Wednesday, January 27, 2016

Why GDP fails as a measure... period

At CBS Moneywatch, Mark Thoma reviews the standard "textbook" flaws in GDP that cause it to fail as a measure of wellbeing:

  • It counts "bads" as well as "goods." 
  • It makes no adjustment for leisure time. 
  • It only counts goods that pass through official, organized markets, 
  • It doesn't adjust for the distribution of goods. 
  • It isn't adjusted for pollution costs.
Thoma then points to the discussion in Davos of another flaw in GDP -- it doesn't fully account for the benefits of technology. Isn't that just part of only counting goods that pass through official markets? GDP also doesn't adjust for the unpaid work outsourced to consumers. Some of the "benefits" of technology are a matter of perspective as well as taste. 

Although useful as a framing introduction, Thoma's discussion misses three crucial points. First, GDP was never meant to be a measure of wellbeing but a measure of the revenue-generating capability of the economy. In this capacity, a more salient flaw is the arbitrary treatment of government expenditures as output for final consumption when much government spending would be better treated as intermediate goods to avoid double counting.

Another flaw results from the instability of the unit in which GDP is measured and reported. Change in GDP from period to period doesn't simply represent a proportional increase or decrease of the same goods and services at the same prices but a changing mix of goods and services at different prices. Adjusting for "real GDP" with an average index for inflation may provide a short term, rough estimate of the vitality of economic activity but cumulative changes in the GDPs composition renders long-term assessments of "growth" essentially meaningless.

The third point is actually a combination of that last flaw and Thoma's first point that GDP counts "bads" as well as goods. But first a clarification of Thoma's explanation. -- GDP doesn't count the earthquake; it counts the repairs and rebuilding. Thus the problem is that the accounting is asymmetrical -- adding the repairs without subtracting the damage that required the repair. Over time, the proportion of total economic activity devoted to remedial goods and services increases, resulting in what Stefano Bartolini refers to as "negative externality growth." The cumulative effect is thus not just additive but multiplicative in that the increasing proportion of remedial goods and services distorts the index by which the prices for welfare-enhancing goods and services are adjusted.

A rubber band yardstick would be unreliable. This one is silly putty.

What it all adds up to is the arbitrariness of the idea of an objective aggregate measure of economic activity. Tinkering with some minor technical detail is not going to result in a "more accurate" measure -- simply a different measure whose accuracy or otherwise will be a matter of subjective judgment. 

The questions we need to ask are: What do we really want to know and why? What purposes were we pursuing when we sought to measure economic activity? Is measuring GDP helping to achieve those purposes? Are those purposes still our priorities? If not, what should be? What different institutions might we invent to achieve our purposes as we NOW understand them?