05 April 2011

GDP No Real Guide to Wealth or Welfare

Reposted in full from The Australian, 31 March 2011

'After the tsunami slammed the Japanese coast, economists rushed to update their forecasts for Japan's GDP. A major investment bank cut its 2011 growth rate from 1.5 per cent to 1.4 per cent, but ratcheted up its 2012 forecast from 2.1 per cent to 2.5 per cent.

If that forecast turns out to be correct, by 2012 Japan's economy will be bigger than it would have been without the disaster. Sure, the tsunami would retard factory output in the short-term owing to power shortages and crippled infrastructure, but vast rebuilding efforts would stimulate demand for machines and workers, wrenching Japan from its economic slump.

Australia's floods and New Zealand's earthquake have prompted similar expectations.

If disasters like these spur the economy, why not have a more systematic program of destruction, without the human cost? One day each year could be set aside for GDP Day. With citizens out of harm's way, local governments could carefully blow up a bridge or flatten a building. Families could break a household appliance.

GDP Day would create jobs, bolster construction, and promote retail sales. Economic benefits seemingly abound.Clearly this is ridiculous. Yet attributing economic silver linings to disasters like tsunamis and earthquakes is no less so.

The confusion about what makes a country prosper arises from our fixation with GDP, which is a misleading metric of economic performance.

GDP is the estimated total value of final expenditures in a given period. It is gross because it takes no account of depreciation of machines and infrastructure. If a country suddenly loses $200 billion worth of public goods in a day or two, as the Japanese painfully have, GDP is not reduced. The loss of wealth is ignored, but the cost of reconstruction boosts GDP.

Moreover, because GDP adds up the values of expenditures without considering their rationale, it encourages belief in the broken window fallacy - that destruction of goods can stimulate commerce.

As Frederic Bastiat pointed out in the mid 19th century, smashed windows might be good news for glaziers, but they are bad news for the window's owner and everyone else. The owner could have spent his money on a new suit, invested the money in his own businesses, or put it in a bank for another business to use. Likewise, businesses in Japan, Australia and New Zealand that benefit from reconstruction are absorbing funds that would have been directed elsewhere.

Followers of GDP are often considered to be hard-headed free-marketeers, derisive of soppy happiness indices and the like. Yet the national accounts, from which GDP is calculated, were developed to facilitate government control of the economy.

The world wars, the growing welfare state and the arrival of Keynesian economics massively expanded the size and scope of government in the early to mid 20th century. Governments craved a statistical dashboard that they believed would enable them to manage and monitor their economies.

The intellectual justification for government intervention in the economy waned in the 1980s, but the system of national accounts has thrived as a source for economic commentators.

Perhaps its popularity should be no surprise. GDP provides a free, quick and simplistic summary of economic performance. Thousands of bureaucrats, academic researchers and economists rely on it to sustain their jobs.

GDP is not only causing smart people to misdiagnose the economic impact of disasters and fanning fallacies. It has become so entrenched as barometer of growth that policy is being judged not by its effect on prosperity but its ability to boost GDP.

Take the Building the Education Revolution . This entailed borrowing about $16bn and building school halls no-one had asked for in a short space of time. A wasteful use of money, but it increased the almighty GDP.'

1 comment:

  1. This may be overly simplistic but the reconstruction of disasters and breakages is either financed from existing wealth, in which case it becomes unavailable for spending on education, hospitals etc or it is financed by expanding debt. Neither is desirable yet the "GDP is everything" crowd just go marching on with their economics fantasy ideas.


Please leave your comment here. Please note these stories are posted for information rather than for debate; if you wish to disagree with something posted, no problem, but since I post both things that I do and don't support, it would be appreciated if the criticism was about the issue.