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GDP is more of a fuzzy reflection of the Economy

Economics / Economic Statistics Sep 06, 2016 - 12:50 PM GMT

By: John_Mauldin

Economics

GDP is a fairly recent statistic. Though it is malleable in its construction, it can be contentious in its application. Yet the media tend to release GDP numbers as if they are an accurate reflection of the general economy.

GDP is one economic model among several that could serve the purpose. But its use can lead to policies that reflect the thinking of a particular school of economic, monetary, and fiscal policy.


GDP is more of a fuzzy reflection of the economy. It comes from a model that is continually adjusted in an effort to figure out the scope of the economy.

GDP is not a precise number

Most people see the GDP number and think of it as a precision figure… like the bottom right-hand number in their bank accounts.

And when the media report the number, they rarely mention the caveats that the Bureau of Labor Statistics publishes along with that data.

The best book on GDP that I’ve ever read is GDP: A Brief But Affectionate History by Diane Coyle. Ms. Coyle takes us through not just the development of GDP but the problems with the concept.

There is no such entity out there as GDP in the real world, waiting to be measured by economists. It is an abstract idea…. I also ask whether GDP alone is still a good enough measure of economic performance – and conclude not. It is a measure designed for the twentieth-century economy of physical mass production, not for the modern economy of rapid innovation and intangible, increasingly digital, services. How well the economy is doing is always going to be an important part of everyday politics, and we’re going to need a better measure of “the economy” than today’s GDP.

GDP is a huge enterprise. It is full of rules… with almost as many exceptions.

For example, if you pay someone to mow your lawn and report wages paid, that adds to GDP. If you pay that person under the table, it doesn’t.

If you pay your maid to clean your house, it adds to GDP. Except if you marry her, then it doesn’t. Unless she gets access to the credit card, in which case, spending adds to GDP.

GDP has a hard time detecting innovation

Consensus is growing among economists regarding the weakness in the formula for calculating GDP. But when it comes to measuring the way innovation contributes to GDP, there is nothing close to consensus.

How do you measure the value of Google maps? Or voice recognition software?

If I buy a solar energy system for my home, that purchase adds its cost to GDP. But if I then take myself off the power grid, I am no longer sending the electric company $1000 a month. And that reduces GDP by that amount. Yet I’m using the same amount of electricity! My lifestyle hasn’t changed, but my disposable income has risen.

Black markets? The sharing economy? The new gig jobs which are off the radar? So much of our economy doesn’t easily fit into neat financial models.

GDP is a political construction

Coyle points out the political nature of GDP:

We are now awash with macroeconomic models and forecasts, published by official agencies and central banks, by investment banks, by think tanks and researchers, as well as by commercial forecasters such as DRI’s successors. Indeed, the idea of the economy as a machine, regulated by appropriate policy levers, took firm hold….

Debate rages in particular about the multiplier, because the issue of whether extra government spending or tax cuts (a “fiscal stimulus”) will boost GDP growth turns on its size. If it is greater than one, a stimulus will help growth, while austerity measures will hurt it. Its actual size is hotly contested among macroeconomists, especially in the context of the present political debate about how much “fiscal stimulus” the government should be applying to get the economy growing faster. There is an unsurprising alignment in the “multiplier wars” between macroeconomists’ answer to the technical question about the size of the multiplier and their political sympathies….

It will be clear by now that the ambition of measuring national income has a long history, with correspondingly many changes in how people have thought about it. As Richard Stone put it, national income is not a “primary fact” but an “empirical construct”: “To ascertain income it is necessary to set up a theory from which income is derived as a concept by postulation and then associate this concept with a certain set of primary facts.” There is no such entity as GDP out there in the real world waiting to be measured by economists. It is an abstract idea, and one that after a half century of international discussion and standard-setting has become extremely complicated. [emphasis mine]

Coyle compares comprehending GDP to what happens when kids play a video game. The basic concepts are simple. Then, as you master each level and move on to the next, the complexity increases almost ad infinitum.

Today, it takes an international community of statisticians to figure out what is statistically relevant to GDP. The first United Nations guide on national accounts was 50 pages. The latest edition has 722. Every few years, new rules are created for measuring GDP.

British statisticians just declared the UK economy to be 5% bigger than previously thought. What brought about this magical boost in productivity? Statisticians began to count the contribution of prostitution and illegal drugs.

Did the size of the US economy grow by 3% last summer? According to statisticians, it did. They added music and entertainment and made changes to how we deal with investments.

When these changes were then calculated for all previous years, the economy was 3% bigger! Small positive annual changes can add up over 40 years.

GDP has always been a political construction. It changes with the need to raise taxes and the military needs of the day. It is also a tool used to argue for or against income inequality (depending on what country you’re in).

GDP isn’t the only important tool

Let me note that I have no problem with the concept or the calculation of GDP in general. GDP is an important concept.

But it's just one tool in the economic toolbox. And that’s the problem. For some, the hammer of GDP is the only tool used to guide economic growth. When that happens, the world ends up being a rather deformed nail, bent time and time again by the imprecise blows of those wielding the hammer.

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