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Make GDP great again

from David Ruccio

Mainstream economics presents quite a spectacle these days. It has no real theory of the firm and, even now, more than nine years after the Great Recession began, its most cherished claim to relevance—the use of large-scale forecasting models of the economy that assume people always behave rationally—is still misleading policymakers.

As if that weren’t embarrassing enough, we now have a leading mainstream economist, Havard’s Martin Feldstein, claiming that the “official data on real growth substantially underestimates the rate of growth.”

Mr. Feldstein likes to illustrate his argument about G.D.P. by referring to the widespread use of statins, the cholesterol drugs that have reduced deaths from heart attacks. Between 2000 and 2007, he noted, the death rate from heart disease among those over 65 fell by one-third.

“This was a remarkable contribution to the public’s well-being over a relatively short number of years, and yet this part of the contribution of the new product is not reflected in real output or real growth of G.D.P.,” he said. He estimates — without hard evidence, he is careful to point out — that growth is understated by 2 percent or more a year.

This is not just a technical issue for Feldstein: 

it is misleading measurements that are contributing to a public perception that real incomes — particularly for the middle class — aren’t rising very much. That, he said, “reduces people’s faith in the political and economic system.”

“I think it creates pessimism and a distrust of government,” leading Americans to worry that “their children are going to be stuck and won’t be able to enjoy upward mobility,” he said. “I think it’s important to understand this.”

Here’s what folks need to understand: mainstream economists like Feldstein, who celebrate an economic system based on private property and free markets, build and use models in which market prices capture all the relevant costs and benefits to society. And, since GDP is an accounting system based on adding up transactions of goods and services based on market prices, for mainstream economists it should represent an accurate measure of the “public’s well-being.”

Mainstream economists can’t have it both ways—either market prices do accurately reflect social costs and benefits or they don’t. If they do, then Feldstein & Co need to stick with the level and rate of growth of GDP as the appropriate measure of the wealth of the nation. And, if they don’t, all their claims about the wonders of free markets simply dissolve.


Notice also that, for Feldstein, the problem is always in one direction: GDP statistics only undercount social well-being. What he and other mainstream economists fail to consider is that whole sectors of the economy, like financial services (or, more generally, FIRE, finance, insurance, and real estate), are counted as adding to national income.

As Bruce Roberts has explained,

because “financial services” are deemed useful by those who pay for them, those services must be treated as generators in their own right of value and output (even though there is nothing there that can actually be measured as output at all). . .

the standard (neoclassical) approach embedded in GDP accounting means, in concrete terms, that profits in FIRE must be treated as a reflection of rising real output generated by FIRE activities, requiring a numerical “imputation” of greater GDP. And, worse, that *rising* profits in FIRE then go hand in hand with *rising* levels of imputed “output” and hence enhanced “productivity.”

If Wall Street doesn’t add to GDP—if FIRE activities just represent transfers of value from other economic sectors (both nationally and internationally)—then its resurgence in the years since the crash doesn’t contribute to output or growth.

The consequence is that GDP, as it is currently measured, actually overcounts national output and income. Actual growth during the so-called recovery is much less than mainstream economists and politicians would have us believe.

That’s the real reason many Americans are worried they and “their children are going to be stuck and won’t be able to enjoy upward mobility.”

  1. February 17, 2017 at 8:06 pm

    I agree with most of David Ruccio’s critique of the position of Feldstein & Co. I agree in particular that we are on very dangerous ground thinking that profits earned in monopolistic and oligopolistic sectors (like much of the FIRE sector is) are in any meaningful sense an additive element in a measure of national income that purports to say anything about human welfare, given the zero-sum nature of so many transactions in that sector.

    Nonetheless, I find it quite staggering, that any critic of neoclassical economics, when correctly pointing out what a ramshackle measurement of well-being GDP is, can fail to also point out that the GDP accounting rules make no effort whatsoever to measure the degradation and depletion of critical stocks of natural capital.

