, and Ireland.