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GDP as a false measure of a country economic output

GDP is a questionable measure of economic growth

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  I take note that the 'indicators' are usually based in numbers which, upon further inspection, are rosy at the very least. Indicators for main street activity is particularly bad and skewed. Greenspan was the genius behind this going back sometime ago, with beautiful headline numbers but when one took a look (if one could) you would find that much was left out.

So we are left, as the government is basically lying or misleading us, to try and figure it out. We speculate, we find others who have analytical skills to do what others of us cannot. We listen to the 'on the street views' of others. The faith in the methods behind decades of increasingly distorted headline numbers, particularly in the '90s, was like watching Jim Jones give a speech to his faithful, fully accepting for support of their own selfish motivations and endorphin-laden highs.

Nanoo-Nanoo in

Feldstein- House Prices to Fall Further

Correct calculation of nominal GDP depends on correct calculation of inflation, which is the most politicized of economic metrics and as such subject to tremendous level of manipulation. If a country becomes increasingly in debt, and spends large amounts of income servicing this debt this is not reflected in a decreased GDP. GDP does not take into account change in country population iether, but per-capita GDP  account for population growth. Citing Wikipedia

In economics, gross domestic product (GDP) is a measure of the value of economic production of a particular territory in financial capital terms during a specified period. It is one of the measures of national income and output. It is often seen as an indicator of the standard of living in a country, but there may be problems with this view. GDP is often abbreviated as Y.

GDP is defined as the total value of final goods and services produced within a territory during a specified period (or, if not specified, annually, so that "the UK GDP" is the UK's annual product). GDP differs from gross national product (GNP) in excluding inter-country income transfers, in effect attributing to a territory the product generated within it rather than the incomes received in it.

Whereas nominal GDP refers to the total amount of money spent on GDP, real GDP adjusts this value for the effects of inflation in order to estimate the actual quantity of goods and services making up GDP. The former is sometimes called "money GDP," while the latter is termed "constant-price" or "inflation-corrected" GDP -- or "GDP in base-year prices" (where the base year is the reference year of the index used). See real vs. nominal in economics.

GDP measures only final goods and services, that is those goods and services that are consumed by their final user, and not used as an input into other goods. Measuring intermediate goods and services would lead to double counting of economic activity within a country. This distinction also removes transfers between individuals and companies from GDP. For instance, buying a Renoir doesn't boost GDP by $20m. (If it did, buying and selling the same painting repeatedly to a gallery would imply great wealth rather than penury.) Note that the Renoir purchase would affect the GDP figure, but not as a $20m receipt, the auctioneer's fees would appear in GDP as consumption expenditure, because this is a final service.

The most common approach to measuring and understanding GDP is the expenditure method:

GDP = consumption + investment + exportsimports

Consumption and investment in this equation are the expenditure on final goods and services. The exports minus imports part of the equation (often called net exports) then adjusts this by subtracting the part of this expenditure not produced domestically (the imports), and adding back in domestic production not consumed at home (the exports).

Consumption and investment in this equation are the expenditure on final goods and services. The exports minus imports part of the equation (often called net exports) then adjusts this by subtracting the part of this expenditure not produced domestically (the imports), and adding back in domestic production not consumed at home (the exports).

Economists (since Keynes) have preferred to split the general consumption term into two parts; private consumption, and public sector spending. Two advantages of dividing total consumption this way in theoretical macroeconomics are:

Therefore GDP can be expressed as:

GDP = private consumption + government + investment + net exports
(or simply GDP = C + G + I + NX)

The components of GDP

Each of the variables C, I, G, and NX :

It is important to understand the meaning of each variable precisely in order to:

... ... ...

The GDP Income account

Another way of measuring GDP is to measure the total income payable in the GDP income accounts. This should provide the same figure as the expenditure method described above.

The formula for GDP measured using the income approach, called GDP(I), is:

GDP = Compensation of employees + Gross operating surplus + Gross mixed income + Taxes less subsidies on production and imports

The sum of COE, GOS and GMI is called total factor income, and measures the value of GDP at factor (basic) prices.The difference between basic prices and final prices (those used in the expenditure calculation) is the total taxes and subsidies that the Government has levied or paid on that production. So adding taxes less subsidies on production and imports converts GDP at factor cost to GDP(I).

Simon Kuznets, the economist who developed the first comprehensive set of measures of national income, stated in his first report to the US Congress in 1934, in a section titled "Uses and Abuses of National Income Measurements":

The valuable capacity of the human mind to simplify a complex situation in a compact characterization becomes dangerous when not controlled in terms of definitely stated criteria. With quantitative measurements especially, the definiteness of the result suggests, often misleadingly, a precision and simplicity in the outlines of the object measured. Measurements of national income are subject to this type of illusion and resulting abuse, especially since they deal with matters that are the center of conflict of opposing social groups where the effectiveness of an argument is often contingent upon oversimplification. [...]

All these qualifications upon estimates of national income as an index of productivity are just as important when income measurements are interpreted from the point of view of economic welfare. But in the latter case additional difficulties will be suggested to anyone who wants to penetrate below the surface of total figures and market values. Economic welfare cannot be adequately measured unless the personal distribution of income is known. And no income measurement undertakes to estimate the reverse side of income, that is, the intensity and unpleasantness of effort going into the earning of income. The welfare of a nation can, therefore, scarcely be inferred from a measurement of national income as defined above.

In 1962, Kuznets stated:

Distinctions must be kept in mind between quantity and quality of growth, between costs and returns, and between the short and long run. Goals for more growth should specify more growth of what and for what.

Continuing progress should not lead not to ever-escalating levels of consumption, but to a society where improving productivity and technology would provide higher quality goods, better health and more leisure. GDP never measured economic efficiency of the country; it measures the level of economic activity. Healthcare is a classic example. The USA spends 20% to subsidize maladaptive behavior between producers and consumers in the medical food chain.

The other problem with GDP, which the USA actually shares with the USSR is the quantity is substituted for quality.  As Paul Krugman has pointed out, generally Europeans has better understanding of this problem with GDP then Americans and thus less susceptible to the "cult of GDP" which dominated the USA economic discourse.  There are also other areas where Americans place too high priority on quantity sometimes in detriment to quality For example, "House slaves" is another example of overconsumption in this case overconsumption of housing as measured by size. 

Consumption as a status symbol is another similar phenomenon. The  term Conspicuous consumption was coined by the US economist for a reason.  This idea was further investigated by John Kenneth Galbraith  in his famous  book The Affluent Society

It looks like "cult of GDP" which definitely represent dominant economic religion in the USA is very similar to the  cult of GDP which existed in the USSR. And like in the USSR GDP is very misleading, politically distorted metric of economic well-being of the country. As Yves Smith observed in comments to  Krugman on the Need for Jobs Policies

American GDP figures are wildly distorted, this has never gotten the press it deserves. The US is the ONLY economy that uses hedonic adjustments to GDP. That means it increases GDP to allow for the fact that computers have become more productive over time (this is completely different than the hedonic adjustments for inflation, BTW).

A modern desktop computer is about as powerful as a mainframe as of late 1980s. So I kid you not, these adjustments started in 1987, and they count you desktop in GDP as the same value what the equivalent big iron computer would have cost in 1987. Mish managed to get the BEA to send him a spreadsheet in 2005, and it showed the cumulative impact was 22% of GDP. This is far and away the most dubious of the official statistical adjustments, and gets far and away the least commentary.

The Bundesbank has also complained a few years ago that if German calculated GDP the way the US did, it’s growth rate would be a half a percent higher. If you take the Bundesbank figure instead, and calculate GDP growth over 22 years, using 2.5% versus 3.0% growth, you get an 11% cumulative difference.

There is other, more dangerous aspect of GDP is that tail wags the dog -- it implicitly stimulated counter-productive behavior of government and its major economic agents. In a recent article  by Samuel Brittan (Financial Times) put it very well:

A typical talk on BBC’s Radio Three might start by bemoaning the consumer society, with its passion for shopping and the rush to make pointless purchases. It might then bemoan the nervous strain in the quest for economic growth and the lack of time or energy for more worthwhile activities.

But then comes a more interesting twist. All this frenzy of pointless activity is required, it is said, to keep the economy going. Without it, the implication is, production would dry up and jobs disappear, and we would wallow in semi-permanent depression.

The contention is that the economy would collapse if we ceased to demand more and more, a belief sometimes called the saturation bogey. Many practical businessmen, who have no time or inclination for political economy, suppose that we must go on churning out more and more to survive, whether or not we enjoy the process. The US president Calvin Coolidge remarked in 1926: “The chief business of the American people is business.” UK politicians used to ask what would happen when every family in the country had two cars.

The clue to the whole matter is provided, as so often, by a dictum from Adam Smith: “Consumption is the sole end and purpose of production; and the interests of the producer ought to be attended to, only so far as it may be necessary for promoting that of the consumer.” To demonstrate the falsity of the belief that we must continue to feed the productive machine with ever more ridiculous demands, let me indulge in a brief thought experiment.

Let us take a medium-sized, western economy with no major population change and negligible net migration or other problems. What might then happen if a majority of people were to turn their backs on further improvements in their real spending? The basic answer is that, in this no-growth new world, people could enjoy the fruits of technological progress with a mixture of increased leisure and a more congenial and relaxed working life. The reduction in labor input would be voluntary and completely different from what happens in an economic slump.

Some political economists have looked forward to this state of affairs. John Stuart Mill regarded what he called the “stationary state” as a delight rather than a disaster. He could not believe that the perpetual struggle to get on and elbow other people out of the way was other than a temporary phase in humanity’s progress. Keynes also looked forward to such a world (in his essay “Economic Possibilities for our Grandchildren”) when “we shall honor the delightful people who are capable of taking direct enjoyment in things: the lilies of the field who toil not, neither do they spin.” He allowed for the persistence of a minority of people who would feel satisfaction only if their behavior made them feel superior to their fellows, “but the rest of us would no longer feel under any obligation to applaud”.

There is another view, stated most eloquently by Joseph Schumpeter. As he put it: “Capitalism is by nature a form or method of economic change and not only never is, but never can be, stationary.”