    I suppose that is in some sense subsumed in the critique that says you can’t measure anything that matters, using market prices. Natural capital stocks are never counted by mainstream economists – instead their depletion is only sporadically (and rather absurdly) counted as income when (after appropriation from nature) such stocks are sold, as if out of a reproducible inventory – so if we somehow were not so determined to be exclusively reliant on revealed market prices, we might naturally begin to get to grips with the issue of depletion of natural capital.

    Still, if some form of national income accounting is to survive in mixed economies, we will probably have to start with market prices for a lot of economic activity. What we desperately need though, is to also account, via judicious adjustment rules, for unpaid labour, non value-adding, zero-sum transactions between households and economic agents with market power (or even among households) and certainly among firms, and above all else, for the dangerous depletion and degradation of stocks of natural capital.

    Michael Barkusky
    Pacific Institute for Ecological Economics (now a division of the Board of Change)
    Vancouver BC

    • merijntknibbe
      February 18, 2017 at 10:36 am

      Dear Michael,

      It is not entirely true that economic statisticians do not look at the depletion of stocks of natural resources. To an extent, they do. Resources with a market price, like oil, are part of the stock of capital of a country. Lower prices or extraction will lead to a decline of the stock of capital – though this is not (as might be) subtracted from the flow of income. Resources without a clear price are not part of the stock of capital. I think this is right. When you look really hard at the statistical definition of capital it turns out that the value of measured capital is not a factor of production but a factor of redistribution: the value of rights to wealth or income. And some kinds of ‘stocks’ – biodiversity – simply do not have any kind of meaningful price. Economists can of course use some kind of ‘shadow price’ to estimate the economic value to biodiversity. But this entails a risk that biodiversity becomes a kind of tradeable commodity, at least when it comes to economic analysis. Don’t do it! We will have to learn to live with multidimensional estimates of all kinds of variables (so called dashboards) which together give a multidimensional idea of prosperity (one can even argue if biodiversity should be included in measures of human prosperity at all but this question quickly leads to a kind of homunculus fallacies). The other side of this that we have to understand national accounts for what they are: nominal estimates of flows of wages, profits, redistrubution as well as estimates of employment, unemployment and estimates of (the distrubution of) wealth etcetera. Not as measures of prosperity.

    • February 19, 2017 at 12:18 am

      “Nonetheless, I find it quite staggering, that any critic of neoclassical economics, when correctly pointing out what a ramshackle measurement of well-being GDP is, can fail to also point out that the GDP accounting rules make no effort whatsoever to measure the degradation and depletion of critical stocks of natural capital.”

      There was a joke in Roxanne:

      Q: What can you sit on, sleep on, and brush your teeth with?
      A: A chair, a bed, and a toothbrush.

      Coming up with a number for GDP that takes into account coal and oil depletion and environmental damage sounds really, really difficult. Moreover it would be hard to build trust in the result.

      Maybe it would be possible to just create another statistic that takes these issues into account?

  2. February 18, 2017 at 12:41 am

    Ecolecon it’s worse than that. Not only do they implicitly attribute zero value to many valuable things, they count many negatives as positives.
    They count the cost of cleaning up pollution, storm damage, car crashes etc as positive contributions to GDP. It’s all just “economic activity” folks. They get the sign wrong!

    • February 18, 2017 at 6:48 pm

      Absolutely. Remember Justaluckyfool’s recent quote from Soddy?

      “Let us right from the start get the signs right. The owner of money is the creditor and the issuer of it is the debtor, for the owner of money gives up goods and services to the issuer. In an honest money system the issuer of money who gets for nothing goods and services would do so on trust for the benefit of the community. In a fraudulent money system he does so for the benefit of himself.”

