government spending.
GDP Is a Political Construction
Coyle underlines the inherently political nature of GDP measurement:
We are now awash with macroeconomic models and forecasts, published by official agencies and central banks, by investment banks, by think tanks and researchers, as well as by commercial forecasters such as DRI’s successors. Indeed, the idea of the economy as a machine, regulated by appropriate policy levers, took firm hold….
Debate rages in particular about the multiplier, because the issue of whether extra government spending or tax cuts (a “fiscal stimulus”) will boost GDP growth turns on its size. If it is greater than one, a stimulus will help growth, while austerity measures will hurt it. Its actual size is hotly contested among macroeconomists, especially in the context of the present political debate about how much “fiscal stimulus” the government should be applying to get the economy growing faster.There is an unsurprising alignment in the “multiplier wars” between macroeconomists’ answer to the technical question about the size of the multiplier and their political sympathies….
It will be clear by now that the ambition of measuring national income has a long history, with correspondingly many changes in how people have thought about it. As Richard Stone put it, national income is not a “primary fact” but an “empirical construct”: “To ascertain income it is necessary to set up a theory from which income is derived as a concept by postulation and then associate this concept with a certain set of primary facts.” There is no such entity as GDP out there in the real world waiting to be measured by economists. It is an abstract idea, and one that after a half century of international discussion and standard-setting has become extremely complicated. [emphasis mine]
Today, as Coyle notes, the process of comprehending GDP is somewhat akin to what happens when my kids play a videogame. The basic concepts are simple, but as you master each level and move on to the next, complexity increases almost ad infinitum. There is now an entire international community of statisticians (a surprisingly small one at that) that actually determine what is accepted as statistically relevant to GDP. The first United Nations guide on national accounts was 50 pages. The latest edition has 722.
It should not surprise readers that every few years new rules are created for the figuring of GDP. British statisticians just this year declared the UK economy to be 5% bigger than previously thought. What brought about this magical boost in productivity? There was no discovery of buried treasure hidden away in the vaults of the Bank of England. Instead, statisticians turned to counting the economic contribution of prostitution and illegal drugs (along with a few other odds and ends). If you are borrowing money and your creditworthiness depends on cash flow and your debt-to-GDP ratio, you tend to look for sources of income that weren’t previously accounted for.
Did the size of the US economy increase by 3% last summer? According to the statisticians it did. They decided to include music and entertainment and make adjustments to how we deal with investments. These changes were then calculated for all previous years, and suddenly the economy was 3% bigger! Small positive annual changes can add up over 40 years.
GDP has always been a political construction, subject to the ebb and flow of the intellectual and political climate, the need to raise taxes, and the military needs of the day. It is also a tool used to argue for or against income inequality (depending on what country you’re in).
GDP is particularly bad at detecting innovation, as George Gilder’s powerhouse workKnowledge and Power explains. There is a clear consensus emerging in economic circles about that weakness in the formula for calculating GDP, but there is nothing approaching consensus on how you might actually measure the contribution of innovation to GDP. How do you measure the value of Google maps? The voice recognition software that I’m using right now has made me significantly more productive, but how do we measure that?
And somewhat provocatively, there is growing disagreement over the contribution of the financial services sector. Depending on how you measure it, you can even determine that the actual contribution of the financial services sector is negative, although I would not make that argument. But was the contribution of financial services in 2005-2006 as positive as their impact on GDP suggests? Or was it part of the destructive process?
GDP is a financial construct at its heart, a political and philosophical abstraction. It is a necessary part of the management of the country, because, as with any enterprise, if you can’t measure it you can’t determine if what you are doing is productive. That said, the act of measuring GDP precipitates the observer effect writ large.
But as we will see next week, there are additional (note, I am not saying alternative) ways to measure growth and the size of the economy. Those measures would actually lead to policies more favored by Hayek, as the largest “dials” on the control panel would become productivity and income rather than consumer spending and government.
Conveniently, the Bureau of Economic Analysis will be giving us a new “Hayekian” statistic in its release next Friday. I am looking forward to seeing what this new measure says about the growth of the economy in the first quarter. Stay tuned as next week we ponder the question of “How in the name of all that is righteous and holy could Hayek lose the argument?” His proponents are right to argue that the match was rigged and the judges were bought. If you have a few minutes, watch these two brilliantly done, hilarious, and instructive YouTube videos, here and here. I think you will come away smiling but also gain an understanding of the true terms of the debate. At the end of the day, I keep coming back to how central the arguments between Hayek and Keynes are to almost every economic discussion.
Minneapolis, Vancouver, and Maine
Wasn’t it just a few weeks ago that I was talking about how much time I would get to spend at home this summer? Monday I will leave for a day trip to Minneapolis to do an on-site visit with my friend Pat Cox, who writes our Transformational Technology Alertletter. It’s really an easy trip, and Minneapolis is nice this time of year. Then, as a last-minute thing, I will leave on Thursday evening to spend the weekend with Louis Gave and his friends to celebrate his 40th birthday and christen his new home in Whistler, a few hours north of Vancouver. I always enjoy my time with Louis, as he is one of the most intellectually stimulating thinkers I know and a genuinely nice guy. I’m sure many of my friends will be flying in from around the world as well.
My only problem with Louis is that this is just his 40th birthday. I hadn’t even figured out where the restroom was in the economics building when I was 40. I’m not sure what kind of inequality this is, but it just doesn’t seem fair. Admittedly, he did grow up with one of the finest French economists this century has seen (and one of the few), his father Charles. That might have been a small advantage. He says he is going to make me do something called rope climbing. It can’t be any worse than the hour I spent “boxing” with The Beast this afternoon. It’s a good thing I use voice recognition to do this letter, because my arms are too weak to type.
Then I am back for a few days before I leave with my young son Trey to go to Maine for our annual fishing trip at Camp Kotok.
I’m not quite sure how to deal with how pleasant the weather is here in Dallas in July. The highs the last two days have been in the mid-70s. That is some 20°+ below the average high at this time of year.
I spent my days in New York this past week, meeting with my partners in Mauldin Economics (and George Gilder drove down to meet with us) and outlining a new documentary we want to do on Bitcoin. I had extensive meetings with new team members and potential partners who will be part of a major project with me, one I’ve been working on for several years that is getting close to the point where I can actually talk about it in public.
All in all, this has been a great week, and I expect an even better one next week. New friends, old friends, and a few challenges. I’m curious as to what a ropes course is. And whether someone my age should be doing something like that. I have always been somewhat “coordinationally challenged” (to use a polite term). Since it would be rather bad form for Louis to have his guests come away plastered with bandages or hobbling on crutches, I am going to assume the best. You have a great week.
Your thinking about the The Road to Serfdom analyst,
John Mauldin
[email protected]