Let us concede at once that the resulting system would not look much like capitalism as we know it. But even in such a society there would be great advantages in retaining competitive markets based on private ownership. Those who have now, belatedly, discovered Schumpeter and quote him out of context do not realise that, writing in the 1940s, he expected entrepreneurial capitalism to have died out long ago and be replaced by some variant of state socialism. He failed to see how unworkable the latter would be. Like many other seers he was an excellent analyst, but a poor prophet.

As soon as we add more realistic conditions, the saturation bogey becomes more and more remote. Even if demand for conventional consumer goods were to peak, there might still be demand for more public services and more expenditure to relieve poverty at home and abroad. Most western countries are likely to see net immigration for the foreseeable future, which would bring with it opportunities for new investment without any need for whipping up artificial needs and anxieties. This is not to speak of devoting a margin of extra production to dealing with environmental threats, whether or not of a global warming variety.

This preliminary observations suggest that GDP is a too broad and thus questionable measure of economic growth. As such it should not be absolutized as the sole metric of the economy growth. Such usage in many respects simply contradict common sense.  In a way the calculation of  GDP became just a complex (and by-and-large counterproductive) ritual not unlike some religious rituals like calculation of certain dates.  That's why we can talk about "Cult of GDP" as a religious phenomena. 

It does not necessary correlates with well-being of the people as the term "jobless recovery" implies: for most working people any period of slow growth is not that different from recession.  See Olivier Vaury, Is GDP a good measure of economic progress, Post-Autistic Economics Review, issue 20 .  Recently there was an interesting new evidence that suggests that shifting production overseas has inflicted additional damage on the U.S. economy by creating "phantom GDP"

BusinessWeek's analysis of the import price data reveals offshoring to low-cost countries is in fact creating "phantom GDP" -- reported gains in GDP that don't correspond to any actual domestic production. The only question is the magnitude of the disconnect. "There's something real here, but we don't know how much," says J. Steven Landefeld, director of the Bureau of Economic Analysis (BEA), which puts together the GDP figures. Adds Matthew J. Slaughter, an economist at the Amos Tuck School of Business at Dartmouth College who until last February was on President George W. Bush's Council of Economic Advisers: "There are potentially big implications. I worry about how pervasive this is."

By BusinessWeek's admittedly rough estimate, offshoring may have created about $66 billion in phantom GDP gains since 2003 (page 31). That would lower real GDP today by about half of 1%, which is substantial but not huge. But put another way, $66 billion would wipe out as much as 40% of the gains in manufacturing output over the same period.

It's important to emphasize the tenuousness of this calculation. In particular, it required BusinessWeek to make assumptions about the size of the cost savings from offshoring, information the government doesn't even collect.

GETTING WORSE

As a result, the actual size of phantom GDP could be a lot larger, or perhaps smaller. This estimate mainly focuses on the shift of manufacturing overseas. But phantom GDP can be created by the introduction of innovative new imported products or by the offshoring of research and development, design, and services as well--and there aren't enough data in those areas to take a stab at a calculation. "As these [low-cost] countries move up the value chain, the problem becomes worse and worse," says Jerry A. Hausman, a top economist at Massachusetts Institute of Technology. "You've put your finger on a real problem."

Alternatively, as Landefeld notes, the size of the overstatement could be smaller. One possible offset: Machinery and high-tech equipment shipped directly to businesses from foreign suppliers may generate less phantom GDP, just because of the way the numbers are constructed.

... ... ...

Phantom GDP can also be created in import-dependent industries with fast product cycles, because the import price statistics can't keep up with the rapid pace of change. And it can happen when foreign suppliers take on tasks such as product design without raising the price. That's an effective cost cut for the American purchaser, but the folks at the BLS have no way of picking it up.

The effects of phantom GDP seem to be mostly concentrated in the past three years, when offshoring has accelerated. Indeed, the first time the term appeared in BusinessWeek was in 2003. Before then, China and India in particular were much smaller exporters to the U.S.

The one area where phantom GDP may have made an earlier appearance is information technology. Outsourcing of production to Asia really took hold in the late 1990s, after the Information Technology Agreement of 1997 sharply cut the duties on IT equipment. "At least a portion of the productivity improvement in the late 1990s ought to be attributed to falling import prices," says Feenstra of UC Davis, who along with Slaughter and two other co-authors has been examining this question.

What does phantom GDP mean for policymakers? For one thing, it calls into question the economic statistics that the Federal Reserve uses to guide monetary policy. If domestic productivity growth has been overstated for the past few years, that suggests the nation's long-term sustainable growth rate may be lower than thought, and the Fed may have less leeway to cut rates.

In terms of trade policy, the new perspective suggests the U.S. may have a worse competitiveness problem than most people realized. It was easy to downplay the huge trade deficit as long as it seemed as though domestic growth was strong. But if the import boom is actually creating only a facade of growth, that's a different story. This lends more credence to corporate leaders such as CEO John Chambers of Cisco Systems Inc. (CSCO ) who have publicly worried about U.S. competitiveness--and who perhaps coincidentally have been the ones leading the charge offshore.

In a broader sense, though, the problem with the statistics reveals that the conventional nation-centric view of the U.S. economy is completely obsolete. Nowadays we live in a world where tightly integrated supply chains are a reality.

For that reason, Landefeld of the BEA suggests perhaps part of the cost cuts from offshoring are being appropriately picked up in GDP. In some cases, intangible activities such as R&D and design of a new product or service take place in the U.S. even though the production work is done overseas. Then it may make sense for the gains in productivity in the supply chain to be booked to this country. Says Landefeld: "The companies do own those profits." Still, counters Houseman, "it doesn't represent a more efficient production of things made in this country."

What Landefeld and Houseman can agree on is that the rush of globalization has brought about a fundamental change in the U.S. economy. This is why the methods for measuring the economy need to change, too.

Also many components of GDP (especially FIRE -- finance, insurance and real estate) might be partially anti-social and their fast growth might be detrimental for the health and prosperity of society. Jesus attitude toward bankers is well known and probably was not without the reason ;-)  There are several well-known problem with GDP:

The arguments presented above cast doubt on the usefulness of GDP as the main “pilot” of economic policy. If the thermometer is wrong, then the policy based on it should be wrong too.  Also people are very adaptable and if some numeric scale became an official goal. people demonstrate tremendous ability to abuse any numeric scales of measurement both by fraud and by corruption of the initial goals and purpose of the measurement.

But even if we assume the GDP is a useful metric there are some concerns about the validity of the official figures: Ronald R. Cooke in his editorial American GDP published 01-17-2008 at Financial Sense noted:

In another life (circa 1962), I was an auditor for AT&T. Nothing spectacular. Mostly cash and property reviews. Then some business process analysis. It was my good fortune to have two older gentlemen as partners. They graciously decided to teach this green college kid how to be a good auditor. It was a great learning experience. One of the tricks they taught me was called the “reasonable test”. If the data under audit was within the parameters of like data from other audits, then it was reasonable to assume there were no problems of procedure or management. If, on the other hand, the data did not seem to make sense versus circumstantial criteria, then it would be reasonable to assume further audit investigation was warranted. This technique of measuring the quality of information has become a cornerstone of my work ever since.

In early November, 2007, the Commerce Department’s Bureau of Economic Analysis (BEA) announced the United States had achieved a third quarter Gross Domestic Product (GDP) of 3.9 percent. That number was later updated to 4.9 percent. Those numbers set off my “reasonable test” alarm. How, I wondered, with an accelerating rate of inflation and declining economic activity, could the United States turn in such a stellar performance?

The BEA’s report flunked the reasonable test.

GDP

The BEA reported American GDP in billions of Current Dollars (the money we actually spent for goods and services) for Q3 2006 and Q3 2007. It also reported this same data adjusted for inflation using “chained” 2000 dollars. As of December 20, 2007, the quarterly data, using seasonally adjusted annual rates for the National Domestic accounts, yields the Current-Dollar and “Real” Gross Domestic Product data shown in the following Table. It shows that annual GDP growth in current dollars grew from 4.53% in Q1 2007 to 5.30% in Q3 2007. Using inflation adjusted chained 2000 dollars, economic growth grew from 1.55% in Q1 2007 to 2.84% in Q3. Not bad.

But wait. Does this imply an inflation differential of only 2.46% for Q3? And do we really believe the inflation differential actually declined from 2.98% in Q1 to 2.46% in Q3? Didn’t the value of the dollar decline over these three quarters?

 

GDP in billions of current dollars

% Change from year ago quarter

GDP in billions of chained 2000 dollars

% Change from year ago quarter

Inflation Differential

2007q1

13,551.9

4.53%

11,412.6

1.55%

2.98%

2007q2

13,768.8

4.67%

11,520.1

1.89%

2.78%

2007q3

13,970.5

5.30%

11,658.9

2.84%

2.46%

The BEA’s Price Index for Gross Domestic Purchases (which measured prices paid by U S. residents) increased by just 1.8% in Q3. By contrast, the Labor Department’s Bureau of Labor Statistics (BLS) CPI-U inflation index was 2.36% for this same period. Which number is a better measure of inflation? Can we trust either number?

And to further compound the confusion, the BEA has reported a current dollar gain of 6.0% for Q3. BUT this is against average GDP for all of 2006, rather than a comparison of Q3 2006 vs. Q3 2007.

Collecting the copious amounts of data used to compute GDP has to be a tedious and sometimes frustrating job. Unfortunately, sophisticated analysis and hard work does not guarantee credible results. The BEA’s conclusions appear to be a bit optimistic.

Simple Net GDP Calculation

Pundits frequently ignore current dollar GDP (the total production of goods and services priced as though they were purchased with current dollars). Instead they use a number that has been adjusted downward called “Real” GDP that deducts the rate of inflation and makes other adjustments to current dollar GDP in an attempt to compare GDP from one period, with the GDP for a subsequent period, using dollars of a constant value .