  3. merijntknibbe
    February 18, 2017 at 10:50 am

    Dear David,

    market prices are, for many, many reasons, indeed no indicators of welfare or prosperity. I was, against a small cost, inocculated against smallpox. Which not just protected me but wich was also part of the global and ultimately succesful battle against smallpox. Is the (cost)price of this battle indicative of the increase of welfare due to the extermination of smallpox today? A ludicrous idea. The national accounts are essentially a nominal system which maps the nominal value of the flows of wages, rents, profits, expenditure and production and enable the calculation of the share of nominal income going to labor etc. Or to calculate the part of the rise in the Greek debt ratio due to the about 25% decrease of nominal income. And which is in a way more MMT than MMT as it does not look at income to explain (in fact: account for) spending but looks at (Income + net borrowing) to account for (spending + change in financial assets), a formula which, when people hoard cash, automatically shows that spending will be less (as in the real world). We really have to say goodbye to the neoclassical delusion about prices and hello to a system which enables us to map (as Piketty and Saez have shown) changes in the distrubition of wealth and income. GDP is NOT a measure of prosperity. it is a measure of the, not entirely unimportant, nominal flows in our economy.

  4. February 19, 2017 at 5:09 pm

    I hope to be weighing in on this debate, in a more formal way, shortly, if editors Fullbrook and Morgan will allow, in a just completed essay “Major Miscalculations: Globalization, Economic Pain, Social Dislocation and the Rise of Trump.” We’ll see.

    For now, please consider the arguments of Satyajit Das in “The Age of Stagnation: Why Perpetual Growth is Unattainable and the Global Economy is in Peril,” ((2016), and Robert Gordon’s “The Rise and Fall of American Growth: The U.S. Standard of Living Since the Civil War,” (2016). Their titles are pretty good indicators that both authors incline towards David’s points here: well done David.

    I must add that this question of economic well-being – or not – was a central one in the 2016 US Presidential Election, with the Clinton-Obama camp claiming “all is well” – just look at the low unemployment rate, and low inflation…and Trump and Sanders before him dwelling on the national pain – as Naomi Klein put it, their rejoinder was “All is hell.”

    I tried to indicate in my essay why those two indicators hardly gave a full picture of the precariousness of the American middle and working classes, and thus why 70% or more of the public told the pollsters that the nation was on “the wrong track.”

    A lingering question is why the left has such a difficult time connecting emotionally with the mood of the middle class and on down…and the Right, not just in this election, but more scarily, historically, has done “better”…sometimes with horrific final results. Because it is never just about emotionally connecting, that’s just part of the “task,” its about the content and viability of one’s proposals…to remedy that pain and dislocation.

    Good luck to us all…

  5. February 20, 2017 at 4:20 am

    Creating and returning larger and larger returns to corporate investors has become not just one objective but the only objective of American and many other corporations around the world. This has to affect GDP. That affect is I think that no matter what GDP may be in theory it is in fact an effort to summarize the status of this effort. In other words, how well is this objective being achieved? If GDP is just a measure of total economic activity (without signs) and all this activity has one objective, maximizing investor return, then GDP is just a measure of inventor return. Simple identity.

  6. A.J. Sutter
    February 20, 2017 at 7:35 am

    1. A general question that has long perplexed me: if, under neoclassical theory, market prices are arbitrary and all that matters are preference orderings, why should a sum of absolute (i.e. cardinal) prices signify anything meaningful within that theory?

    2. @Ken Z, regarding GDP and investor return: there are several reasons why these might not mesh. First, investor return is measured not just by real-economy profits but by share price, among other factors. Both profits per share and share price can be manipulated by share buy-backs, which are transactions that don’t show up in GDP. Also, for the last several years the annual total volume of trading on the world’s equity markets has been roughly equal, or slightly in excess, of annual global GDP. Of that, typically < 1% represents new capital raised in the equity markets. (My stats are ground by hand from World Federation of Exchanges data.) The rest is gambling. Capital gains from equities (and most other instruments) are very unequally shared, with about half of them going to the 0.1% wealthiest, at least in the US. This seems to have two corollaries: First, these individuals obviously don’t account for 100% of global spending. So simple arithmetic suggests that less than all their gains are liquidated as consumption. Second, these wealthy individuals tend to be very globalized, and don’t necessarily spend everything in one country. So the “wealth effect” impact on a particular country’s GDP might be hard to isolate.

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