the inclusion of services in the concept was misleading. “The provision of more services was a cost to the national economy, in his view. A servant was a cost to his employer, and did not create anything. Importantly, money spent on warfare or the interest on government debt was also being used unproductively. The nation’s wealth was its stock of physical assets less the national debt. National income was what derived from the national wealth.”
(I read this book on my iPad using my Kindle app, an extremely useful tool. As it turns out, if you highlight passages in the book you read [and even make notes and comments], you can go to your Kindle web page and see all the passages you highlighted. I regularly do that now and find it an extremely useful exercise, one that I would suggest to any serious researcher, as notes in a book tend to get buried and lost; and often you just can’t quite (at least at my age) remember those connections five or ten years later, especially if you’re reading more than a few books a year. Now my notes are in the cloud. Wow. And when I access the notes, I can touch a link to go back to the original passage in the book, making sure I have the context. How cool is that?
I found myself highlighting more than the normal number of passages, as seemingly every page had something I wanted to be able to remember for future use. Just for fun I cut and pasted my highlights into a Word doc and found that they ran to some 15 pages, or more than 10% of the book.)
And while I would suggest you read Coyle’s book, I know that many of you don’t have the time or inclination, so I’m going to try to summarize the highlights and arguments and quote somewhat freely from the text here and there. (Unless otherwise noted, all quotations below are from the book.)
Will the Real GDP Please Stand Up?
Let me note up front that Ms. Coyle takes us through not just the development of GDP but also the problems inherent in the concept. She delves into its misses and its misfires, some regularly discussed in public circles and a few new to me.
There is no such entity out there as GDP in the real world, waiting to be measured by economists. It is an abstract idea…. I also ask whether GDP alone is still a good enough measure of economic performance – and conclude not. It is a measure designed for the twentieth-century economy of physical mass production, not for the modern economy of rapid innovation and intangible, increasingly digital, services. How well the economy is doing is always going to be an important part of everyday politics, and we’re going to need a better measure of “the economy” than today’s GDP.
GDP is a huge undertaking, full of rules, with almost as many exceptions to the rules, changes, fixes, and qualifications, so that, as one Amazon reviewer noted, GDP is in reality so complex there are only a handful of people in the world who fully understand it, and that does not include the commentators and politicians who pontificate about it almost daily. The quarterly release of GDP statistics is more akin to a religious service than anything resembling a scientific study. The awe and breathlessness with which the number is discussed is somewhat amusing to those who understand the sausage-making process that goes into producing the number. Whether the GDP reading is positive or negative, it often changes less in a given quarter than the margin of error in the figure itself, and it can be and generally is revised significantly – often many years later when almost no one is paying attention. When’s the last time the mainstream media reported a five-year -old revision?
If you pay someone to mow your lawn and report wages paid, that adds to GDP. If you pay that person under the table, it doesn’t. If you pay your maid to clean your house, it adds to GDP. Except if you marry her, then it doesn’t. Unless of course she gets access to the credit card, in which case spending probably increases GDP dramatically. In England, sex with your wife does not add to GDP, but sex with a prostitute does – even if it is unreported. Go figure. There are so many jokes and one-liners that I could add to this litany, but I’m going to resist. Okay, just one. Can you imagine the reception if you came home with a blonde hair on your dark suit and your excuse was, “Honey, I was just doing my bit for the national economy. We all have to make sacrifices.”
Housekeeping, cleaning, cooking, and other such duties do not get counted in GDP, although without them GDP would suffer significantly. Perhaps that is because when the original discussions about what constituted GDP were underway, “woman’s work” was significantly undervalued.
But we are getting ahead of ourselves. Before we discuss how GDP is constructed (and abused), let’s take a look at the history of how it came about. It will not surprise most readers to know that governments decided they need to know what the gross domestic product of the country was in order to be able to both tax that productivity and decide about a nation’s capabilities to wage (and pay the wages of) war.
Ms. Coyle starts her book with the rather dramatic story of the calculation (or rather the miscalculation) of Greek GDP upon that country’s entry into the European Union. The Greek group responsible for creating such numbers worked in a dusty old apartment without any computers and seemingly engaged in little activity. The real work was done by politicians, who did not appear to feel the need to be burdened by anything so aggravating as actual numbers. When the European Commission and the IMF decided to send someone to create an actual statistical agency in Greece, they selected a well-respected Greek economist, who within a year was charged by the Greek government with the crime of betraying the national interest, an offense that theoretically carries a life sentence. Essentially, he was charged for not cooking the books, which the Greeks had perfected as an art form. Evidently, in Greece economics is a full-contact sport, and the “calculation” of G DP had real-world implications for whether the government would get desperately needed money from its Eurozone lenders and for how many government workers would lose their jobs, not to mention the impact it would have on the living standards of millions of Greeks.
GDP is the way we measure and compare how well or badly countries are doing. But this is not a question of measuring a natural phenomenon like land mass or average temperature to varying degrees of accuracy. GDP is a made-up entity. The [current] concept dates back only to the 1940s….
