WASHINGTON, August 25, 2014 – The Obama Administration is pleased to report the continued growth of GDP. Their policies are working; the economy is fine. We have the number to prove it.
It is time for politicians and journalists to recognize something that has become very clear to many economists: Gross Domestic Product (GDP) is a terrible way to measure the economy and a terrible tool for setting policy.
GDP was forged in the economic ruins of the Great Depression. What if, people asked, we had had a single number to tell us what was going on in the economy? What if we had a standard to guide economists and politicians in setting policy for the future?
Simon Kuznets, an economist at the National Bureau of Economic Research, was the first to define National Income. With the creation of the IMF, GDP was adopted as the one statistic that would bind all economic statistics into a single measure of the economy. Y=C+I+G+NX.
GDP, the value of all goods and services produced in an economy net of imports, is a measure of the size of the economy, and a bad one. If I go to the store and buy a tomato, it counts towards GDP; if I grow my own tomato, it doesn’t count. If I hire a maid to vacuum my living room, it counts towards GDP; if I make my kids do it, it doesn’t count.
GDP doesn’t count illegal drugs, prostitution, or black market cigarettes, all things that are still economic transactions. It doesn’t include transactions like trading plumbing services for dentistry, or getting my taxes done in exchange for a bowl of ceviche and a pie. It doesn’t count free apps and free movie downloads.
At the same time, GDP includes bridges to nowhere; it treats an F-35 the same as a fleet of automobiles; it treats a superfluous government bureaucrat the same way it treats a top-notch accountant. If the government spends it, it’s GDP.
GDP growth is official American economic policy, and probably the policy of most governments around the world. Has that made us happier? Has it made us better off? GDP has been rising since 2009, yet half the people in the country feel as bad or worse off than they did then. In terms of real income, they really are worse off. Whatever GDP is measuring, it isn’t the well-being of most of society.
Real GDP (RGDP) adjusts GDP for inflation; it measures the amount of stuff produced, not just its dollar value. If gasoline gets more expensive, GDP rises, but not RGDP. If computers get cheaper, GDP falls, but not RGDP.
Some economists began to doubt the value of GDP early on, but not all. The true believers forged a link between GDP and unemployment, and found that if GDP rose 3 percent, unemployment would fall 1 percent. This made GDP growth golden with policy makers.
Economists have been busily looking for better metrics, but GDP remains popular for political reasons. Economists don’t foist policies on the public; the president and Congress do. They only listen to economists when we tell them what they want to hear. Economists who work in Washington are like lawyers; they work for the client, helping the client (government) by producing evidence that supports the client’s case.
Economists use GDP because governments use it. It’s a nice neat number that allows America to compare itself to Germany and China. Calculating per capita GDP allows Germans to feel smug when they talk to Greeks, Lichtensteiners to feel smug when they talk to everyone. It’s such a politically potent number that governments wouldn’t abandon it even if every economist in the world said they should.
“My GDP is bigger than yours, Putin.” “Our GDP is growing faster than yours, America. You are a loser. Loser!”
There’s no one number that can quantify an economy in any meaningful, policy-oriented way. There just isn’t. Meaningful policy has to be based on a variety of indicators. GDP isn’t one I’d choose for anything except, if I were president, bragging about how much better the economy is doing under me than under my predecessor.
President Obama’s legacy hinges in part on GDP. He ended the Great Recession. He appeared on the scene, and the economy (GDP) has grown ever since. So too has the Dow, another potent number. “GDP and the Dow Jones Industrial Average have grown; don’t you feel better? Haven’t I done a great job, America?”
Not really. Perhaps we should throw GDP away. Abandon the Precious. It enslaves you, saps your will, it’s so, so … Hey, GDP is up, and better than Europe’s. We’re still number one!
The U.N. has a competing metric, the Human Development Index which includes measures of health and education, making a stab at measuring well-being, not just income. Amartya Sen, who won a Nobel Prize in economics for his work in development, referred to the HDI as “an index as vulgar as GDP, but more relevant to our own lives.”
When economists suggested a new and improved way to measure inflation, it created a firestorm in Congress; changing the way you measure inflation will gore someone’s ox. Just imagine the exploding congressional heads if we were to try moving to better ways to measure the impact of economic policies than GDP.
It’s time to elect Frodo as president.