I dislike the term “Real” GDP. There is nothing sacred about using inflation adjusted dollars as a measure of economic performance. Current dollar GDP is just as “real” as any other measure of value and provides a useful way to compare multiple sets of data from period to period. We should remember. Consumers can not spend inflation adjusted dollars to purchase goods and services. They can only pay their bills with the money that is actually in their pocket – current dollars. So .. if we want to adjust current dollar GDP for inflation, then let us do just that … and call it “Net” GDP. In other words, Net GDP is the percentage increase (or decrease) in current dollar GDP for a specified period vs. the current dollar GDP of a like prior period, less the rate of inflation from the prior period to the specified period. In the following example, seasonally adjusted current dollar GDP increased from $13,266.9 billion in Q3 2006, to 13,970.5 billion in Q3 2007 – an increase of 5.30%. The BLS reported a seasonally adjusted price index increase of 2.36% for these same two periods. If we subtract the BLS CPI from BEA current dollar GDP, that gives us a net increase in GDP of 2.94% from Q3 2006 to Q3 2007, - far less than the GDP gain of 4.9% reported by the BEA.

BEA Q3 2007 GDP Growth in Current Dollars from Q3 2006

5.30%

Increase of Q3 2007 GDP vs. Q3 2006 GDP

BLS CPI-U Q3 2006 vs. Q3 2007

2.36%

Deduct Q3 2007 Rate of Inflation

Net GDP

2.94%

Net GDP

If we take the BEA seasonally adjusted quarterly current dollar Gross Domestic Product percent change for Q3 2007, and compare it with this same data adjusted for chained 2000 dollars, the “inflation” differential is only 1.1 % even though the BEA price index was 1.8. In addition, note that while real world food and fuel prices have been going up, the inflation differential has been going down.

How is this possible?

BEA GDP Data

10/29/2007

GDP percent change based on current dollars

GDP percent change based on chained 2000 dollars

Inflation Differential

 

 

 

 

2007q1

4.9

0.6

4.3

2007q2

6.6

3.8

2.8

2007q3

6.0

4.9

1.1

If you go to www.tce.name and click on the Cultural Economics tab, you will see my essay of the rate of inflation: “CPI: Sophisticated Economic Theory, Terrible Ethics”. To quote from that essay: “If we use the weighting and data points from the above factoids to calculate an alternative estimate of CPI (the Consumer Price Index), we get a very different picture of American inflation from Q3 2006 to Q3 2007. There is a dramatic increase in food and housing costs. …... Granted.

Accuracy would require the acquisition and analysis of a lot more data than assembled for this effort. But the large discrepancy suggests something is wrong with either the survey methodology or the process of analysis. Whereas the BLS reported a CPI increase of 2.36% for this period, the actual rate of inflation was more like 4.02%.”

Ok. I like my economics simple, uncluttered, and straight. Assuming the credibility of the BEA current dollar estimates, let’s deduct my alternative CPI from the BEA data to estimate economic performance.

BEA Q3 2007 vs. Q3 2006 GDP in Current Dollars

5.30%

TCE CPI-U Q3 2007 vs. Q3 2006 Dollar value inflation

4.02%

“Net” increase in Q3 2007 GDP

1.28%

Using this methodology, could one conclude America’s economy posted a modest performance in Q3 2007? And by the way:

which number reflects contemporaneous comments on the economy:
the 4.9% gain in GDP reported by the BEA, or the above estimate of 1.26%?

... ... ...

Conclusion

GDP is one of the most closely watched economic statistics: It is used by the White House and Congress to prepare the Federal budget, by the Federal Reserve to formulate monetary policy, by Wall Street and the media as an indicator of economic activity, and by the business community to prepare forecasts of production, investment, and employment. Because of its extremely sensitive business and political ramifications, reported GDP (current or chained) needs to be accurate, unambiguous, and trustworthy.

And this brings up an interesting point. One of the issues in this election cycle is trust. Can we trust the information we receive from the Federal Government? Congress? The Administration? Federal agencies? Aside from outright falsification, and intentional or intrinsic bias, data and information can be rendered untrustworthy by establishing a misdirected premise for the methodology or by overly sophisticated manipulation.

Hopefully, we will elect a management team in November that has the ability to review our measurement objectives and the analytical processes used to achieve them. In other words:

In God We Trust. All others need an occasional audit.

In GDP, the quantity is substituted for quality. As a result  American GDP figures are wildly distorted (hedonic adjustments, etc). In a way the calculation of  GDP became just a complex (and by-and-large counterproductive) ritual not unlike some religious rituals like calculation of certain dates.  That's why we can talk about "Cult of GDP" as a religious phenomena. 

This cult has mirror image in large corporate behavior.  Both on the level of society and the level of large corporation if the metric is wrong, then the policy based on it is destructive. 

The USSR example suggests that the most dangerous aspect of GDP is "tail wags the dog" effect  -- it implicitly stimulated maladaptive, counter-productive behavior of government and its major economic agents. The term for the USSR was "phantom GDP" and now it applies to the USA to the full extent possible. For example  offshoring may have created about $66 billion in phantom GDP gains since 2003 . A lot of phantom GDP was also created in import-dependent industries. Accounting at large multinationals is as distorted as in the USSR to the extent that some parts of profits are completely fictional (writing down as research many non-research activities is a one popular trick).  The danger amplifies when individual firms adopt questionable metrics like "maximizing shareholder value" as capitalism is by nature a dynamic economic force what seeks change and became destructive if corporate goals for such a change are misaligned with the larger society. In other words "maximizing shareholder value" implicitly presuppose minimizing societal value and responsibility.  One telling example is the emergence of "blockbuster" drags, like all those cholesterol lowering drags, painkillers  and recreational drugs like Viagra in big pharma.

There is also a more generic problem with one dimensional metrics of economic performance that USSR was first to demonstrate to the world.  People are very adaptable and if some numeric scale became an official goal they demonstrate tremendous ability to abuse this metric both by fraud and by corruption of controlling organizations defeating the initial goals and purpose of the measurement.  So "maximizing shareholder value" paradoxically might be the best way to destroy any traces of honest accounting and honest auditors :-).  This phenomena was independently rediscovered in the USA by the name of  "numbers racket".


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[Jun 24, 2013] Time to ditch GDP By Martin Hutchinson

Jun 11, 2013 | Asia Times

Much commentary this year has been devoted to the dramatically negative effect the "sequester" spending cuts would have on US gross domestic product. In Japan, one leg of Prime Minister Shinzo Abe's three-part plan to revive the economy is additional state spending, predicted to increase gross domestic product (GDP) in spite of its damaging effects on Japan's huge debt and budget deficit.

Yet in both cases, the economic effects predicted are statistical artifacts, not real changes. GDP, which includes government spending at cost, unlike its treatment of all other economic activity, is a deeply flawed statistic, rigged up by Keynesians to make Big Government look better.

Several economic statistics have similar flaws. Consumer Price Indexes, for example, no longer include house prices or any realistic proxy therefore, allowing inflation watchers to miss price bubbles like that of 2002-06 in the US, which if statistics had been collected properly would have led to far higher interest rates and a resultant deflation of the housing bubble. Similarly, the 1996 "hedonic pricing" adjustment, which over-compensates for quality improvements in the tech sector by pretending that each Moore's Law doubling in chip capacity produces an actual doubling in value, has suppressed reported CPI inflation since it was introduced.

While the elimination of asset prices from the CPI and the suppression of tech sector inflation had substantial academic support when they were introduced - in economics, you can always find academics to support anything - their true driver was political. Politicians like lower interest rates, which asset-bubble-driven CPI increases would prevent, and want the appearance of good economic stewardship produced by lower reported CPI figures.

It also doesn't hurt that lower reported CPI figures greatly reduce the actuarial future cost of social security and other benefits politicians have promised the electorate. Voters will never notice a little chiseling on the CPI figures by which their benefits are adjusted, whereas they will certainly notice the tax increases that would be necessary to fund them properly.

The current proposal to adjust benefits by "chained CPI" figures, which reflect a re-balancing of consumption on price movements that bears no relation to consumers' actual behavior, is another step in this direction that will remove another tiny slice each year from social security recipients' welfare. Truly, the proponents of these CPI changes should go into the salami business.

As with the CPI, the designers of the GDP statistic (and its Gross National Product brother, which bases output on ownership, rather than physical location) had their own political agenda. Simon Kuznets, who unveiled the GNP statistic to the US Senate in 1934 (and published it in the National Bureau of Economic Research Bulletin of June 7, 1934) was a lifelong Keynesian who was trying to put an economically sound foundation under the New Deal's intellectually incoherent policies. Since he regarded government activity as a positive good that should be expanded in downturns, he included the cost of government directly in GNP/GDP at full cost -- thus automatically producing an increase in output when the size of government increases.

Kuznets should not be blamed inordinately. To get GDP, he went through "national income paid out" and then adjusted for business profits. That's not the way we'd calculate the statistic today, and it makes the inclusion of government at cost more understandable - he simply assumed government made neither a profit nor a loss.

In reality, on his methodology, government makes a huge loss, because the market value of its outputs is greatly exceeded by the cost of its inputs. You can see the effect of this in the US Postal Service, which some want to privatize, as with a US$4 billion privatization of the Belgian postal service, planned for this month.

However if you look at the Post Office's financials, privatization is obviously impossible, because the entity has negative value, with a net worth of minus $35 billion and an operating loss of $16 billion in 2012. By GDP accounting, if the USPS is included in government its output is deemed to be its $81 billion of expenses, while considered as a private sector entity its output is only $65 billion.

From a national accounting perspective, the US Postal Service is one of the easiest bits of government to assess: its output is sold at market prices, just like a private corporation, albeit a horrendously unprofitable one. Other parts of government are much more difficult. The State Department and Department of Defense have no measurable outputs at all and, in the case of defense, vast inputs, yet few would argue that the government could function without them, at least in some form.

Conversely, the Environmental Protection Agency, issuing regulations covering effectively the whole of US economic activity, imposes a vast hidden cost through regulation that is nowhere accounted for in GDP. That's the pernicious effect of regulation: if the US improved automobile fuel efficiency through a higher gasoline tax, the costs would be out there for all to see, whereas by imposing the Corporate Average Fuel Economy Standards the EPA is able to impose far higher costs on the economy that are completely invisible directly.

Some of those costs are visible indirectly, in the higher costs and lower profits of US automobile manufacturers; others, such as the additional lives lost of inadequately protected passengers in high-gas-mileage cars involved in automobile accidents, are completely invisible. (Lives would also be lost if a higher gas tax caused manufacturers to make the automobile fleet flimsier, but in that case consumers would have the option of buying a steel-reinforced gas guzzler and paying the extra fuel cost, whereas under CAFE regulation they don't.)

