Monday, August 24, 2009

On The Calculation Of GDP

Rolfe Winkler who writes one of the Reuters blogs - formerly of Option ARMageddon posted a really good quote from Bobby Kennedy circa 1968. It reminded me of something else I had read.

They both have to do with the absurdity of how we calculate our economy's progress - namely GDP (formerly known as GNP). Just as looking at someone's income bracket and trying to make a determination of how "happy" they are, it is a bit of a stretch to simply measure the amount of economic activity as if "activity" can simply be defined as one homogeneous unit. It cannot. Some activity is legitimate progress. Some activity shows progress now, but is only at the expense of a necessary future regression. Other activity is just plain damaging from the outset.

Unfortunately, making such determinations about the nature of economic activity is extremely subjective. It is so for the same reason that many people find living on an income of $20,000 very comfortable, while others cannot do without $200,000. Neoclassical economists try to label one as rational, and the other as irrational. This way they can eliminate the irrational from their models. By doing so, they allow their own subjective values to reflect themselves in the numbers that result from these models and the policies that are then recommended. They know of no other way. If these economists were forced to admit that they cannot even judge the total economic activity in a nation, they would be completely disposable. GDP calculations are used as the anchor for virtually all other economic models.

Kennedy's quote below highlights the social degradation that inevitably results from focusing on absolute numbers rather than the quality and independent nature of each input. It could have been said today - more than 40 years later - as increasing focus is put on financial innovation and accounting tricks to "meet the number," while we accumulate more and more long term debt and watch the manufacturing portion of our economies erode to an afterthought.

Too much and for too long, we seemed to have surrendered personal excellence and community values in the mere accumulation of material things. Our Gross National Product, now, is over $800 billion dollars a year, but that Gross National Product - if we judge the United States of America by that - that Gross National Product counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage. It counts special locks for our doors and the jails for the people who break them. It counts the destruction of the redwood and the loss of our natural wonder in chaotic sprawl. It counts napalm and counts nuclear warheads and armored cars for the police to fight the riots in our cities. It counts Whitman’s rifle and Speck’s knife. And the television programs which glorify violence in order to sell toys to our children. Yet the gross national product does not allow for the health of our children, the quality of their education or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our wit nor our courage, neither our wisdom nor our learning, neither our compassion nor our devotion to our country, it measures everything in short, except that which makes life worthwhile. And it can tell us everything about America except why we are proud that we are Americans.

-- Robert Francis Kennedy, speaking at the University of Kansas, Lawrence KS, 3/18/68

The quote reminded me of something I had read along the same lines by Lawrence Parks. Burn Your House, Boost The Economy:

As recently as 50 years ago, economists regarded the vitality of the economy as consonant with its ability to produce things people want (and would pay for). Today, the economy has been redefined into something called the Gross Domestic Product, or GDP. It measures all goods and services brought to market in a given year. But is it really an accurate measure of how well an economy is serving people's needs? Here are some outlandish ways the GDP can be boosted.

Things Kids Can Do. Get sick. Constant medical attention is good for the GDP. Medical costs account for 14 percent of it. Let's stay on the growth curve. Kids can also become juvenile delinquents. If they get arrested for heinous crimes, they go to jail, the expensiveness of which gives the economy a jolt.

Things Adults Can Do. Get a divorce. Legal costs, two houses, and all the things that go with two houses (furniture, kitchen supplies, pictures, etc.) are important components of the GDP. Divorces stimulate consumer demand.

Break something around the house, like a television, a dish, or a window. Replacing these increases the GDP and creates jobs.

Smash up the car. It will have to be fixed or replaced. The auto industry employs, directly and indirectly, one of every seven workers in the U.S., and they need the overtime.

For great results, burn down the house. Don't worry. If you handle it right, insurance will pay for it and the rebuilding will keep a lot of people busy for a while.

Quit your job as a scientist and become a taxi driver. Research and development is not included in the GDP, but money spent on taxicabs is.

Overeat, don't exercise, don't brush your teeth, do drugs, smoke, drink, and make yourself terribly sick. Get family members to do the same. Higher medical expenditures especially help the GDP move up, up, up.

Hire help to take care of the kids, and force your wife to get a job. This gives the economy a double boost. If your wife takes care of kids and cooks, this is not counted in the GDP. Hired help is. If she gets a paycheck too, that counts towards measuring economic growth.

