Should We Jettison GDP As an Economic Measure? Posner

This past September, the “International Commission on the Measurement of Economic Performance and Social Progress,” which had been appoined by French president Sarkozy and was chaired by the well-known economist Joseph Stiglitz, issued a report of almost 300 pages criticizing Gross Domestic Product as a measure of social welfare and proposing a variety of alterations and alternatives. Such criticisms are nothing new, but Stiglitz relates them to the deficiencies of GDP as a measure of our current economic situation, and this makes the report especially timely. For U.S. GDP (and that of many other countries) grew in the third quarter of this year, leading a number of economists and journalists to declare the end of the recession that began in December 2007 and that dramatically intensified in the financial collapse of September 2008.

 

There are three types of objection to the GDP as a measure of welfare. The first is that it is defective even from the narrowest economic perspective. GDP is the market value of all goods and services produced in a year. It thus explicitly excludes nonmarket values. But its treatment even of market values is defective because it excludes depreciation. Suppose the calamitous effects of Hurricane Katrina on New Orleans and other parts of the Gulf Coast had caused (it probably did cause) a surge in the output of various services such as emergency relief, building repairs, and construction. The market value of those services would be counted as part of GDP, without subtraction for the depreciation of the value of property that the flooding triggered by the hurricane caused.

 

Another objection to GDP as a measure of economic welfare, also a criticism based on economics though now viewed a little more broadly, is failure to adjust for monetizable, but not monetized, economic values. An obvious example is household production, which can be valued in money terms by estimating what the household producer would earn in the market; that is only a lower-bound estimate, but it is better than nothing. Leisure, which is also a value, can be monetized similarly.

 

Quality is another economic dimension that can be monetized, as is recognized in calculating the consumer price index; without an adjustment for quality change, the rate of inflation would be greatly overstimated. More to the point, it would be wrong to conclude that if the cost of making a product declines and competition forces the producers to cut price, there has been a loss of value. A great deal of the modern increase in the standard of living is due to improvements in product quality that do not result in cost increases commensurate with the improvements, and often result in lower costs. A dramatic example is modern dentistry. A possible further example is increased longevity, which can be monetized; the problem is relating increased longevity to the enormous expenditures on health care.

 

Turning to bads, economists can and do estimate the costs imposed by crime, pollution, and traffic congestion, but these costs are not subtracted, in the calculation of GDP, from the costs of police and prisons, costs of pollution control, and costs of dealing with congestion—all those costs (except a loss of production from congestion delays) are included in GDP. Put differently, the monetizable value of investments in police, pollution control, and reducing congestion does not enter into GDP.

 

Even with all the suggested corrections made, GDP would be an imperfect measure of economic output, because government provides many services that are difficult to value: expenditures on the military and on foreign and domestic intelligence and counterintelligence are conspicuous examples. It would be odd to say that the “market value” of a bomber that costs $100 million to build and is sold only to the U.S. Air Force has a market value equal to the purchase price. Its market value in a meaningful sense would depend on its contribution to reducing the expected costs of foreign threats to U.S. security.

 

Which brings me to the third and broadest problem with GDP as a measure of welfare--that even if improved along the lines I have just suggested it would not really measure happiness or well being. Market value is a function mainly of cost. The value that people derive from goods and services is better measured by what they would pay for them if competition did not reduce their price to or near the cost of production; but that value (“consumer surplus”) is difficult to estimate. Or consider—coming closer to current events that have sharpened traditional concerns with GDP’s adequacy as a measure of welfare—the anxiety that people who are involuntarily unnemployed experience.

 

The second in command at the international commission was the economist Amartya Sen, a pioneer (along with the philosopher Martha Nussbaum) in attempting to develop measures of human “capabilities” and ranking countries according to their ability to equip their citizens with such capabilities (long life, adequate nutrition, education, etc.). The United Nation’s Human Development Index attempts such a ranking, and some might think it a candidate for replacing GDP.