There are thus two approaches to reforming GDP. One would be to take each division of government and attempt to assess the value of its output, which is negative in the case of the EPA, parts of the Commerce and Agriculture Departments (protectionism) and possibly the Education Department (dumbing down schools).

That sounds like a fun intellectual exercise, but it would involve endless political judgments about which the two sides could not possibly agree. In the extraordinary US political system, that could perhaps be managed - you could have two different party groups in the Congressional Budget Office, producing Republican and Democrat GDP estimates. The Republican estimate would take a free market approach, assigning a negative value to large parts of government. Conversely the Democrat estimate could go further than current GDP accounting, and include all kinds of hedonic adjustments, as in Joseph Stiglitz's "well-being" proposal, supported by France's ex-president Nicolas Sarkozy in 2009. However every time control of congress changed, the "official" estimates of GDP would be revolutionized, altering the entire economic history of the preceding decade - and causing the utmost confusion in the markets.

A better alternative therefore would be to ignore government altogether, and calculate a Gross Private Product, the national output of the private sector, from which almost all government costs must in any case be borne. To a first order of accuracy, this can be done already from the Bureau of Economic Analysis' published data - you simply subtract line 21 (government consumption expenditures and gross investment) from GDP (line 1) and the result is a decent ballpark estimate of GPP.

Using GPP, US economic history takes a different shape, most notably around World War II. Economic growth becomes more sluggish in 1933-38 than the conventional record shows, (still with a downturn in 1937-38) then in 1939-40 (after the November 1938 mid-term congressional elections had swung heavily to a bipartisan conservative consensus and stopped the New Deal in its tracks) there was a rapid recovery that brought back the output levels of 1929. Later, instead of soaring in World War II as did GDP, GPP was squeezed during the war, before enjoying an astonishing recovery in 1946 that doubled real GPP and finally pushed prosperity beyond 1920s levels.

Paul Krugman proposed in 2011 that the US would benefit from an alien invasion, since the military expenditure on death rays and so forth to fight the aliens would stimulate the economy. Indeed, later he even proposed that the government stage a fake alien invasion to achieve the same effect. His proposal demonstrates nicely the fallacy of GDP accounting.

Under GPP, the additional government waste on death rays would be ignored, while GPP would decline as the private sector was squeezed to provide the resources for the extra military spending. Krugman's proposal also illustrates nicely the intellectual (and incipient financial) bankruptcy of Keynesianism; it's obvious nonsense if you do the accounting properly.

GPP accounting also illustrates the true effect of government cutbacks in the last six months. First quarter GPP, boosted by the sequester and defense cuts, both of which allowed more room for the private sector to thrive, grew at 4.1% compared with the anemic 2.4% growth in GDP. It's not surprising the stock market has taken off.

When leftists whine that cutbacks will destroy growth or cheer that stimulus spending will increase it, they can be confident of their forecast - because the GDP statistic is constructed to make it true. The spending stimulus of 2009-10, which peaked in the fourth quarter of 2009, delayed the recovery of GPP by six months, into 2010.

Moving from GDP to GPP would kill off many damaging economic policies, as well as giving us a much better picture of where the economy is really going. It's a slam-dunk.

(Gross Domestic Product (GDP) is a broad measure of the economy that measures the retail value of goods and services produced in a country. Gross National Product (GNP) is a measure of a country's economic performance, or what its citizens produced (ie, goods and services) and whether they produced these items within its borders.)

Martin Hutchinson is the author of Great Conservatives (Academica Press, 2005) - details can be found on the website www.greatconservatives.com - and co-author with Professor Kevin Dowd of Alchemists of Loss (Wiley, 2010). Both are now available on Amazon.com, Great Conservatives only in a Kindle edition, Alchemists of Loss in both Kindle and print editions.

(Republished with permission from PrudentBear.com. Copyright 2005-13 David W Tice & Associates.)

High Noon The Greenback Goes For Its Gun in the Fight Of Its Life

April 9, 2012  | The Kremlin Stooge

kirill

Nice article. I would repeat a point I made in a previous thread that the GDP of the USA is a fiction. Using the methodology to define the CPI pre-1990, the current and for most of the last 20 years CPI in the US is understated by a factor of two. This is a big deal since it means that the GDP growth in the range of 3% was more like zero and periods of no-growth were actual contractions. The CPI is only one component of the GDP deflator but there is indication that producer price increases have been quite high too.

The mass migration of US factory jobs to China and all the “right-sizing” and “down-sizing” was not for free and it looks like the US GDP has been stagnating for the last 20 years. I originally bought into the line that there were productivity gains, but there were also major wage reductions (all those lost manufacturing jobs were replaced with low pay service sector jobs.) All the talk about the new electronic economy was a crock too since those jobs went to China and India as well. The only source of growth that I can see is population increase in the US which is significant at around 2%.

So I would say the US GDP is closer to 10 trillion and not the 15 trillion that is being trumpeted in the media. China is a bigger economy now than the USA, except in per capita terms. The estimate of 2050 for the BRICS to overtake the west is based on overly rosy figures for the western GDP. There are too many inflation measurement shenanigans to take these figures at face value. So my thinking is that Uncle Sam and his minions will be able to do nothing to stop the US dollar from losing its world reserve status. The BRICS are not Iraq or Iran. Even Iran is an impossible nut for the west to crack since there is no way there is going to be an Iraq style invasion due to the much larger size and military capability of Iran compared to Iraq. Bunker busters will not do much either. Trying to bomb Iran back into the stone age will fail as well since Iran has surface to air missile systems that will actually bring down US jets and not some junk from the sixties.

The End of GDP

The Big Picture

There is a longish article on the value (and misuse) of the GDP stats in the Sunday NYT magazine. The author lays out the case that the US will, over the next few years, supplement or perhaps even replace GDP as the ultimate measure of economic growth.

In its place? Several 100 metrics that measure all manner of other factors, both quantitative and qualitative.

This is intriguing, for numerous reasons. First, of all the official economic data points the government releases, GDP is the easiest to game — you simply under-report inflation, and GDP appears to be better than it is. And ever since the Boskin Commission’s misbehavior (I call it a cowardly theft from the elderly), we have been dramatically under-reporting inflation data. Hence, we have nearly two decades of bogus GDP data in the can.

Second, and perhaps more significantly, GDP simply measures how much stuff we produce, buy and sell, and the folks we hire to make that stuff. It ignores all manner of other elements that go into that process.

I am not suggesting that GDP is a valueless measure (at least, if it were somewhat more accurate). But it is woefully incomplete. And the impact of making policy towards GDP has had very specific, corporate benefits. If we were to incorporate other more human factors, the net result could be quite substantial.

I wonder if we might see some sort of a pushback on this, especially from the Randians and Chicago-ites.

Regardless, it is a worthwhile topic to think about, if you are at all interested in how the government deploys its substantial resources into the economy.

Here is an excerpt:

“Whatever you may think progress looks like — a rebounding stock market, a new house, a good raise — the governments of the world have long held the view that only one statistic, the measure of gross domestic product, can really show whether things seem to be getting better or getting worse. G.D.P. is an index of a country’s entire economic output — a tally of, among many other things, manufacturers’ shipments, farmers’ harvests, retail sales and construction spending. It’s a figure that compresses the immensity of a national economy into a single data point of surpassing density. The conventional feeling about G.D.P. is that the more it grows, the better a country and its citizens are doing. In the U.S., economic activity plummeted at the start of 2009 and only started moving up during the second half of the year. Apparently things are moving in that direction still. In the first quarter of this year, the economy again expanded, this time by an annual rate of about 3.2 percent.

All the same, it has been a difficult few years for G.D.P. For decades, academics and gadflies have been critical of the measure, suggesting that it is an inaccurate and misleading gauge of prosperity . . . In the U.S., one challenge to the G.D.P. is coming not from a single new index, or even a dozen new measures, but from several hundred new measures — accessible free online for anyone to see, all updated regularly. Such a system of national measurements, known as State of the USA, will go live online this summer. Its arrival comes at an opportune moment, but it has been a long time in the works. In 2003, a government official named Chris Hoenig was working at the U.S. Government Accountability Office, the investigative arm of Congress, and running a group that was researching ways to evaluate national progress. Since 2007, when the project became independent and took the name State of the USA, Hoenig has been guided by the advice of the National Academy of Sciences, an all-star board from the academic and business worlds and a number of former leaders of federal statistical agencies. Some of the country’s elite philanthropies — including the Hewlett, MacArthur and Rockefeller foundations — have provided grants to help get the project started. “

That’s your weekend homework assignment . . .

Selected Comments

tamesthyena:

The US moved from GNP to GDP when those pesky Exports-Import accounts started going negative in the early Eighties. The US authorities then encouraged the IMF to rebase their Purchasing Power Parity adjustments at the core of making real international economic comparisons when the Nominal GDP numbers using regular Dollars started to make the Chinese economy look too large for comfort two or three years ago.

Now they are focusing on what, Happy National Production as the measure for economic performance? These adjustments are to clear thinking macroeconomics and policy making what Pro Forma earnings are to Accurate Accounting and investing; they initially intentionally delude the public, and end up softening the blow of relative economic decline

riverra:

Progressive and environmental economists have long recognized that GDP is a grossly inaccurate measure of how well we are doing economically. Principal reasons are that it counts a lot of “bads” as well as “goods”- anything that generates cash flow (e.g. money spent on cigarettes) and externalizes (does not count) a range of negative externalities that arise from economic activity (e.g. pollution produced when we import goods on container ships).

One of the original alternative measures to gain traction was the Index of Sustainable Economic Welfare (ISEW), which is similar to the later Genuine Progress Indicator (GPI).

