How GDP betrays the Economy

Isn’t the crisis over, albeit the recovery may be slow? Hasn’t GDP contraction slowed down, been stopped, maybe reversed? Isn’t all that good news? Couldn’t it have been worse if the Fed hadn’t done the right things?

The problem with almost all macro-economic aggregates ist that

(See more statistical material in our References section!)

1. they’re largely fictitious numbers,
2. their data are collected rather arbitrarily,
3. after arbitrary collection these data are, as a rule, processed arbitrarily,
4. and, but what does that matter after 1.-3., they refer to no real entity in economic life.

The more elaborate proof of all these allegations has to wait until another post, however, since everyone eyes GDP as the rabbit does the rattle-snake, let’s just debunk the GDP myth here as it is, besides “inflation” as a CPI figure, one of the more dangerous illusions for investors, retirement planners and the population at large.

(Real) Gross Domestic Product is (loosely) defined as “what has been produced in a certain geographic region [normally a nation or a set of nation states, such as the EU, the OECD etc.] during a certain period [normally a year in year-on-year comparisons, so that even quarterly measures are e.g. quadrupled in a  "seasonally adjusted" fashion to give a full-year comparison with other periods]. Or so one would think … actually the trouble starts with GDP being more of what is consumed, not created.

Let’s just think about some things statisticians can’t find out:

• they don’t know how much you worked on your own home last year in improvements
• even if they did know, they wouldn’t know if any and how much of it had been due to necessary repairs, only to bring the house back to the former level or
• which of your work as actually increasing your home’s value or
• which, you and your two left feet, have actually made you poorer through shoddy work?
• They also don’t see any of the “black economy“, or if, then record only those who get caught and who, after fines are deducted, likely are worse off than without having worked “illegally” in the first place
• and then there’s criticism as to other intangibles.

But what’s probably worse, is what they actually put in (and some suggest to tweak even that a bit more) or how they calculate it:

• “This statistic is constructed in accordance with the view that what drives an economy is not the production of wealth but rather its consumption. … By focusing exclusively on final goods and services, the GDP framework lapses into a world of fantasy wherein goods emerge because of people’s desires. This is in total disregard to the facts of reality (that is, the issue of whether such desires can be accommodated). All that matters in this view is the demand for goods, which in turn will give rise almost immediately to their supply.  Because the supply of goods is taken for granted, this framework completely ignores the whole issue of the various stages of production that precede the emergence of the final good.“
• “Familiar usage and complacency of thought have allowed the idea to arise that any increase in prosperity can be measured strictly in terms of the macro-economic entity called Gross Domestic Product (GDP). This has led to a horrible inversion of means and ends. Relying on the GDP encourages ever more monetary and regulatory violence to be visited on the free economy by self-serving, collectivist politicians and bureaucrats. These people believe that keeping GDP expanding at some arbitrary minimum rate during their term of office is their primary function, whatever economic or social harm this causes along the way.“

