Sunday, May 3, 2015

GDP Number Is A Master Illusion

Its Magic Illusion 101
Years ago a Seinfeld episode was centered around the idea of producing a television show about nothing! Sadly, in many ways, this is the direction America has moved towards when it comes to measuring our economic growth. We have allowed numbers that mean "nothing" to seep into how the gross domestic product (GDP) is calculated all in an effort to create the illusion of growth. In years past America far outproduced the rest of the world and manufactured goods that it exported across the seas. Today much of our economy is dominated by the service sector, this means if you wash my windows, then I will mow your yard. The recent first quarter GDP number of 0.2% could be no more than a rounding error and makes the hyped pre-election 2014 third quarter 5% growth a distant memory.

As time goes by small events often seem to drift into the distance or be forgotten, it could be I'm getting a little soft in the head or this is how I explain having to do research when I write. The Bureau of Economic Analysis (BEA) has made a significant change on how they calculate the GDP.  It slid by unnoticed by many people but they changed how they classified and recorded expenditures for R&D and for entertainment, literary, and artistic originals. An announcement of this change was made by the BEA during February of 2013, this resulted in an increase in the GDP. This kind of "bump" means that a gain of 2% today is, in reality, less than a gain of 2% years ago. This means we are comparing apples to oranges.

Gross Domestic Product is defined as the total market value of all final goods and services produced in a country in a given year, equal to total consumer, investment, and government spending, plus the value of exports, minus the value of imports.Within that definition, it appears those in power have discovered some wiggle room and even before that a debate exist as to what it really tells us. When we delve into all of this it is easy to see this is not simple at all and that the GDP can be a master illusion when we look at how it filters down to both society and the Main Street economy. The first comprehensive set of measures of national income was developed by economist Simon Kuznets who in 1934 told the US Congress the formula was problematic, he said. 

"The valuable capacity of the human mind to simplify a complex situation in a compact characterization becomes dangerous when not controlled in terms of definitely stated criteria. With quantitative measurements especially, the definiteness of the result suggests, often misleadingly, a precision and simplicity in the outlines of the object measured. Measurements of national income are subject to this type of illusion and resulting abuse, especially since they deal with matters that are the center of conflict of opposing social groups where the effectiveness of an argument is contingent upon oversimplification."

In 1962 Kuznets again emphasized that we must keep in mind the difference between quantity and the quality of growth. He made clear a distinction exist between cost and returns, and between the long and the short run. Kuznets went further to specify we needed goals concerning both growth "of what, and for what." Other economists have agreed that GDP is an empty abstraction with a very weak link to the real economy. The framework fails to reflect the difference between real wealth expansion or capital consumption. Kuznets used the example of the government building a pyramid that added nothing to the well-being of individuals, it would be viewed as economic growth, but in reality, divert funding away from real wealth generating activities harms the generation of real wealth.

What is not stated can often be far more important than what is. The number we are spoon fed and await with such glee has little to do with real growth but most likely mirrors or is merely a reflection of monetary pumping. The GDP number fails to highlight a slew of important factors that feed directly into our standard of living and the health of our economy, such as;

    * How wealth is distributed and inequality
    * Taxation and how it affects both the economy and society
    * Non- market transactions like volunteer and off book work
    *  Underground economy, illegal trade, and many cash transactions.
    * Asset value, meaning GDP ignores changes in what things are worth
    * The non-monetary part of the economy, bartering of goods and services
    * Distinguishing between production that is subsidized and that which is not
    * Quality improvements and new products
    * What is being produced, bombs or butter and a better-educated populace
    * The sustainability of growth or misallocation of either capital or resources
    * Cross-border parity and changes in currency value
    * External factors such as negative environmental effects or the health of the people

Some countries have even gone as far as to including things like prostitution and other illegal activities in a way to boost GDP and in effect lower their ratio of GDP to government debt. In 2013 in advice to their government the UK's Natural Capital Committee highlighted some of the failures of GDP when they pointed out its focus on flows can allow an economy to run down its assets while recording high levels of GDP growth until a point is reached where this begins to impact future growth. They went on to make it clear the recorded GDP growth rate is prone to overstate the sustainable growth rate. This number as with most numbers once put out there is subject to full blown manipulation and spin. Bottom-line in the words of its creator, "The GDP framework is more or less an empty abstraction devoid of any link to the real world."

1 comment:

  1. Since GDP counts government spending, and politicians spend (other people's) money on stuff whose purpose is getting them reelected, we can imagine a situation where the Clown Congress borrows another 12 trillion dollars, spends it on hookers and blow, and GDP doubled.

    If this isn't the clearest cut case that the calculation of GDP is meant to obscure, rather than to inform, I can't imagine what would be.