Here is a link to info about the latter, including its theoretical foundation:
http://en.wikipedia.org/wiki/Genuine_Progress_Indicator

VennData:

Let’s get Michael Boskin on it. He did such a great job on CPI…

http://www.ssa.gov/history/reports/boskinrpt.html

…and then blame Clinton for it…

http://www.shadowstats.com/article/consumer_price_index
http://seekingalpha.com/article/7061-beware-of-core-rate-hypnosis-pre-clinton-cpi-shows-7-inflation-etf-gld
http://www.thefinancialhelpcenter.com/Economy/Inflation-the-Big-Lie.html

etc… etc…

The Curmudgeon:

The problem with measuring GDP cuts to the heart of what an economic system is for. Presumably, economic systems exist to maximize the welfare of their participants in some way. Whenever GDP is mentioned intelligent analysis should necessarily include what the GDP level means for per capita income and then how that income is distributed. Otherwise, you just get an abstract, meaningless number.

When China takes the top GDP spot in the world in the next few years as it surely will, its people will still, on average, be far less well-off than the US, Japan, and most every other developed economy on the basis of both per capita income and the distribution of that income among its people.
 

alfred e:

Ouch! I still sting from how Clinton and Boskin raped America for the federal government’s benefit. CPI my ass.

Once I have that recalled I am off-base and beyond logic.

It just all becomes more unbelievable every day. And we get to eat it.

mgkurilla:

It’s even worse than merely comnig to grips with a realistic and honest GDP figure. Currently GDP makes no effort to evaluate the sustainability of the growth. All the low interest rate credit inducing growth earlier in the decade was worse than unsustainable, it was metastatically toxic to everything else.

In addition, we don’t distinguish between GDP contributors that are functionally merely extractive based generators of GDP (like GS) versus the truly growth promoting activities. If you pay to tear down an eyesore in a city, you contribute to GDP. But there’s a difference if you stop there versus doing something economically useful with that location.

Health care is another component that can go either way. Spending 25% of our health care dollars on the last 6 months of life is not going to produce returns down the road. This is why there is usually a disconnect between main street and wall street.

ezrasfund:

GDP is a very crude measure, indeed. Yesterday’s computer, slow and expensive, added more to GDP than today’s much faster and cheaper device. The NYTimes I read today online, updated every few minutes, adds less to GDP than the paper that was printed, distributed and sold. That unnecessary surgical procedure adds more to GDP than a wellness program. That auto accident resulting in a totaled car adds more to GDP than a safe trip.

Our pursuit of GDP has gotten us a lot of things we don’t need, including plenty of financial services, lots of expensive medical procedures, and some houses in AZ.

Moss:

Well stated ezrasfund.

The existing GDP measure always puts emphasis on more quantity with no real measure of feedback loops either positive or negative. Energy efficiency, clean air or water, safety, health…. Eating less will reduce GDP but probably go along way to having a healthy population and a much less expensive health care system.

Joseph Martinez:

Since the hegemony forces are behind the ‘State of the USA’ that is the overpaid all-star board from the academic and business world and some of the country’s elite philanthropies just how accurate can it be?

As part of the middle class I have seen the middle class real income increase 0% in the past ten year and have watched that the income of the people that are behind the ‘State of the USA’ increase 100% to 1000%.

I can’t take any prudence in the report. I know that the USA status in the world is in question but to have another report out moving numbers around again is not what we need.

evans:

Best argument against GDP per capita as a measure of comparative well-being is the position of Ireland in OECD or World Bank tables.

One only has to spend a few days traveling around there to realize that its “wealth” is illusory (as we are now discovering).


Even back in 2007 when it was flying, it was a “poor” country: crappy houses; crummy public infrastructure; and–not that it counts in these figures– a provincial and derivative culture.

The fact that it scores higher than Canada, Denmark, or Germany says it all.

1 Luxembourg 78,559
— Macau 59,451
2 Norway 58,141
3 Singapore 49,288
4 United States 46,716
5 Ireland 44,195
— Hong Kong 43,922
6 Switzerland 42,534
7 Netherlands 40,850
8 Austria 38,153
9 Sweden 37,383
10 Iceland 36,770
11 Denmark 36,604
12 Canada 36,444
13 Australia 35,677
14 Germany 35,613
15 United Kingdom 35,445
16 Finland 35,426
17 Belgium 34,493
18 Japan 34,099
19 France 34,045

World Bank GDP p.c. (PPP) 2008

Actually, GDP overstates national well-being. From the point of view of anyone who works for a living, the GDP is nearly irrelevant. Since the start of the 80s, an hour of work has meant less and less in terms of per-capita share of the GDP. That is, the GDP has grown, and it has grown faster than the population, but working an hour gets you less and less of it. If you look at the current recession, which has supposedly ended because the GDP is rising again, then you can see the disconnect is complete. GDP can rise all it wants, but your hour of work will get you no more, and that’s assuming you can get an hour of paid work.

MikeinNOLA:

“Ezrafund has it right…moreover, the existence of a GDP stat gives positive feedback to the Keynsian babboons who think that juicing the number with QE or stimulus number is the equivalent of a recovery….They don’t seem to get the difference between cause and effect: a good economy will produce a good GDP, but having a good GDP doesn’t mean you have a good economy.”

Ezrafund does indeed have it right. Same point I was trying to make, but in a less verbose and more direct fashion.

I think MikeinNOLA misinterprets the potential of Keynesian stimulus though.

To be sure, shoveling borrowed money into the economy without proper analysis of true costs and benefits can easily exacerbate problems with mindless GDP growth that alternative measures of economic well-being are designed to account for. But if stimulus money is spent on sustainability-oriented infrastructure such as mass transit, greater energy efficiency, etc. per capita economic well-being may very well increase over the longer term.

In other words, whether or not Keynesian stimulus spending makes sense depends to a great degree on what the money is being spent on or invested in. Analytical tools such as ISEW and GPI are intended to facilitate better decision making about precisely these kinds of issues.

markwax:

“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 the people who break them. It counts the destruction of the redwood and the loss of our natural wonder in chaotic sprawl. . . .

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 can tell us everything about America except why we are proud that we are Americans.” Robert F. Kennedy, 1968.

Mike in Nola:

riverrat: You from NOLA, too?

Although, I can’t claim an extensive knowledge of Keynes theory, it seems mostly to prescribe deficit spending during recessions. I don’t count what you describe as really Keynsian; it’s just common sense spending that might do some good along the way and probably should have been started even when we didn’t have huge deficits. As long as we are having to pay extended unemployment, we should have a new WPA, not just thowing money at states to support the same old bureaucracies that employ many administrators who don’t really produce anything.

Inventories Don't Kill Growth — People Kill Growth - Robert P. Murphy - Mises Institute

Mises Daily: Monday, March 01, 2010 by

The most destructive ideas in academia are those that are technically defensible but nonetheless encourage erroneous intuitions. In economic science, a prime example of such a destructive idea is GDP accounting. As the recent punditry on the "inventory blip" of the fourth-quarter growth figures perfectly illustrates, the mainstream macro framework leads us into absolute absurdity.

The GDP Hall of Shame

In previous articles, I have pointed out that the familiar GDP accounting tautology, Y = C + I + G + X, is technically correct, but leads many economists to abuse the equation and in the process make horrible policy recommendations.

For example, it is this typical macro framework that leads our financial press to assume that saving is bad because consumer spending "is responsible for" so much of the economy. The national-income tautology also recently led Paul Krugman — who won the Nobel for his work on international trade theory — to (apparently) commit a basic mercantilist fallacy in a quick blog post.

GDP and Inventory Adjustments

Before we dive into the latest confusion, let's review the theoretical relevance of changes in inventories when it comes to calculating GDP. First of all, remember that Gross Domestic Product tries to measure the total amount of finished goods and services produced during a particular period (typically three months or a year).

In practice, the Bureau of Economic Analysis (BEA) estimates how much consumers, businesses, government, and foreigners spent on finished goods and services (made in the country) during the period in question. Let's say it was $10 trillion. Then, the BEA looks at the change in the value of inventories during the period. So if inventories started out at $500 billion and ended up at $400 billion, then inventories fell $100 billion.

Now the last step is to adjust the "final demand" figure by the change in inventories. In our case, the $10 trillion in total purchases must be adjusted to only $9.9 trillion in new production during the period, because $100 billion of those purchases were fulfilled by drawing down inventories.

So yes, those goods were produced within the country and contributed to GDP, but they did so in a previous period and were already counted in an earlier GDP figure. It would be double counting the same production if we included $100 billion of output

  1. when a business "invested" by buying the newly produced output and throwing it in the warehouse and then again
  2. when the retailers moved the goods from the warehouse and into consumers' houses.

So far, so good. Setting aside the severe conceptual and data problems for GDP estimation, it is an obvious refinement to look at changes in inventories to better isolate how much "stuff" was actually produced in a certain period, as opposed to how much stuff was purchased.

The Economists Make a Mess of Things

Even though technically the inventory adjustment makes sense, in practice economists botch things horribly. (We do this a lot.) Recently, when the GDP estimates for the fourth quarter of 2009 came out, many cynics dismissed the 5.7 percent "headline figure" as being mostly an "inventory blip" or an "inventory bounce." Although he was not alone, AEI economist Kevin Hassett was the most forceful I saw on the topic, so it's worth quoting from his Bloomberg article:

When is quarterly gross domestic product growth of almost 6 percent bad news? When it looks like what was reported last week.

US GDP increased 5.7 percent at the end of last year, with more than half of that growth — 3.4 percent — attributable to changes in inventories. This astonishing impact of inventory has ample historical precedent, and the bottom line has terrible implications for 2010.

Inventories are a remarkable corner of the economy. They are the goods and materials that companies keep on hand to make sure that their operations run smoothly. They are the boxes of food on shelves at the grocery store and the bins of metal parts sitting next to the assembly line in a manufacturing plant.…

Inventories are even more important during recessions. In [a] paper, co-authored with Louis Maccini in 1991, [Alan] Blinder found that 87 percent of the decline in GDP from the peak to the trough of the recession was attributable to inventories.…

Since 1970, there have been nine quarters, like the last one, when GDP grew by at least 3 percent and inventories accounted for at least half of that growth. The history of those quarters is hardly a favorable sign of what is in store. (emphasis added)

First, let us note the familiar problem with relying on conventional GDP calculations. Hassett talks as if inventories themselves have some power to steer the economy, as opposed to the human choices underlying changes in inventories. It's a bit like saying 87 percent of fevers can be attributed to thermometers.