Hire a lawyer and sue somebody. Lawyers' fees are directly added to GDP.

Things You Can Do With Your Neighbor. Riot and burn the neighborhood. The damage won't be subtracted from GDP. But rebuilding puts people to work and benefits the GDP.

Form a gang and commit crimes with a view to getting caught. The more people in jail, especially folks who would not otherwise have jobs, the better off the economy. Today, building and managing jails is one of the hot "growth" industries, to say nothing of the security business.

Things Businesses Can Do. Pollute. A giant oil spill would be great. Superfund sites expand the GDP.

Leverage up and build excess real estate, e.g., see-through buildings. They add to the GDP when they go up, but the waste is not subtracted when they are demolished. Similarly, companies can build excess plant capacity (as IBM did in the mid-to-late 1980s to the tune of $30 billion).

All of this counts toward GDP. Again, when companies are "downsized," nothing is subtracted from the GDP. It's similar in concept to the "roach motel": GDP counts the things going up, but not going down.

For Best Results, Get The Government Involved: Lobby your elected representatives to raise taxes and spend more money. Government spending on goods and services adds to the GDP and "creates" jobs.

Start a war. Preferably one far away where no Americans get killed. B-2 bombers, tanks, bullets,...all count in the GDP. Also, send Stinger missiles to liberation armies around the world. Maybe some of these missiles will be used to knock down airliners. Replacing them helps the economy, and, if lawyers get involved, there's a GDP bonus.

Target savers! People who save actually hurt the economy because they don't spend. If people spend their savings, then those purchases are added to the GDP. When they don't spend, the economy suffers. What can be done to discourage saving? First, tax the return on savings: a higher capital gains tax would be very helpful. Second, and best, debase the currency. By printing up more and more money, we can dilute the value of people's savings (especially their long-term savings such as their pension funds) surreptitiously stealing their savings for politicians to spend and thereby increase GDP.

Get Mother Nature On Your Side. Pray for a natural disaster: a hurricane, an earthquake, a big fire, a flood. Disasters give the GDP a tremendous life because of all the rebuilding that must take place.

If we do all these things, we'll have enough statistical growth to replace decades of economic stagnation. We may achieve double-digit rates. As for whether the economy is actually vibrant, we'll have to ask an economist who exercises more critical judgment than those who swear by GDP data.

I suppose GDP could register a positive reading for the 3rd quarter. Perhaps the 2nd is revised higher as well. But what exactly would that be telling us? What would it mean for the millions of newly unemployed workers who can't find jobs in anything close to their area of specialization? What would it mean for the heavily indebted who see no rise in their incomes as assumed when they chose their payment plans? The numbers, as always, will be completely meaningless for individuals who make their decisions based on their own unique situation, not some vague indefinable concept like "the average person."

Statistics like GDP, price changes (known as inflation), consumption, manufacturing, and wages all focus on "aggregate" numbers. They tell us nothing of what is occurring at the individual level. As such, they are useless for all practical purposes. We'd be better off without them - and the economists who propagate them.

Bobby Kennedy was a Democrat. It would be nice if some of his common sense could be resurrected today.

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1 comment:

RRB said...


Usually your critical analysis is excellent, but this post is not, IMHO.

1. Do you have an alternative measurement for GDP? The current measurement may be flawed, but what if its still the best available metric for economic activity?

2. Bobby Kennedy's argument is also flawed. Yes - if your house burns down, your costs for replacing it are significant. However, spending more money on a new house means you have to spend less money elsewhere, either now, or in the future.

In a nutshell, whether you spend money on 'negative' or 'positive' things, GDP is still an accurate projection of the economic activity in an economy during a certain period of time.

Yes, foolhardy decisions may certainly boost short term GDP at the expense of long term GDP - but the GDP numbers themselves are nevertheless an accurate description of economic activity.

Your argument seems to be that aggregate numbers miss some information. Of course they do - thats why they're an aggregate. And just like any back-of-the-envelope analysis, it makes significant assumptions, but is useful for many overview-type analyses.

It would be a mistake to look at GDP numbers and decide thats all the information you need about an economy - but it would also be a mistake to decide that it doesn't contain any information either.

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