Top critical review
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on March 17, 2013
I applaud the effort to detail the many ways in which GDP fails to measure national well-being, but lament the fact that this report does so little to attack the revered GDP edifice at its questionable economic foundation. Rather than conclude that over-reliance on indices might be a fundamentally flawed way to relate to a complex, evolving and unpredictable non-mechanical ecosystem, the report concludes there is a need for an abundance of new and more complex and more refined indices to be piled on top of the existing ones.
It has been widely observed that GDP cannot and should not be used to measure things other than what it purports to measure (as first stated before Congress in 1934 by the very man who developed the metric). This report is a thorough and detailed, if not dry, summary of how and why GDP fails to measure those things. But what if GDP does not really even measure what it purports to measure? What if it is fatally flawed not only as a general indicator of societal well-being, but as a specific metric of productive economic output? I'm afraid that territory remains too dangerous and heretical for many mainstream economists to explore deeply.
This book essentially says, let's continue to use the GDP metric but supplement it with an array of other metrics that account for non-market productivity, environmental and resource sustainability, wealth and income inequality, life expectancy and health, education outcomes, debt levels, quality of government "output", inflationary bubble effects, and the general happiness of the citizenry. Even if we could objectively quantify ALL these things (can we really quantify that which is subjective?) into ever-better metrics, how reliable would the metrics be in establishing causation, and how reliably would they be used (or abused) by policymakers in attempts to achieve "desired" changes? If certain policy promotes improvement in one set of metrics at the expense of another set, how will policy proceed (other than in the usual way, on the basis of political expediency)?
No matter what supplemental metrics are developed, GDP will still be the SINGLE metric used in the headlines and by the talking heads in most public spheres of media, politics and economics. The only way this might change is to debunk the myth that GDP represents "the economy" or "productive economic output". What GDP measures is the money-value of FINAL spending/investment (minus imports) over a period of time. In so doing, it imputes dollar-values to some things that cannot be measured, and then to other things that cannot be measured it assigns values that simply equal expenditures. It supposedly accounts for the effects of inflation and monetary overvaluation while somehow also accounting for qualitative improvements and the deflationary nature of productivity gains in certain consumer goods. Most importantly, GDP growth makes no accounting for any accompanying growth in debt. These facts are touched upon in the book, but not focused upon as reasons for a wholesale rejection of the GDP metric itself, based on its being an artificial construct unable to objectively measure sustainable productive output.
By assigning values equal to expenditures, spending on "bads" (things that in no way should be considered productive goods or services) is automatically deemed to be... spending on goods. When government pays a private contractor for the "service" of crushing obsolete military goods or cash-for-clunker cars, it is paying the contractor to destroy value; the GDP accounting tallies up the destruction of value as... a creation of value. The same applies to any variety of non-productive and non-beneficial "services" that are produced, or to any reduction in productivity that might occur with featherbedding or make-work jobs.
The greater a society's "demand" for bads, mostly via government, the greater its GDP growth. Rather than learn this lesson in WWII, and logically reject the GDP metric, we concluded that destruction for destruction's sake is a vital source of economic growth. This ignores that the whole point of consumption, which is the destruction of produced wealth, is to satisfy the wants and needs of humans. In making zero distinction between consumption that benefits humans and consumption that harms them, embracing the GDP metric allows governments to destroy and squander wealth in untold amounts, all in the name of "growth". Not surprisingly, governments can be much better at spending than investing. (To justify his budget, and to see it increase, a bureaucrat MUST find uses for money in amounts greater than allocated - useful uses are not always required.)
In addition, we immediately we see that by definition, as a final-expenditure metric, GDP ignores the spending at intermediate stages of production. So obviously the metric does not represent all economic activity, but only the final resulting dollar-value of that activity. Referring to GDP as a measure of all economic activity is false and misleading, and relying on the expenditure-method for estimating GDP gives rise to the mistaken belief that consumption is substantially more important than investment and production to a vibrant and healthy economy. "Mismeasuring Our Lives" ignores this, and concludes that more attention should be paid to consumption and less to production. This erroneous conclusion comes from considering GDP to be purely a production metric.
GDP is in fact NOT really a true production metric, since some of what it measures is not of any economic value in the sense of being exchangeable for other goods and services (especially imports). When an individual (or business) seeks to measure his economic output, he measures output in terms of the purchasing power it generates. But his actual SPENDING power (NOT true "purchasing power") is potentially much greater, depending on his access to credit and/or newly created money. The value of his final expenditures is a function of BOTH his output-based income AND his change in debt/savings. His effective demand at a given real output level, and the potential value of his expenditures over time, will increase with an increase in his debt -- and that level of demand will decrease with an increase in savings. So it is with nations, and thus evident that GDP is better thought of as a demand metric and not strictly as a metric of productive economic output.
By far the biggest flaw of GDP is the fact that it IS a demand metric. In measuring so-called production by measuring expenditure, one must ask, what is the source of that expenditure? Since ability to spend consists not only of income generated by production (true "ability to pay"), but also of income generated by credit growth and/or money-printing, the GDP metric cannot answer that vital question. Consumption on the basis of ever-expanding credit obviously allows for a decrease in true wealth-generating activities (such as the production of export goods and capital goods), since the need for true productive "ability to pay" is decreased.
As economic activity grows on the basis of debt growth, it allows for the increased transition of a greater number of productive non-market activities, and a greater number of non-productive activities, into the formal money-economy. As these activities (childcare, housecleaning, pet grooming, personal training, government consulting/contracting, economics teaching, etc.) are formally monetized, there is not necessarily a true increase in productive output, but only an increase in the dollar-value of that output. The increase in value is partly a measure of debt-based demand, not just a measure of production-derived income. Thus GDP growth, in a regime of rapid and continual credit expansion, COULD simply be a measure of increasing debt-based demand, and not a measure of increasing productive output.
Evidence that this is indeed the case for the U.S. can be seen in increased debt levels, especially financial-sector debt: after four decades of total (public and private) debt at around 150% of GDP through the early 1980s, that level more than doubled over the next three decades. That expansion of debt has played a large role in the expansion of economic activity and consumption. Any significant contraction in debt will mean a contraction in demand, and a potentially devastating contraction in GDP in the form of a deep depression.
Consider also that by dramatically increasing demand for goods and services and assets, credit expansion has inflated the dollar-values of some of those things to levels that can only be sustained by further credit expansion (demonstrated by recent asset bubbles, on what may turn out to be a relatively small scale). By not accounting for growth in debt, GDP fails as a useful metric, and serves to lead us towards the brink of disaster rather than away from it.
Economists will continue to use the GDP metric as though it truly represents "THE economy." Indeed, the authors at one point refer to an "economy that grew at a rate of 2.75%" when what they really should have said was an "economy whose currency-denominated expenditures reflecting domestic-based demand grew at a rate of 2.75%". Simple growth in demand should not be equated to the growth of an economy. Anyone can increase effective demand by simply increasing debt (just ask Paul Krugman). That is not true economic growth, that is borrowing from future demand to create current demand, with unknown consequences.
Perhaps someday a better "all-purpose" metric will be developed. I think the best part of this book is the eloquent foreword by Nicolas Sarkozy, who warns we "have wound up mistaking our representations of reality for reality itself... but reality always ends up having the last word". The book, alas, then goes on to express the need for developing even more representations of reality, since our current ones fall short. The real need is to embrace sound principles regardless of what all the instruments on the dashboard, and all the math in the aggregate models, might be telling us.