 

So should GDP be changed or abandoned or supplemented or supplanted? I think not, for three reasons. The first is that even the adjustments that every economist would favor in principle, such as subtracting depreciation from market value, involve contestable judgments (there is a measure called Net Domestic Product that subtracts normal depreciation from GDP). If private economists want to make such adjustments and offer up their own estimates of the economy's output, fine; but GDP is an official government statistic, and to avoid the suspicion and perhaps reality of political interference it is essential that government statistics be calculated in a thoroughly objective, uncontroversial manner. An extreme example is the U.S. census, which would be a lot cheaper to conduct if it used sampling, rather than trying to count every household and individual in the United States. But the loss of credibility would be damaging.

 

The objection to adjusting GDP would grow with every adjustment. And adjustments that were not monetizable would require controversial decisions on weighting. That is a standard problem with multicriteria rankings.

 

Second, crude as it is, unadjusted GDP is at least roughly correlated with adjusted measures of welfare. In the international commission’s report, adjustments for leisure and other nonmonetized but monetizable values boost France’s GDP from being 66 percent of America’s to 87 percent. In another words, France is poorer than America, though not by as much as the unadjusted GDP figures suggested. Anyone who knows something about France knows that it’s a wealthy country, though not so wealthy as the United States, and that the French don’t work as hard as Americans.

 

Third, except at extremes (Norway versus Zimbabwe, say), the significance of GDP lies not in its use as a method of ranking nations, but its use as a method of measuring the business cycle in an individual nation. A chart of U.S. GDP oscillates around a trend line of about 3 percent per annum; there is a big dip in the Great Depression of the 1930s and a smaller though still significant dip since 2007. The oscillations in GDP since 2007 provide a rough but serviceable starting point in appraising the performance of the economy—a sharp drop of GDP in the last quarter of 2008 and the first quarter of 2009, a smaller drop in the second quarter, an increase (of 2.8 percent) in the third quarter, which still leaves GDP well below its trend line.

 

But it is necessary to emphasize that it is just a starting point. I disagree with economists who say the “recession” ended in the third quarter. The depression (as I think we should call it if only because of its enormous potential political consequences) has caused massive unemployment with all the associated anxieties and hardships, has greatly reduced household wealth, has caused private investment to turn negative, has cost the government trillions of dollars in lost tax revenues and recovery expenditures (TARP, the fiscal stimulus, the mortgage-relief programs, the auto bailouts, etc.), has undermined belief in free markets and altered the line between government and business in favor government, and is threatening a future inflation while deepening our dependence on foreign lenders. To view a change in GDP from negative to positive as signifying the end of a depression (by which criterion the Great Depression ended in 1933 and again in 1938) is to misunderstand the utility of GDP as a measure of economic activity.

Comments

[Ted H]

Firstly, I don't think that the recession being declared "over" recently means the GDP is a bad metric for what it intends to measure. It may mean people need to rethink the definition of a recession rather than GDP. I'll admit it's tricky to find a consistent metric besides negative GDP growth, but perhaps someone can come up with something that characterizes the dire economic situation better by combining the GDP figures with unemployment numbers or something so when someone declares that the recession is over the rest of the country looks at newspaper or television and agrees, rather than like right now where massive confusion comes across most people's faces when Bernanke or Summer's declare the recession is over.

Secondly, I think the criticisms of the GDP metric are completely bogus. GDP is quite good at measuring what it's intended to measure, the overall output of a nations economy. Yes, it doesn't measure other important factors such as externalities, depreciation, the distribution of income, the quality of life, quality of goods, quality of healthcare and education, the non-market economy, etc etc. But it's not intended to measure those things and combining those into some single metric would not only be challenging (how do you measure quality of healthcare numerically to get a meaningful number?, for example), it would be worthless. I'm also deeply skeptical we could measure externalities accurately and still have GDP reflect anything meaningful. I think what criticisms aimed at the GDP metric should tell us is that citizens and pundits need to look at other metrics for the state of an economy and the respective population. Look at the Human Development Index, look at the Gini coefficients, look at the Index of Sustainable Economic Welfare, the Genuine Progress Indicator, look at quality of life and happiness surveys, look at surveys on the quality of education and health care, look at the Human Poverty Index, the Digital Opportunity index, Net Domestic Product etc etc. We don't need to rework the GDP as a metric for overall output (well, some tweaks might be needed, but the overall structure is what it should be). We just need to learn to look at other metrics of an economy other than GDP and take a view of it on the whole. While I suppose one large figure that incorporated all of those would be somewhat useful (though, I think, not possible to form), I think the figures separately are actually superior. For example, China has a good GDP; but how's pollution their for you guys? A single figure would distort that so individual metrics are better in my view.