• “GDP does not, and cannot, reflect the waste of enormous effort, and precious natural resources, that went into building something that suddenly no one wants.“
• “The truth is that the great bulk of spending and income payments in the economic system is concealed under net investment!“
• “… GDP actually misses to account for the larger share of all spending that takes place in the economy.“
• “GDP has never correctly presented the true state of a country’s economy as it does not take account of wealth destruction, but only deals with production. Hurricane Katrina destroyed for millions of dollars and ruined the lives of thousands of people, but only the rebuilding was included in the GDP.“
• “In the GDP, for example, we find included what the private sector sells: the goods and services offered on the market for purchase. For government, though, the GDP counts what it costs to make, whether or not there is a market for what they produce. The higher the costs, the more the contribution to GDP. In the private sector, in contrast, if your costs are too high, and you go bankrupt, your products won’t be counted in GDP at all.“
• “In general, governmental services are valued in the GDP accounts by adding up compensation paid to employees, which is to say on payments to inputs rather than a valuation of output. Given the very high levels of economic rent present in much government employment, this is a  doubly dubious procedure.“
• “Criticism of GDP can also be directed at faults in basic methodologies, compilation procedures and data collection systems, even in the most developed countries. In the developing world quality can be very poor indeed.“
• “The use and calculation of the GDP indicator is inconsistent with three principles of good bookkeeping: (i) divide clearly between costs and benefits; (ii) correct for changes in stocks and supplies; and (iii) use accurate measures for all social costs (= private + external costs). If a commercial company were to employ the method that is the basis for calculating GDP, its accounts would not be legally approved. The fact that the GDP calculation method continues to coexist with institutionalised, legal rules for financial accounting of firms is somewhat of a mystery.” (Emphasis CrisisMaven)
• “… much of the contemporary data is quite simply incongruous with an annual growth rate of 3.3% GDP …”
• “A major improvement could directly be implemented by using the net domestic product, rather than the gross domestic product, as an indicator of economic performance. … Since the gross domestic product includes consumption of fixed capital, the economic performance shown is always too high; in Germany by about 15%. Consumption of fixed capital (depreciation) is the value equivalent to the wear and tear and economic obsolescence of the capital stock (machinery, vehicles, buildings, etc.), which means that this value has been consumed and is not part of the new output created. It is just tradition that the public interest focuses on the gross domestic product. This is because, in the past, consumption of fixed capital was not calculated by all countries, so that only the GDP was available.“
• “The GDP positively records all forms of evil and destruction, such as increase in the number of accidents, progression of illnesses stemming from food insecurity, pollution… (which, to be offset, requires defensive expenditures) the same way it accounts for common well-being resources (education and participation in cultural and leisure activities in a society where people are healthy, for instance). “
• “… inflation’s father, a weakening dollar, will show paper growth even as the real economy is shrinking. GDP figures from the late 1970s were higher than the real economy’s lackluster performance. The same is true today, which is why Obama’s poll numbers are evaporating even though GDP growth has returned to positive. Still another valid criticism of GDP is that promiscuous government spending can make it look higher. Cash for Clunkers, an unsustainable government gift to the auto industry, goosed third-quarter growth numbers.“
• “While the statistics don’t account for it, there’s good reason to suspect intangible investments are falling.“
• Which of the following make you wealthier: curing or preventing or not having diseases in the first place and spending that money on more productive things?
  “Health insurance has been the topic du jour the past few weeks. From the Secretary of Health and Human Resources’ own lips, the United States is now spending $2.5 trillion on health care, about 17 percent of GDP. So where are we headed? Will 50 percent of all jobs in America eventually be either in the healthcare industry or the government? That is no framework for a prosperous nation.“

Others are referring to this as “GDP fetishism“.

An article on Patrick Chovanec’s blog “An American Perspective from China” titled “China’s Quality of GDP” makes very interesting reading too and ties in with what we’ve said here:

“… my main concern lies in a concept I’d like to introduce called “quality of GDP.”
If you Google the phrase “quality of GDP” on the Internet, you’ll find a variety of articles relating to the reliability of the way GDP statistics are gathered in different countries.  … My concern is how even true-blue GDP figures can sometimes paint a misleading picture of the real health of an economy.
… All the government had to do was take all the laid off migrant workers and hire them to dig a hole in the ground one day and fill it up the next.  Since the total would be added to National Income, the government could simply pay them enough to hit whatever GDP target it had in mind. … Focusing exclusively on GDP, as a number, is a distraction.
GDP tells you how much the economy is producing; it doesn’t tell you whether that production is actually creating real value or not. … when the State is either directing economic activity without regard to prices, or when it is artificially influencing the conditions of supply and demand in a way that distorts prices, … Production may actually consume more value than it creates, destroying wealth, or divert resources from more productive pursuits, yet in the short term, still count positively towards GDP. … what, … if the government simply went out and bought 10 trillion paper clips that nobody needed at $10 a piece? … GDP would rise, but our quality of life would fall.  The same reasoning can be applied to a war economy that produces tanks, planes, and ships that blow each other up.  U.S. GDP surged during World War II, but don’t kid yourself: real wealth was being destroyed and/or supplanted.
… GDP may overstate the real benefit of government spending or policies designed to artificially stimulate economic growth.
… all GDP is not created equal, and we need to be asking deeper questions about whether an economy is creating wealth, not just maximizing output.  To speak of “quality of earnings” (for a company) or “quality of GDP” (for an economy) is simply a reminder that numbers never speak for themselves. …” (Emphasis CrisisMaven)

Now, to all that add the margin of error that pertains to any statistical estimate or, worse,  prediction and it makes you wonder how the people that run the economy can actually gloat over a 0.1% rise in GDP month-over-month. Ru(i)n the economy? Run? Yes … run!

P.S.: This article has just been linked in: Friday Links: DC Snowmageddon Edition (February 5, 2010 by Nick Krafft) on his blog “Open Economics – Economic Encounters of the Plural Kind“

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