According to Benjamin Mitra-Kahn, “The Wealth of Nations introduced a new idea of the economy, and through the effort of Adam Smith’s students and admirers, it was adopted almost instantly.” In Smith’s own words: ‘There is one sort of labour which adds to the value of the subject upon which it is bestowed: There is another which has no such effect. The former, as it produces a value, may be called productive; the latter, unproductive labour. Thus the labour of a manufacturer adds, generally, to the value of the materials which he works upon, that of his own maintenance, and of his master’s profit. The labour of a menial servant, on the contrary, adds to the value of nothing…. A man grows rich by employing a multitude of manufacturers: He grows poor, by maintaining a multitude of menial servants.’ The idea of a distinction between productive and unproductive activity, adopted by Adam Smith, dominated economic debate and measurement until the late nineteenth century.”
(A side note: Karl Marx agreed with Adam Smith, and up until the collapse of communism in 1989, the Soviet Union’s economic statistics ignored service activities. Go figure.)
Simon Kuznets was a Russian-American economist and a true giant in the field. Much of what we regard as economics today was developed under his aegis. Wikipedia notes: “His name is associated with the formation of the modern economic science … as an empirical discipline, the development of statistical methods of research, and the emergence of quantitative economic history. Kuznets is credited with revolutionising econometrics, and this work is credited with fueling the so-called Keynesian revolution” (even though Kuznets had significant disagreements with Keynes). Kuznets himself was influenced by Schumpeter, Pigou, and Pareto; and he early on introduced Kondratiev to the West.
Kuznets, when he originally developed an approach for measuring GDP for the American economy, did not want to include expenses on “… armaments, most of the outlays on advertising, a great many of the expenses involved in financial and speculative activities, and much of government activity,” including the building of subways, expensive housing, etc.
Such thinking could not stand the scrutiny of politicians, however:
With this aim, in fact, Kuznets was out of tune with his times. Welfare was a peacetime luxury. This passage [and his early work on GDP] was written in 1937, when his first set of accounts was presented to Congress. Before long, the president would want a way of measuring the economy that did indicate its total capacity to produce but did not show additional government expenditure on armaments as reducing the nation’s output. The trouble with the prewar definitions of national income was precisely that, as constructed, they would show the economy shrinking if private output available for consumption declined, even if the government spending required for the war effort was expanding output elsewhere in the economy. The Office of Price Administration and Civilian Supply, established in 1941, found that its recommendation to increase government expenditure in the subsequent year was rejected on this basis. Changing the definition of national income to the concept o f GDP, rather than something more like Kuznets’s original proposal, overcame this hurdle.
There was a “heated debate between Kuznets and other economists, especially Milton Gilbert of the Commerce Department, about the right approach. The discussions were highly technical, but the underlying issue was profound: what was the meaning of economic growth and why were statisticians measuring it? Gilbert and his colleagues were clear that the aim was to construct a measurement that would be useful to the government in running its fiscal policy.”
The inclusion of business taxes and depreciation [in GNP measured at market prices] resulted in a production measure that was more appropriate for analysis of the war program’s burden on the economy. Kuznets was highly skeptical: “He argued that Commerce’s method tautologically ensured that fiscal spending would increase measured economic growth regardless of whether it actually benefited individuals’ economic welfare.” In the policy tussle in Washington, Kuznets lost and wartime realpolitik won. [And that those arguing against Kuznets were heavily influenced by Keynes is rather difficult to deny. –JM]
… This decision was a turning point in the measurement of national income, and it meant that GNP (or later GDP) would be a concept strikingly different from the way the economy had been thought about from the dawn of modern industrial growth in the early eighteenth century until the early twentieth century. For two centuries, “the economy” was the private sector. Government played a small role in economic life, and featured mainly because it looked to raise taxes to pay for wars. Its role expanded steadily over the centuries, however. In Victorian times this began to extend to the provision of other services, those we take for granted now such as roads and water as well as the historic government roles of defense and justice.”
Keynes himself, on the other side of the Atlantic, was arguing for an extended role for statistical analysis in government planning. He set forth his case in a 1940 pamphlet called How to Pay for the War.
Coyle notes (emphasis mine):
Crucially, the development of GDP, and specifically its inclusion of government expenditure, winning out over Kuznets’s welfare-based approach, made Keynesian macroeconomic theory the fundamental basis of how governments ran their economies in the postwar era. The conceptual measurement change enabled a significant change in the part governments were to play in the economy. GDP statistics and Keynesian macroeconomic policy were mutually reinforcing. The story of GDP since 1940 is also the story of macroeconomics. The availability of national accounts statistics made demand management seem not only feasible but also scientific.
Understand what this means. One thing that Paul Krugman and I can agree on (and I say this with utmost confidence) is that we both believe that real economic growth is necessary to get us out of our current situation. (I am sure there are some other things that we could agree on, such as our mutual love for science fiction, but nothing else leaps to mind just yet.)
However, if your measure of economic growth overweights the contribution of government spending to growth and underweights private production by focusing on final consumption, then when you are looking for “policy dials” to turn on the economic control panel in order to increase growth, the dials you reach for will be the two largest ones in your equation for measuring success: final consumption and