[Jim]

The GDP is a relative data point and is inclusive of multiple unidentified components. As such it is mostly apolitical. If it were changed to, let us say, categories of positive and negative components (prisons, weapons, welfare, etc) it would immediately be politicized and thereby become meaningless and irrelevant to the economic life of the nation. Leave it alone or as one wag said, "perfect is the enemy of good."

[Mark Nielson]

I think it would be good to replace GDP with some other measure, but with what? Possibly it should be replaced with GDP minus government expenditure, for the inclusion of Fed, State, Local spending in the GDP figure gives the impression that government expenditure actually increases welfare, rather than channeling resources into inefficient opeartions and thus making the populice poorer.

Sincerely, Mark Nielson PhD

[Charles]

My concern with using GDP growth as an indicator of economic health is that, as we have seen, growth in demand (and hence production) of goods and services that is fueled by unsustainable debt isn't actually healthy. But despite having read numerous discussions of GDP shortcomings such as this over the past few years, I don't recall that concern having been emphasized, if raised at all. So as a non-economist, I have to assume I'm missing something that makes this an invalid - or at least insignificant - concern. What is it?

Thanks.

[kevinearick]

GDP measures economic activity, instead of economic profit.

Basically, it ignores organic growth, and it allows borrowing from the future to generate "earnings" as the basis for additional borrowing, the demographic Ponzi scheme.

Good luck getting the economists to give up their bag of tricks voluntarily.

I - C / G is much more instructive, but there is no real data on I because nearly all current operations are pulling forward revenue to get retained earnings.

As you know, the Supreme Court short-circuited organic growth with Family Law decades ago, turning savings and investment into debt and consumption, resulting in government, finance, and consumption economic activity, at the expense of production.

We no longer have willing markets for our products as a result.

[Marc]

I may be missing something here, but surely it is untrue to claim that GDP does not reflect improvements in the quality of goods. If we are talking about real (as opposed to nominal) GDP, then the hedonic adjustments made to reflect quality improvements will have the effect of reducing the deflator, thereby boosting real GDP.

Also, it seems to me that a far more pertinent criticism of GDP as a measure of economic output is that it fails to take into account the imported components of domestically produced goods. If a series of vehicle parts are imported from, say, China and assembled in Detroit, the entire value of the finished vehicle will be added to US GDP, despite the fact that only the assembly work is attributable to the US.

[Marc]

Just to correct my above post: I apparently was missing something. A quick Google search reveals that there is no hedonic adjustment implicit in real GDP vs nominal GDP, so I rescind my initial claim.

[Mario Rizzo]

We should call something a "depression" because of its political consequences?! Why not call it a recession with significant political consequences? This would distinguish it from a "depression" with significant political consequences.

[Thorstein Veblen]

I have a suggestion for a topic for next week. Is the Fed's Monetary Policy too tight? Should the Fed adopt an inflation target of say, 2.5%? The likes of Ryan Avent, Scott Sumner, Matt Yglesias, Brad DeLong, Paul Krugman, and Tim Duy are all pushing for the Fed to do more. Should it? The Fed's unemployment prediction for next fall is 9.3-9.7%, while it expects inflation to be 1.4-1.7%. Is this acceptable? And if so, why/why not? Are the risks of doing too much and too little really symmetric?

I look forward to hearing both of you weigh in on this key economic policy question.

Very Respectfully Submitted,

Thorstein Veblen

[Jim]

Worthwhile reading "If the GDP is Up, Why is America So Down?" by Cobb in The Atlantic October,1995. "The GDP; An Outdated Measure." In The Atlantic November, 2009. And the cover story in the current Economist on the perils of progress.

