GDP: the silly number

As the financial crisis becomes a general economic crisis it seems that GDP is going out the window. I certainly hope so. No, I’m not some Luddite hoping the economy collapses and we all end up in caves eating wholesome grass and breathing brisk fresh air. I’m hoping we’ll stop using GDP and “the economy” interchangeably and stop now.

Perhaps I sound eccentric. Sure, GDP isn’t perfect, but it’s a pretty good measure of the economy and we need one, right? Wrong. I don’t know if we even need a good measure of the economy. But if we don’t have one, we harm ourselves by thinking we do.

GDP is not the way to measure economic activity. It’s a way, designed by certain people for certain purposes a long time ago, and those purposes were fatally flawed. I don’t want to get so technical that I lose not just readers but also my own way. But what GDP measures, fairly accurately but for Keynesian purposes and in Keynesian ways, is how hard we work commercially to create wealth. It is, effectively, a commercial labour theory of value, and thus worthless.

In an economy where nothing much changes, it would be reasonable to use GDP as a proxy for “how we’re doing economically”. Whatever the failings of GDP, they would remain constant relative to the actual creation of wealth so if GDP went up total wealth probably would too. But a defining characteristic of modern economies is that lots of things change constantly. And when they do, the defects of GDP become overpowering. Which is especially misleading at precisely those times, like the present, when we are urgently trying to determine how much things are changing and how.

Let me illustrate a few really major holes in GDP. These are not technical problems that can be patched with yet more cleverness but defects in the concept. GDP actually measures what Keynesians wanted to measure quite well. It’s just that, to quote John Rhys-Davies’ character in Raiders of the Lost Ark, “they’re digging in the wrong place.”

Speaking of digging, if I start growing my own tomatoes it may be good for my soul, my health and the environment. But if it also saves me money, if I increase my spending on fertilizer, pruning forks, gloves and so on less than I cut my spending on commercial tomatoes, GDP will drop. What is that a measure of?

Environmentalists have long complained that GDP fails to account for environmental damage. Most of them got the technical problem dead wrong; GDP only misses the harm done by pollution because property rights to air and water are not assigned so damaging them is free to individuals. That we could fix, to the horror of these same environmentalists, by privatizing them, so that I could sue anyone dumping sludge into the lake in front of my cottage as readily as if they’d put it on my lawn.

To see where the greens almost tripped over a major issue, take back my library book. Please. It’s overdue. But I digress. If I read a book from the library instead of buying it, I don’t spend the purchase price, paper and glue for an extra copy are not bought by the publisher, it is not shipped (or is sent within Ottawa instead of to it), bookstore employees don’t get paid and so on. From the point of view of GDP, it’s a dead loss and I am an antisocial wretch. But why? I’ve reduced my environmental footprint, saved money, and helped strengthen an important “civil society” institution especially useful to the poor. Yet GDP cannot like a library book.

Because GDP measures commercial effort, anything that increases efficiency registers as a loss. And again, this is no mere correctible technical defect. John Maynard Keynes really believed it would be good for the economy if the government buried old bank notes in bottles and then people went and dug them up. So does GDP... provided, of course, that buriers and diggers-up are paid wages.

GDP can reconcile itself to increased efficiency, with a non-trivial delay, if I go out and spend the money I save on library books or home-grown tomatoes. But as the Federal Reserve Bank of Dallas noted in its 1993 Annual Report, “By far, the largest omission in measured GNP is leisure”. If increased efficiency lets us spend more time with the kids, help the needy, improve our minds or cultivate a hobby, it’s bad for “the economy”. And if everything gets easier, which is another way of saying “if there’s technological progress,” GDP makes growth look slower precisely because it’s faster. Indeed, if manna were to rain down from heaven for any length of time, GDP would fall drastically, prompting calls for government stimulus packages or perhaps a “war on manna.”

GDP is either blind to qualitative change or hostile to it, clearly a major defect in a modern economy. Which is why I save for last the example that the GDP of China was larger than that of Britain until the late 19th century. Yet any fool (even one with a PhD) can see that Britons could muster far more wealth in 1880, individually, for social purposes and in pursuit of political ends. Britain was colonizing China, not the other way around.

The bewilderment or enmity that GDP exhibits toward efficiency is especially dangerous in times of tumultuous change. It produces bad measurements and bad reasoning that combine to generate bad policy. We may well be living through a massive liquidation of unsound institutions and bad habits. Yet an Ottawa Citizen story early in March bore the telling secondary headline “GDP snapshot shows we are learning to save again — not the prescription for restarting the economy”. The story admitted that Canadians were rational to spend less given recent shocks to their net worth. I would add that such conduct is both prudent and dignified given the absurd recent tendency of people to live beyond their means in societies wealthy beyond the dreams of Bourbon kings. Yet in the funhouse mirror of GDP, it becomes an obstacle to “restarting the economy” which isn’t even a machine that could have “stopped” anyway.

If you must have numbers, ydon’t tinker with things like the UN Human Development Index. It measures only life expectancy, time spent in school and per capita income. You wouldn’t write an obituary based on those three measures, praising the man who spent six decades at graduate school over the one who laid down his life for a friend. So don’t use it to categorize a country.

You might be better off using unemployment adjusted for labor market participation, or total profits. But you might not. I said near the beginning that we might not want a number that measures “the economy.” Milton Friedman often described visiting Hong Kong in 1963, praising Financial Secretary John Cowperthwaite’s laissez-faire policies and asking why he didn’t collect data to publicize their success, and Cowperthwaite replying that if he collected numbers people could insist that something be done about them while now they could only look out the window and see that business was booming.

In retirement, Cowperthwaite advised poor countries to abolish their offices of national statistics. In that spirit, I liked the impressionistic measure cited in 2004 by the CEO of Wal-Mart, that so-called “displaced merchandise,” that is, things people put into their shopping baskets then take back out and leave elsewhere in the store, is a really good indicator that consumers are hurting. But whatever you do, don’t measure GDP and then demand that the government do something about it. Especially not now.

No sir. Open the window, look around, and while you’re there, chuck GDP out through it.

[First published on Mercatornet.com]