But when it comes to the discussion of last quarter's GDP figures, the focus on inventory changes is particularly perverse. I bet those readers who don't already know the answer would have been quite confident after reading Hassett's article that inventories rose in the fourth quarter.

After all, it would make sense for someone to say, "Sure, production was up 5.7 percent in the 4th quarter of 2009 compared to its level in the 3rd quarter. But that spike in output is unsustainable, because 3.4 percentage points of the growth went right into warehouses. It's not as if the final consumers picked up their spending by the full 5.7 percent."

As I say, the above reasoning would be problematic because it presumes that spending green pieces of paper is the ultimate source of prosperity, but besides that, it would make a certain sort of sense.

Yet that's not what happened in the fourth quarter of 2009. No, inventories fell, as the BEA's press release makes clear:

Real gross domestic product — the output of goods and services produced by labor and property located in the United States — increased at an annual rate of 5.7 percent in the fourth quarter of 2009.…

The increase in real GDP in the fourth quarter primarily reflected positive contributions from private inventory investment, exports, and personal consumption expenditures (PCE). Imports, which are a subtraction in the calculation of GDP, increased.

The acceleration in real GDP in the fourth quarter primarily reflected an acceleration in private inventory investment, a deceleration in imports, and an upturn in nonresidential fixed investment that were partly offset by decelerations in federal government spending and in PCE.…

The change in real private inventories added 3.39 percentage points to the fourth-quarter change in real GDP after adding 0.69 percentage point to the third-quarter change. Private businesses decreased inventories $33.5 billion in the fourth quarter, following decreases of $139.2 billion in the third quarter and $160.2 billion in the second. (emphasis added)

The BEA's press release is a testament to the Orwellian nature of GDP accounting. An innocent person would have every reason to assume that phrases such as "positive contributions from private inventory investment" and "an acceleration in private inventory investment" meant that inventories rose in the fourth quarter. But, as the press release says, inventories actually fell by $33.5 billion.

What's really strange is that the change in inventories was fairly small. So the real "contribution" was not even the change in inventories, but the change in the change. In other words, we have moved the analysis one more step into absurdity by explaining the creation of real goods and services by referring to the second derivative of something (inventories) that does not have the power to create goods and services.

A Numerical Illustration of the Absurdity

I have tried to spell out my frustration with the typical handling of GDP inventory accounting to my colleagues, and yet the sharpest of them were nonplussed to say the least. But I hope that the following numerical example will show quite convincingly just how crazy the techniques that I've described above are.

Suppose we have an economy with the following characteristics:

Year

Starting Inventories Ending Inventories Final Purchases

GDP

GDP Growth
2010 $1 trillion $1 trillion $2 trillion $2 trillion N/A
2011 $1 trillion $0 $2 trillion $1 trillion −50%
2012 $0 $0 $2 trillion $2 trillion +100%

Of course, the numbers above are completely unrealistic, but they can illustrate the knots we tie ourselves in when worrying about inventories.

First, let's make sure we understand the cells in the table. In 2010, inventories didn't change, and so the only way people could consume $2 trillion in purchases of finished goods and services is if that output were actually produced during 2010. Hence GDP is also $2 trillion.

Things are different in 2011. People still bought $2 trillion worth of total stuff. However, only half of that was newly produced in 2011, because the other $1 trillion was taken from the inventory stockpile. That's why GDP fell in half, down to $1 trillion.

In 2012, people once again spent a total of $2 trillion on finished goods and services. Since inventories didn't change during the year, obviously these purchases were consummated through entirely new production during the period. Hence, GDP rose back up to $2 trillion for the year, a 100-percent increase over the previous year's level of output.

Now in this context, look at what someone like Hassett would be forced to say after the 2012 number came out: "Sure, the BEA and the press are running around celebrating the ostensible doubling of real output in 2012. But if you dig into the numbers, you see that fully 100 percent of the growth is attributed to the $1 trillion acceleration in private inventory investment. If we net out the contribution of inventories to GDP growth in 2012, we see that growth was zero. We should be prepared for a double dip in 2013, after this one-time blip of statistical GDP growth."

I hope the reader sees just how nonsensical this type of analysis would be for the table above. In what possible sense did inventories "contribute" to GDP in the year 2012? Inventories didn't even exist at any point in 2012. They were $0 at the beginning of the year, and $0 at the end of the year.

What happened is that people spent $2 trillion buying stuff, and workers took raw materials and other inputs and transformed them into $2 trillion of real output. This was twice as much as the same workers physically produced in 2011. So how in the world does an "inventory adjustment" — from $0 to $0 — cancel out that doubling of physical production?

Furthermore, is it really true that we need to worry about real GDP falling off a cliff after such a huge "inventory bounce"? After all, final demand has been steady at $2 trillion for three years straight. And even if entrepreneurs got spooked again and wanted to draw down inventories to satisfy their demand in 2013, they can't — there are no inventories to draw down.

It's true that someone like Hassett could point out that the growth of GDP was bound to collapse, but so what? There would have presumably been huge unemployment in the year 2011, as half of the economy's productive resources sat idle. Yet in 2012, all those resources would be back in normal operations. Those workers, tractors, drill presses, etc., wouldn't have any reason to see their usage dwindle in 2013, despite the massive "inventory contribution" to GDP growth in 2012.

In fact, to the extent that businesses want to rebuild their inventories in 2013 to give themselves a buffer greater than $0, workers will need to put in extra shifts. Under any reasonable standard, the situation of inventories in 2012 would lead us to expect GDP and employment growth in 2013. It's true, there would be a drop in the growth rate of GDP, but workers care more about their hours than they do about second derivatives of arbitrary magnitudes.

Conclusion

The textbook GDP equation is not false; it is a tautology and so of course it is true. Nonetheless, it is a destructive framework for thinking about macroeconomic events. Abuse of the equation leads economists and pundits to blame savings and praise reckless consumption, to hate imports and love exports, and (in principle) to attribute a doubling in the flow of goods coming out of factories to a nonchange in the level of a nonexistent stock of inventory.

Hassett and others are right to doubt the strength of our alleged "recovery." I think that the economy is currently held together by bubble gum and Ben Bernanke's charm. But to explain our economy's fragility, I would analyze the government and the Fed's policies. A slowdown in the fall of inventories per se is not a warning sign at all. If anything, it is a signal that businesses are becoming more optimistic.

Robert Murphy, an adjunct scholar of the Mises Institute and a faculty member of the Mises University, runs the blog Free Advice and is the author of The Politically Incorrect Guide to Capitalism, the Study Guide to Man, Economy, and State with Power and Market, the Human Action Study Guide, and The Politically Incorrect Guide to the Great Depression and the New Deal. Send him mail. See Robert P. Murphy's article archives.

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[Dec 28, 2009] How not to solve a financial crisis by Edward Harrison

December 28, 2009 | nakedcapitalism.com

kevinearick

This caused a bit of an uproar over at the NYT:

GDP, Deficits, Law, & Outcomes

Deficits measure maladaptive behavior, the failure to effectively save, and invest in future viability, to maximize NPV and induce growth. Capital is in trouble because it failed to invest in the future, and the current policy of infinite monetary policy (see Freddie and Fannie) is to accelerate the short, now that the future, demographic deceleration, is here.

There is no way to measure I because capital borrowed from the future to create “earnings” as the basis for borrowing again, compounding the error, to magnify C, supplying artificial demand abroad to create global dependency, increasing self-interested G to process the transactions.

I, C, & G are all artificial, because GDP never measured economic profit; it measures economic activity, maximizing borrowing from the future to pay increasingly irrational, maladaptive costs, to bail out capital – eliminating the path to the future.

Healthcare is classic, 20% of the economy to subsidize maladaptive behavior, created by the ponzi capital pyramid between producers and consumers in the food chain, a problem that would quickly solve itself if the structural subsidy to capital were removed.

Monetary policy is being employed to create artificial scarcity, social demand, to re-enforce non-performing capital and the government serving it.

The constitution was designed to protect the majority from these self-liquidating circumstances. Shorting the constitution with family law terminated savings and investment, doubling down on debt and consumption, in a too-big-to-fail strategy, that always fails. Capital had a going-away party.

The US Supreme court, on the vote of a handful, removed the evolutionary lead of natural new family formation, discharging the middle class battery to ground, capital.

Capital breeds on the laws of property. Labor breeds on the laws of physics. They had an agreement to grow a semi-neutral middle class. Capital broke that agreement under the false assumption that its global economy was the only “game” in town. Labor is protected by its relationship with evolution, and always has access to ground, alternative capital.

The point in developing the Internet was to make the process transparent. The dismantling of the USSR was just a beta test.

The dinosaurs were a sunk cost. Everyone clutching non-performing assets may want to make a new years resolution, or continue partying. Titration is nearly complete, non-performing capital is turning to salt, and social evolution is about to accelerate again.

Now, we watch as the municipalities are pushed over the cliff, as the momentum of global implosion hits American shores, but at least the feds got a big pay raise for putting the states and municipalities at the edge of the cliff first, to buttress themselves.

[Nov 17, 2009] Feldstein- House Prices to Fall Further

patientrenter:

“Thrift in the long run is a very good thing, but increasing thrift as you come out of a recession is going to be a drag." "

Most economists focus on increasing our GDP. They understand its limitations, but after 20 or 30 years of measuring how good an economic policy is by how much it increases GDP, they tend to forget the limitations in their daily work. So when a recession comes along, the reaction is reflexive - the recession decreases measured GDP, and that is bad, so do whatever is necessary to reverse that, setting aside longer-term considerations.

Martin Feldstein is very smart, but he has been completely captured by the always-increase-GDP-at-all-costs faith common amongst professional economists. This is not healthy. It's like identifying hunger as a problem that must be eliminated at all costs. For truly starving people, the resulting actions are great and good. For middle class Americans going from lunch to dinner, it's unhealthy to keep feeding them snacks so that they feel no pangs of hunger.

The recent financial scare and economic recession was a signal that we were doing some things wrong. What we need now is a recognition of what we were doing wrong, and public decisions on the changes. That might result in a decrease in measured GDP, but it would lay a solid foundation for a more productive economy for us all going forward. Instead we have people like Martin Feldstein calling for actions that return us to the old ways, because measured GDP was higher then. Nuts!
 