The GDP notwithstanding, the standard of living in The USA has come down and it will continue to come down as profligiate use of personal, corporate and government debt is paid down or monetized. We will never learn.

By the way, what more could The Fed possibly do that wouldn't make the situation worse. The present and predicted unemployment rate was partially caused by loose monetary policy and now the list of economists above want more of the hair of the dog. Brilliant!!!

[Jack]

Hark! Am I hearing the first sounds of our wise but somewhat staid professors awakening to a greatly changed world in which old metrics are becoming far less relevant?

The wide range of comments would also seem to indicate a loss of faith in a GDP that is enhanced by those benefiting by 100's of billions for "producing" nothing but soaring housing prices while those of median incomes pay more out of incomes that have not increased in decades often have their savings wiped out as the bubble collapses and energy and insurance costs continue to soar.

http://mysite.verizon.net/vzeqrguz/housingbubble/

What would "GDP" measure in the home price bubble? Only the costs of some 20 million new homes built since 2000? Over 8 years, statistically every home in America would have been sold at least once. Is every increased sale or "remodeled and flipped" home to be counted?

Mark Nielson favors taking out state and local expenditures. How so?

Is the man on the costly articulated Volvo road grader plowing a foot of snow off my street producing a lesser product than is an auto insurance firm that returns less than 25% of each premium dollar? or our WS thieves selling companies back and forth only to leave their empty husks for one last feeding of the bankruptcy lawyers and taxpayer financed court system?

"There are three types of objection to the GDP as a measure of welfare." Indeed! Let me add one more!

http://lanekenworthy.net/2008/03/09/the-best-inequality-graph/

As the two graphs show, despite a doubling of GDP (in constant dollars) welfare of more than 60% of our working folk as measured by wages has not improved enough to mention. And surely the soaring costs of H/C, energy and housing has more than gobbled up any savings from "category killer" box stores.

Real GDP graphs:
http://www.data360.org/graph_group.aspx?Graph_Group_Id=149

GDP will always have its place, but as a measure of welfare, surely the median wag is more far more relevant. Better yet an estimated discretionary income figure taken after the costs of a basic living std including H/C are deducted.

(Yeah......... I know, we'd have the hassle of dealing with the embarrassment of negative numbers for some 40% of our people being right out there on the front pages where a huge number in the trillions of "increasing GDP" that few understand is so much more comforting.)

Lastly, a can't help but laugh at our neo-inflation fighters who are "worried" about an inflation over half of which is energy costs derived from what clearly has all the signs of a manipulated "market", while we've 10% unemployment with a similar number either no longer being registered as unemployed or trying to hold it together with part time no bennies Walmart jobs. With stores well stocked with everything but customers where would we get a classic "too many dollars chasing too few goods" inflation to fight?

Worries about low interest rates causing businesses to make foolish investments with the "free" money? With all the normal risks of business and a substantial down payment with the need to make the principle payments anyway, now that the juicy "biz" of kiting mortgages with no more than a desk and a computer is largely over, there seems little risk that low interest rates will create too much business investment. From medicine to energy conservation/alternatives to caring for our elderly we've many problems to solve; let the investment begin! And hey! Wake up the Fed in a couple of years after unemployment approaches 5% and someone is complaining about having to work too much overtime and then consider tightening.

God forbid! an "overheated" economy in which wage increases for median and lower income groups might get started for the first time in 30 years!

[Martin Bento]

Mr. Posner, basically you're saying we should stick with GDP because it is apolitical and uncontroversial. But the topic of the post is the recent amplification of longstanding controversy surrounding it. So how can it be uncontroversial?

As for apolitical, let's look at some of the systematic distortions that you yourself have identified:

1) It does not include depreciation. This means it does not account properly for destructive effects of habitat degradation - including global warming, but also including the recently-proved responsibility of Mr. Go for Katrina. This oversight has political ramifications, because, among other reasons, environmentalism is a political dispute.

