The Limits of GDP
Tyler Cowen observes that “Fiscal policy can raise measured gdp without improving the economy or human welfare.”
This, however, just seems to me to be a special case of the well-known fact that measured GDP can increase without improving the economy or human welfare. Consider two stay-at-home moms. They could agree to go work full-time as housekeepers and babysitters for each others’ families, each at a salary of $20,000 per year. That would raise measured GDP but nobody would be better off. And of course the costs of living in a city whose skies are ruined by smog isn’t really captured by GDP measures. But on the other hand, GDP doesn’t really measure the value of “new goods” properly. There are all kinds of problems with this metric. But it plays an important role in our broad understanding of the economy and nobody’s got a better statistic to use so we muddle on. I don’t see this has having much to do with the merits or demerits of fiscal policy as such.
27 Responses to “The Limits of GDP”
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December 5th, 2008 at 10:26 am
They could agree to go work full-time as housekeepers and babysitters for each others’ families, each at a salary of $20,000 per year. That would raise measured GDP but nobody would be better off.
Well, sure, but why are they doing it then? If no one was better off, they almost certainly wouldn’t do that transaction; it’s just a random construction you’ve invented with little bearing on the real world.
It’s like saying you could pay me $1 million for a pebble I picked up off the street and GDP would go up, but no one is better off. This is true in theory, but in reality people by and large transact when it is in their interest to do so — i.e. you would only pay me $1M for the pebble if it made you somehow better off by $1M or more in value. Obviously this is not necessarily true in every case but I think reality has very few of the non-beneficial transactions Matt describes.
The smog example is a much better example of the limits of using GDP as a proxy for general welfare.
December 5th, 2008 at 10:27 am
December 5th, 2008 at 10:38 am
I think people should focus more on why when Tyler likes a policy, it’s all hunky-dory to use GDP as a measure of it’s benefits (even when it clearly involves distortions like pollution, or transfer pricing (which is the real life example of the two mother childcare problem)) and yet.. and yet… now we have a policy Tyler wants to look contrarian about… he suddenly discovers that GDP might not be the best measure?
December 5th, 2008 at 10:54 am
nobody’s got a better statistic
Employment and real wages.
December 5th, 2008 at 10:58 am
meh beats me to the punch: there’s nothing i’ve seen of tyler cowen’s work that convinces me he’s worth the time to read, but within that context, i don’t ever recall him mentioning that gdp growth under bush (when it was happening, that is) wasn’t all it was cracked up to be.
i’d love stimulus spending that was planned exactly to my specifications, but given a choice between a “good” program (less than “perfect,” that is) and none, i pick “good.” does cowen really believe that the market is going to clear on its own?
December 5th, 2008 at 11:04 am
Real world of breeding animals: Breeder A sells animal for $X to B. B sells a different animal for $X to A. They can now both boast of having an animal that sold for $X. Think of the genetics it must have!
It’s been a while since I talked to the person involved, so I may have the details wrong. The gist is right.
December 5th, 2008 at 11:20 am
What could possibly be wrong with a measure of welfare that accounts the Exxon Valdez spill as a net positive?
December 5th, 2008 at 1:01 pm
Best quote about the GDP:
”We will never find a purpose for our nation nor for our personal satisfaction in the mere search for economic well-being, in endlessly amassing terrestrial goods.
We cannot measure the national spirit on the basis of the Dow-Jones, nor can we measure the achievements of our country on the basis of the gross domestic product (GDP).
Our gross national product counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage.
It counts special locks for our doors and the jails for those who break them. It counts napalm and the cost of a nuclear warhead, and armored cars for police who fight riots in our streets. It counts Whitman’s rifle and Speck’s knife, and the television programs which glorify violence in order to sell toys to our children.
Yet the gross national product does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages; the intelligence of our public debate or the integrity of our public officials.
It measures neither our wit nor our courage; neither our wisdom nor our learning; neither our compassion nor our devotion to our country; it measures everything, in short, except that which makes life worthwhile. And it tells us everything about America except why we are proud that we are Americans.
It measures everything, in short, except that which makes life worthwhile. And it tells us everything about America except why we are proud that we are Americans.”
RFK
On a better measurement, I like the Genuine Progress Indicator (GPI), which “adjusts for factors such as income distribution, adds factors such as the value of household and volunteer work, and subtracts factors such as the costs of crime and pollution.”
http://www.rprogress.org/sustainability_indicators/genuine_progress_indicator.htm
December 5th, 2008 at 1:17 pm
Matt’s example is simply trying to avoid the somewhat sexist traditional example of single man marrying his housekeeper (her salary ceases to be wages and so goes off GDP but she still does the same housework and cooking).
This is why, BTW, there can be societies with ridiculously low GDPs per capita: most productive work is within families and so is not measured as part of GDP. A hunter-gatherer society has almost no GDP (the occasional trade of a fur for a knife) but can be a pleasant way of life.
December 5th, 2008 at 1:55 pm
Dammit, Steven Atwell, I was going to post that piece from Robert Kennedy but you beat them to it.
Alec Nove has some good criticisms about measuring social progress by GDP as well.
December 5th, 2008 at 2:36 pm
steve, great reminder, and it sets off my own comment that, as an oldtimer, you can count me among those who think that had it not been for sirhan sirhan, robert kennedy would have wrested the ‘68 nomination from humphrey, defeated nixon, and in general made the last 40 years a much better time.
December 5th, 2008 at 6:12 pm
I can’t remember which economist who said it – I’d like to say Krugman but I’m not 100% sure – but the point of GDP is not to measure social progress or how strong a nation is. It is to measure exactly what it measures – the trade in an economy. It’s neither good nor bad – it’s really an agnostic thing. It’s just a number.
To respond directly to Matt’s point, I think what Tyler is saying may be an indirect expression of the broken window theory – when you break a window, GDP goes up because the owner of the window has to buy a new one, the windowmaker can buy something else, and so forth. What Tyler is saying is that you can’t justify a particular fiscal policy just because you know it will make GDP go up. Spending millions of dollars to pay people to dig holes in the ground and then fill them up again increases GDP – heck, it even increases “employment” – but it’s by no means a good fiscal policy.
Tyler isn’t arguing against fiscal policy in general – I can’t think of any sane economist who would. He’s arguing against the pitfalls of saying “this fiscal policy makes GDP go up, ergo it must be good!”
Also, Tyler is not making a broad statement about whether GDP is a good or bad measure of economic progress – he is just saying that GDP changes for a number of reasons, not all of which have to do with the actual state of the real economy. Economists generally use GDP as a proxy for the state of the real economy because it is useful – generally the more we trade with each other, the better off we all are, since we clearly have many things to trade. You’ll see pretty much every economist (even “progressive” ones) use GDP as this kind of proxy. But they all have to be aware of its pitfalls. (And so if you want to criticize Tyler for using GDP as this kind of metric, you have to find an alternative explanation for the change in GDP. You can’t just say “GDP is a completely useless metric!” and pronounce victory.)
December 6th, 2008 at 1:05 am
“Well, sure, but why are they doing it then? If no one was better off, they almost certainly wouldn’t do that transaction”
That’s a good and important point…they wouldn’t do it unless it made them better off, so it would be wrong to say that “nobody is better off.”
But the main point is that they are not $40,000 better off. And that’s how much GDP went up. So GDP would overstate the welfare improvement.
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