The GDP Delusion
By: John Brandli
Tags: Federal Reserve, History, Economics, Environment, World War II

Gross Domestic Product, or GDP, measures the total production of a country. Government agencies, the Federal Reserve, and investment firms, all employ the GDP figures to guide their actions. Considered the chief indicator of economic fitness, GDP is the sum of consumption, investment, government spending, and net exports.

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Reliance upon GDP in evaluating the effectiveness of policies and economic states is not merited and until the GDP metric is fixed, politicians should stop focusing on this metric. GDP fails to account for both costs and benefits that are not monetized. It overemphasizes the role the government plays in the economy and it concentrates only on quantity, without regard to production details or sustainability. These factors demonstrate that GDP is a flawed tool that leads to dangerous policies and poor thinking on the part of our officials. Politicians and people who work at places such as the Federal Reserve have an incentive to maximize this GDP number but because of its flaws, increasing this number may bring net harm to society.

Because many of the values we enjoy in our everyday lives are not monetized they never count in any GDP measurements. GDP does not account for our standard of living, arguably a very important factor that central bankers ignore in their attempts to maximize GDP. Imagine two identical countries, Country A and Country B, produce identical quantities of goods, i.e., their GDPs are equivalent. Let us pretend that Country A doubles its capital stock and is now twice as productive as Country B. What if instead of working for the same hours as before, and hence producing twice as much, the people in Country A work half the time and produce the same amount as before? Country A and Country B would still have identical GDP values, but Country A enjoys twice as much leisure as Country B. Looking at GDP, we might think that the countries were equally wealthy.

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Consider a virgin forest or other wildlife sanctuary not given to commercial usage. Despite the value of the sanctuary to hunters, birdwatchers and campers if it was destroyed by an oil spill, then it might count as a boost to GDP! The reason for this is that although the forest provided real utility to some people, because it was not monetized, the value does not get counted in GDP; however, the costs of putting out the wildfire or other environmental calamity will count as either government spending or private consumption as the sanctuary’s caretaker restores it. The resources used to clean up the spill now cannot go to a productive enterprise, and if the caretaker does not revitalize the forest, then a valuable commodity has been lost, so either way it results in a net loss to society. GDP, however, would suggest that society got richer from the disaster. Even if the forest is not destroyed, but rather logged or otherwise commercially harvested, this always shows up as a boost to the country’s GDP regardless of environmental degradation. The forest itself is not quantified in GDP calculation so what appears to be a gain may be a loss once environmental loss is considered. So, we see that trying to maximize GDP incentivizes environmental waste and destruction on the part of governments.

GDP’s failure to account for environmental destruction is part of a wider problem with the measurement says Eric Zencey:

This points to the larger, deeper flaw in using a measurement of national income as an indicator of economic well-being. In summing all economic activity in the economy, gross domestic product makes no distinction between items that are costs and items that are benefits. If you get into a fender-bender and have your car fixed, G.D.P. goes up.

GDP is a measure that seems designed to incorporate the broken window fallacy. The broken window fallacy is a parable by Friedrich Bastiat that shows that destruction brings no net gain to society’s wealth and only replaces what was lost. By treating loss of life and property as profitable, GDP trivializes the costs of natural disasters by making them appear to promote the economy. Perhaps the most heinous example of this is how wartime expenditures serve to vastly inflate GDP, while contributing nothing to consumer well-being and giving the mistaken conclusion that the economy is booming, when in fact people are much worse off than they otherwise would have been. This is no more apparent than in the traditional presentation of the American economy as booming during World War II.

Most people believe that World War II is what finally got America out of the Great Depression. In fact, if you look at Gross National Product (an older measure which only slightly differs from GDP) data, World War II was the most productive era in US history, and we experienced sustained double-digit growth in GNP and an amazingly low 1.2 percent unemployment rate. this is why politicians of both parties love endless wars. However, as Robert Higgs has shown, GNP data is a very misleading indicator for this era of history. The reason for this is the tautological nature of the GNP. If governments want to improve their nations’ income data, they just spend more money and voila they can say that the economy has improved. However, this high increase in the GNP does not mean that the citizens of a country are any better off and as we have already seen, GDP can increase from events which are an absolute loss for the economy. Any measure which is intended to represent the well-being of a nation must reflect its prosperity. How prosperous were Americans during World War II? Turns out, unsurprisingly, that wars are NOT good for a country. With 12 million of the most productive working men now engaged overseas, women, children and the elderly had to fill in the gap in labor, resulting in massive losses of leisure time. In addition to having vastly restricted the American labor force to the least productive groups, the war planning bureaus had most of the labor force tied up in making tanks, planes, ships and other military items which did not contribute to the prosperity of the average American citizen. Furthermore, the government rationed many consumer items such as gasoline and butter in order to supply the war effort. By considering wartime spending as relevant as to the consumers’ well-being private consumption or investment, the use of GNP data makes what must have been one of the starkest times in American, and even world history, appear glamorous. As Higgs points out: “It is difficult to understand how working harder, longer, more inconveniently and dangerously in return for a diminished flow of consumer goods comports with the description that “economically speaking, Americans had never had it so good”.

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Even in the context of private production, GDP in general provides very poor data about the actual state of the country. When the NBER or other groups calculate GDP data, they find the total monetary cost of all expenditures, and then they divide this aggregate by the average price level to create the “Real” GDP necessary for making yearly comparisons. However, this approach reflects a severe methodological problem of how economists calculate the price deflator, or average price level. Prices are an exchange rate between money and goods and services. If a television set costs 100 dollars and a shirt costs 20 dollars, to calculate the average price we would have to sum these values and divide by two. Herein lies the problem, the price of a TV is 100 dollars/TV, and the price of a shirt is 20 dollars/shirt- these values have different units! In any science it is invalid to add together values with different units. It’s apples and oranges. So, we must consider the price deflator completely arbitrary and not representative of any real value. Since we use the price deflator in order to adjust the rest of the GDP aggregates, we must render the entire measure meaningless.

We have seen that the usage of Gross Domestic Product is misleading in several important ways. GDP does consider people’s standard of living, or the consumption of natural resources, which makes natural disasters appear to paradoxically as boons to the economy! GDP even makes the worst of human disasters, war, appear to be beneficial to the economy. Hence economic focus on maximizing GDP can lead to the advocacy of entirely destructive measures as ways to boost growth. In addition to the moral problems it introduces, the statistic is also meaningless by traditional mathematical standards. When government economists look at this number and proclaim that the economy is growing or in recession, they may be, and often are, completely wrong. Even Steven Kuznets, who invented the GNP metric, said that national income should never be confused for the economic well-being of a country. Because of its: numerous statistical deficits, its tendency to count destruction and disaster as positives, and its ability to allow politicians to claim that war is good, economists and politicians ought to disregard the aggregate in favor of a more humanitarian measure.