2) It does not include the value of domestic work. The undervaluing of domestic work is a longstanding grievance of feminism, which is a political movement.

3) It has no way to truly measure the value of military and other security-related spending. The proper level of such spending is a constant political dispute.

So GDP as currently measured is thoroughly political, partly in respects that the alternative measures could at least somewhat address. It seems to be another case of the covertly political being worse than the overtly political, because the political biases of the overtly political can be directly addressed and disputed. That said, I do think some of Becker's criticisms of the UN approach appear at first glance to have merit. The UN approach sounds like a first cut, but much in need of refinement.

[Charles]

"GDP notwithstanding, the standard of living in The USA has come down and it will continue to come down as profligiate use of personal, corporate and government debt is paid down or monetized."

Though I expressed it poorly, this is the point of my question above re GDP and unsustainable debt. There are only to allusions to this disconnect in this thread - this quote from "jim"'s comment, in "kevinearick"'s comment, but not at all in the post.

So to rephrase my question, how can any knowledgeable person consider rising GDP necessarily an indicator of economic health if the rise is well-known to be fueled by unsustainable debt - as was well-known to be the case prior to the current crisis and is obviously the case in the last quarter?

[David]

I can recall liberals regularly criticizing GDP (and before that, GNP) as an incomplete and inaccurate measure of economic well-being. Their criticisms were consistently ridiculed by free market economists as the rants of economic know-nothings.

Now, with GDP growing under a Democratic Administration, after a GOP-induced recession (Depression, to adopt Judge Posner's position), it is more than a little curious to read on this conservative blog that, well, just maybe, GDP is not much of a measure upon which to rely after all.

As Dana Carvey's "Church Lady" character was fond of saying back on Saturday Night Live years ago: "How conveeeeenient!!"

I hope that this self-serving right-wing excuse for economic revisionism does not serve as a faux intellectual underpinning for a right-wing political attack on the present Administration. However, I can already imagine John Boehner or Mitch McConnell decrying GDP growth as meaningless, and relying on this sort of analysis for justification.

Does the phrase "sour grapes" seem at all apt?

[Jack]

Charles: Good question and one I've puzzled about since at least the "jobless recovery". ie........ Is the lack of jobs and flat wages for most working Americans structural due to a combo of productivity increases and outsourcing (once called "trade" until it became such a one way street?) that all of our commercial demand can be filled with 80% of our available workforce?

Wage distribution graphs illustrate flat wages for most Americans so it's no surprise that demand for goods and services will also be stagnant as the few and fewer in the top ranks can not consume the excess. As we see; many fewer new cars sold while the strapped majority patches up worn out cars.

http://lanekenworthy.net/2008/03/09/the-best-inequality-graph/

JFK's memorable one-liner of "a rising tide lifting all of the boats" is apt. But for decades now the tide lifts only the yachts.

If, as I'm sure is the case, today's joblessness and the related jobs that don't pay the bills is structural we'll go broke trying to employ a Keynesian approach that perhaps worked when the increased tide tended to lift most of the boats.

The cure, or at least the best bang for the Keynesian buck, would be that of increasing the incomes of those ankle deep in their sinking skiffs who've a long list of unmet and immediate needs that would spur the business cycle and begin to create jobs.

But despite the long term trend of ALL of the productivity gains going to the topmost income tiers and that trend having been amplified by tax cuts targeted at those top ranks, legislative gutting of collective bargaining, and neglecting to even index the min wage to inflation, much less to the doubling of productivity, we'll be treated to anguished howls of "commie redistributionism" if anything is done to actually cause the long-awaited "trickle down" to begin to trickle.

The alternative is surely that of some form of jobless "stagflation" as we fall behind even in terms of GDP growth and the weakened dollar increases our import costs and adds to the costs of our joblessness.

Eventually, if those many of lower and middle incomes don't have a buck to spend how do those at the top make a buck? Simple in the short run, with paid for Congressional help they continue to sell off what's left of America, and garner their returns from abroad.

[Charles]

Jack -

In the unlikely event you find your way back to this thread, FWIW I agree on all points.

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