[Nov 15, 2009] Who’s Afraid Of A Falling Dollar

"GDP and inflation are as baked as Ken Lay’s books."

The Baseline Scenario

DavosSherman

Who should be how.

Also you might want to watch Chris’s videos on GDP. You own a home and they say, well you’d pay 5k a month in rent. Even though you don’t pay rent they DO add it to GDP.

GDP and inflation are as baked as Ken Lay’s books.

You can fly your plane or drive your car and believe that you have a full tank, when your car runs out of gas and the realization that the gauge was busted sinks in it might not be a pretty sight if it is raining and night and cold and you have a little one in the car.

Best of luck folks, this site has been removed from my RSS reader. Deleted like CNBC’s. Gosh, I can still hear Maria’s voice. Ughh,.

[Nov 15, 2009] Krugman on the Need for Jobs Policies 

naked capitalism

Yves Smith:

American GDP figures are wildly distorted, this has never gotten the press it deserves. The US is the ONLY economy that uses hedonic adjustments to GDP. That means it increases GDP to allow for the fact that computers have become more productive over time (this is completely different than the hedonic adjustments for inflation, BTW).

A modern desktop computer is about as powerful as a mainframe as of late 1980s. So I kid you not, these adjustments started in 1987, and they count you desktop in GDP as the same value what the equivalent big iron computer would have cost in 1987. Mish managed to get the BEA to send him a spreadsheet in 2005, and it showed the cumulative impact was 22% of GDP. This is far and away the most dubious of the official statistical adjustments, and gets far and away the least commentary.

The Bundesbank has also complained a few years ago that if German calculated GDP the way the US did, it’s growth rate would be a half a percent higher. If you take the Bundesbank figure instead, and calculate GDP growth over 22 years, using 2.5% versus 3.0% growth, you get an 11% cumulative difference.

It’s the debt, stupid « naked capitalism

Submitted by Edward Harrison of Credit Writedowns.

Let’s say I run a company. For the sake of argument, we’ll call it a shoe store in New York City. I am making $100,000 net per year now. But, I look around me and see huge opportunity for growth. So I go to my bank and ask for a loan to expand my business.  I invest the money in expanding the store, and over the next five years I increase my earnings to $140,000.  Not bad!

Is this a well-run business?

GDP is not enough

Well, if your first instinct is to say, “you didn’t give me enough information,” I would have to agree. But, this is the way GDP statistics are used to measure the success of an economy.

Clearly then, GDP is an inadequate measure for understanding how healthy an economy is.  Nobel Prize-winning economist Joseph Stiglitz brought this issue into the public domain last week when he spoke in Paris, calling the focus on GDP a ‘fetish’ and favoring a broader measure of economic health.

Stiglitz was responding to reporters after a study on alternative measures of economic growth commissioned by French president Nicholas Sarkozy was released. At the time, Bloomberg reported Stiglitz saying:

GDP has increasingly become used as a measure of societal well-being and changes in the structure of the economy and our society have made it increasingly poor one…

So many things that are important to individuals are not included in GDP. There needs to be an array of numbers but we need to understand the role of each number. We may not be able to aggregate everything together.

Stiglitz is talking about the social costs of growth here.  Think about pollution, infant mortality rate, healthcare, life expectancy, or rates of obesity to name a few.  And his views are echoed in an article which prompted this tirade from me called “Emphasis on Growth Is Called Misguided“ by Peter Goodman in today’s New York Times.  Read it.

However, in this post, I want to focus on one narrow issue: debt.

The income statement vs. the balance sheet

In the shoe store example I gave, I borrowed money to fund growth.  In assessing how successful my growth strategy is, the obvious question is: how much did I borrow? It’s the debt, stupid.

What if I borrowed $1,000,000 at 7% interest? $40,000 is a return of 4% on that money, less than the cost of debt. In that case, the growth strategy is a loser.

We need to see the balance sheet as well as the income statement to know what is happening. GDP gives us no insight into the balance sheet of an economy, and is therefore incomplete as a measure of economic health. (I’ll leave the cash flow statement for another day!)

There is 4% growth sustained only through a rise in debt, growth that would have been 2% without an increase in relative indebtedness. And there is 4% growth fuelled by a positive return on that debt.

I am sure you have seen the graphs I published last October at the height of the panic in my post “Charts of the day: US macro disequilibria.” What should be clear from those charts is that the U.S. has been living in a period fuelled more by increases in debt and a concomitant increase in asset prices than in a world of sustainable growth.

The economics profession focus on the income sheet only

I suspect the GDP fetishism owes a lot to the models currently in use in the economics field, which focus exclusively on an economy’s income statement.

When I studied economics, in our introductory course, we used a book called “Economics – Principles and Policy” by two Princeton-affiliated professors William Baumol and Alan Blinder, a former vice chairman of the Federal Reserve (Yes, I still have the book from over twenty years ago).  The only mention of debt comes in Chapter 15 on “Budget Deficits and the National Debt” and it is basically a discussion of trade-offs between budget deficits and inflation.

Nowhere are aggregate debt levels in the private sector mentioned.  Now, I could be wrong because it is not in the index and I couldn’t find it in the book. I see this is reflective of the absence of debt as a topic in economic theory taught in universities.

In fact, the Chapter just before is called “Money and the National Economy: The Keynesian-Monetarist Debate.” I think the title says it all. Baumol and Blinder are Keynesians and they released a book to teach Economics in the Keynesian tradition.  To the degree they discuss any other economic models, it is only to weave the monetarist view into their own framework.  In the introduction of Chapter 14, the book states:

Then we turn to a very old and very simple macroeconomic model – the quantity theory of money, and its modern reincarnation, monetarism – for an alternative view of the effects of money on the economy. Although the monetarist and Keynesian theories seem to be two contradictory views of how monetary and fiscal policy work, we will see that the conflict is more apparent than real.

Now that crisis has hit, there is no inter-weaving of theories. Those two worlds, the monetarists (freshwater economists as Krugman calls them) and the Keynesians (saltwater economists in Krugman’s parlance), are at war over economic theory’s contribution to the global economic meltdown.  The Economist laments:

Economic writers will continue to try and describe the arguments wracking the field for an audience which wants to know about them, but economists need to figure out how to resolve some of these questions on their terms. If the best the dismal science can do in establishing the merit of one position versus another is make a play for the hearts and minds of lay-people, then economics is in more trouble than we all thought.

More noteworthy for me is how the salt- and freshwater types completely disregard debt, an issue central to the Austrian and Minskyian schools of thought. Paul Krugman wrote 6,000 words focused only on the income statement. There was no mention of the huge rise in debt in the U.S. and other economies like the U.K., Spain, Ireland, Iceland or Latvia (I take up the issue of Latvia, Iceland and Hungary in the post that followed this at Credit Writedowns).

All of these countries have one common feature: asset price booms underpinned by rising debt levels. Let’s hope we start seeing more discussion about the balance sheet in future.

fresno dan:

Very, very good point. But what is more interesting is that it is such an obvious point, yet economists give little attention to financing and debt. Money just appears and debts just get retired.
One hears talk nowadays as if the only trade off is between unemployment (under use of all resources) and inflation. Gee, am I the only dinosaur here? We had this thingy called stagflation in the 70’s. Theoretically impossible. I imagine in a year or two the misery index will reappear.

Greg:

Following this argument to its conclusion, the US government should be borrowing where the ROI of the investment is likely to be significantly higher than the cost of the debt.

To take one particularly compelling example, spending on education has an estimated ROI of 10% annually.

http://www.cbo.gov/ftpdocs/91xx/doc9135/AppendixA.4.1.shtml

The US government can borrow money at 4%.

WH:

Ummm… Let me know if I am misreading this or am thinking about this wrong, but I think you are mistaken. This growth strategy is a winner.

Do you mean “net income” or EBITDA, here?
If it is net income, then, then interest is deducted.

That means that the return on the $1 million is 11% =
($70k interest + $40k net income)/$1 million.

The return is greater than the cost of capital. This investment has a positive NPV and a good ROI. It is a very good growth strategy.

This can also be looked at as a annual increase in expenses of $70k produced an additional annual revenue of $110k. That is a 57% return.

Edward Harrison:

This isn’t an exercise in measuring return on capital of a fictitious shoe store WH. That is irrelevant and is merely for illustrative purposes.

But, if you must go there, you will notice I said “$100,000 net per year now.” That’s net, not gross. Assume that is EBITDA.

Jeff Ellerbee:

Dude, do you even have an advanced economics degree? Saltwater/freshwater isn’t about monetarist/keynesian (even in Krugman’s parlance). Please stop posting about topics you haven’t researched thoroughly–especially academic macroeconomic theory. For your kind information, Minsky is a neo-Marxist (qua Marx as critique of Capitalism; shorter version, “Capital tends to Crisis”). And Austrian is just both dead wrong (with respect to what actions should be taken in this environment) and a political non-starter for a number of reasons. Honestly, Keynesian is about counter-cyclical fiscal policy and maintaining stability in long-run aggregate supply. Please, please get a clue outside of some Economics 101 textbook.

Edward Harrison:

Jeff, you are the one who needs to get your facts straight:

http://en.wikipedia.org/wiki/Saltwater_and_freshwater_economics

Edward Harrison:

I would also suggest you read a 1988 NY Times article by Peter Kilborn:

http://www.nytimes.com/1988/07/23/business/fresh-water-economists-gain.html

The difference between the schools is as you indicate, Keynesians see counter-cyclical fiscal stimulus as key to fighting recessions, while the freshwater types are more libertarian. Friedman believed money supply was the key to control over the economy and best represents the freshwater types along with Lucas.

Your label of Minsky as a neo-Marxist is just that, a label. The key difference between the neoclassicals and the Keynesians on one side and the Austrians and Minskyians on the other is the focus on debt.

steve from virginia:

When I studied economics, in our introductory course, we used a book called “Economics – Principles and Policy” by two Princeton-affiliated professors William Baumol and Alan Blinder, a former vice chairman of the Federal Reserve (Yes, I still have the book from over twenty years ago). The only mention of debt comes in Chapter 15 on “Budget Deficits and the National Debt” and it is basically a discussion of trade-offs between budget deficits and inflation.

Don’t got no debt … don’t got no energy, either!

Dozens if not hundreds of pieces of economic analysis are presented every day in academia, in the media and over the Internet. Energy is either not mentioned at all as an input factor … or is given backhand mention, only.

Consider two economies … separate but equal. The sexy, attractive finance economy gets all the attention. The productive economy upon which the sexpot entirely depends is falling apart due to mis- investment. Mainly, it is currently constrained by oil depletion against a backdrop of expanding – finance driven – demand.

When a big highway bridge falls, due notice is taken. Consider Cantarell oil field in Mexico: 2 million barrels per day at the peak of production with 1m bbls. exported to the US in 2003. Net exports will reach zero in two years, cutting revenue to the Mexican government and oil availability here.

The 500% increase in oil price since 1998 has had a destructive effect on the productive economy, masked/hedged against by the finance bubbles. Theoretically, the Fed can monetize all the US public and private debt. It cannot control or monetize oil prices. $70 oil is an economy destroyer which is working its evil right this minute.

Not just debt. Oil.

mikkel:

As I mentioned in another thread, Stiglitz is the only major economist I know of that has talked about resource utilization and how easy it is to spike the GDP in the short term by destroying the environment with over consumption, but leads to lower growth rates over the long term.

There’s a reason he’s marginalized.

Ishmael:

Mr. Harrison – I believe your point about debt and GDP is an extremely important one but the story is even worse than you portray. I have not worked through the computations but it appears to me that GDP is basically handled on a cash basis of accounting versus the accrual method and when money is borrowed it is added to the GDP and when it is paid back is a subtraction from GDP. Go out borrow money and the money is spent then GDP increases. Save money (or more accurately negatively borrow) and the money is removed from the system so we have a decrease in GDP.

For instance in your shoe store example, the individual borrows money to expand his store and spends it. This does not generate any additional income to the store right then but the general economy will get a lift from his additional spending. The next year, since there is no borrowing by the shoe store there will be a decrease in the economy.

The extra $40,000 of earnings impact is questionable for the store since we do not know as you pointed out what the debt service is for the expanded store. However, for the complete economy is it not really a zero impact because the positive for store was a negative elsewhere in the economy.

It seems to me that GDP should be shown net of the change of borrowing. Then the naturally sustainable level of GDP would be shown.

In truth, for each country sustainable GDP would only be driven by exporting (assuming currency stays constant ie gold standard) or technology changes which would include the use of resources that would incorporate the oil reference above. Overall improvement of GDP for the complete world on a per capita basis would only be driven by technology changes.

In the US if we subracted incremental increases in debt each year from GDP we would have had a declining GDP.

The funds flow statement bridges the balance sheet and the income statement. The current GDP number seems to be fixing funds from operation with funds from financing. This would be very misleading statement for a company and seems to also be true for a country.

Gross domestic embellishments

September 14 2009 | FT.com

Nicolas Sarkozy, president of France, is concerned that gross domestic product, the most popular yardstick of economic performance, does not capture how well societies (in particular, no doubt, France) are doing. Suspicious observers may think he set up his commission on measuring “social progress” mainly to kick Anglo-Saxon capitalism while it was down. In fact, its report is full of sensible, if old, insights.

GDP is riddled with imperfections. It only covers production exchanged in the private market or the public sector and misses the vast amount of productive activity inside the household, such as family care for children and the elderly. Ignoring sustainability, GDP is boosted by resource depletion that may increase income today but lower it in the future: a form of destruction more than production.

"Rethinking GDP"

Joseph Stiglitz says we need better measures of economic performance:

Rethink GDP fetish, by Joseph E. Stiglitz, Commentary, Project Syndicate: ...Eighteen months ago, French President Nicolas Sarkozy established an international Commission on the Measurement of Economic Performance and Social Progress, owing to his dissatisfaction - and that of many others - with the current state of statistical information about the economy... On Sept. 14, the commission will issue its long-awaited report.

The big question concerns whether GDP provides a good measure of living standards. In many cases, GDP statistics seem to suggest that the economy is doing far better than most citizens' own perceptions. Moreover, the focus on GDP creates conflicts: political leaders are told to maximize it, but citizens also demand that attention be paid to enhancing security, reducing pollution, and so forth - all of which might lower GDP growth.

The fact that GDP may be a poor measure of well-being, or even of market activity, has, of course, long been recognized. But changes in society and the economy may have heightened the problems...

For example,... in one key sector - government - we ... often measure the output simply by the inputs. If government spends more - even if inefficiently - output goes up. In the last 60 years, the share of government output in GDP has increased [substantially]... So what was a relatively minor problem has now become a major one.

Likewise, quality improvements ... account for much of the increase in GDP nowadays. But assessing quality improvements is difficult. ...

Another marked change in most societies is an increase in inequality. ... If a few bankers get much richer, average income can go up, even as most individuals' incomes are declining. So GDP per person statistics may not reflect what is happening to most citizens.

We use market prices to value goods and services. But ... the ... pre-crisis profits of banks - one-third of all corporate profits - appear to have been a mirage.

This realization casts a new light not only on our measures of performance, but also on the inferences we make. Before the crisis, when U.S. growth ... seemed so much stronger than that of Europe, many Europeans argued that Europe should adopt U.S.-style capitalism. Of course, anyone who wanted to could have seen American households' growing indebtedness, which would have gone a long way toward correcting the false impression of success given by the GDP statistic.

Recent methodological advances have enabled us to assess better what contributes to citizens' sense of well-being... These studies, for instance, verify and quantify what should be obvious: the loss of a job has a greater impact than can be accounted for just by the loss of income. They also demonstrate the importance of social connectedness.

Any good measure of how well we are doing must also take account of sustainability..., our national accounts need to reflect the depletion of natural resources and the degradation of our environment.

Statistical frameworks are intended to summarize what is going on in our complex society in a few easily interpretable numbers. It should have been obvious that one couldn't reduce everything to a single number, GDP. The report by the Commission on the Measurement of Economic Performance and Social Progress ... should ... provide guidance for creating a broader set of indicators that more accurately capture both well-being and sustainability...

Elliot says...

When Keynes wrote "The General Theory" he focused on the economy reaching and maintaining full employment. Friedman led a shift away from that and pushed for a focus on the price level and growth. We need to return to a focus on full employment.The statistics we use are often misleading (inflation has been a particularly misleading stat during the housing bubble), yet are used to justify and rationalize mere assumptions. Policies that promote job growth ultimately generate GDP growth; however, policies that promote GDP growth do not generate job growth. Government policies should focus on employing the maximum number of people possible. Job growth will ultimately yield way to a growing economy, in which the largest number of people partake in the prosperity and growth.

http://southpawpolitic.blogspot.com/2009/09/full-employment-vs-gdp-growth.html

Posted by: Elliot | Link to comment | Sep 09, 2009 at 11:33 AM

Beezer says...

Redefining progress has the GPI, genuine progress report.
http://www.rprogress.org/sustainability_indicators/genuine_progress_indicator.htm

"The GPI starts with the same personal consumption data that the GDP is based on, but then makes some crucial distinctions. It 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.

Because the GDP and the GPI are both measured in monetary terms, they can be compared on the same scale. Measurements that make up the GPI include:

Income Distribution
Both economic theory and common sense tell us that the poor benefit more from a given increase in their income than do the rich. Accordingly, the GPI rises when the poor receive a larger percentage of national income, and falls when their share decreases.

Housework, Volunteering, and Higher Education
Much of the most important work in society is done in household and community settings: childcare, home repairs, volunteer work, and so on. The GDP ignores these contributions because no money changes hands. The GPI includes the value of this work figured at the approximate cost of hiring someone to do it. The GPI also takes into account the non-market benefits associated with a more educated population.

Crime
Crime imposes large economic costs on individuals and society in the form of legal fees, medical expenses, damage to property, and the like. The GDP treats such expenses as additions to well-being. By contrast, the GPI subtracts the costs arising from crime.

Resource Depletion
If today’s economic activity depletes the physical resource base available for tomorrow, then it is not creating well-being; rather, it is borrowing it from future generations. The GDP counts such borrowing as current income. The GPI, by contrast, counts the depletion or degradation of wetlands, forests, farmland, and nonrenewable minerals (including oil) as a current cost.

Pollution
The GDP often counts pollution as a double gain: Once when it is created, and then again when it is cleaned up. By contrast, the GPI subtracts the costs of air and water pollution as measured by actual damage to human health and the environment.

Long-Term Environmental Damage
Climate change, ozone depletion, and nuclear waste management are long-term costs arising from the use of fossil fuels, chlorofluorocarbons, and atomic energy, respectively. These costs are unaccounted for in ordinary economic indicators. The GPI treats as costs the consumption of certain forms of energy and of ozone-depleting chemicals. It also assigns a cost to carbon emissions to account for the catastrophic economic, environmental, and social effects of global warming.

Changes in Leisure Time
As a nation becomes wealthier, people should have more latitude to choose between work and free time for family or other activities. In recent years, however, the opposite has occurred. The GDP ignores this loss of free time, but the GPI treats leisure as most Americans do—as something of value. When leisure time increases, the GPI goes up; when Americans have less of it, the GPI goes down.

Defensive Expenditures
The GDP counts as additions to well-being the money people spend to prevent erosion in their quality of life or to compensate for misfortunes of various kinds. Examples are the medical and repair bills from automobile accidents, commuting costs, and household expenditures on pollution control devices such as water filters. The GPI counts such "defensive" expenditures as most Americans do: as costs rather than as benefits.

Lifespan of Consumer Durables & Public Infrastructure
The GDP confuses the value provided by major consumer purchases (e.g., home appliances) with the amount Americans spend to buy them. This hides the loss in well-being that results when products wear out quickly. The GPI treats the money spent on capital items as a cost, and the value of the service they provide year after year as a benefit. This applies both to private capital items and to public infrastructure, such as highways.

Dependence on Foreign Assets
If a nation allows its capital stock to decline, or if it finances consumption out of borrowed capital, it is living beyond its means. The GPI counts net additions to the capital stock as contributions to well-being, and treats money borrowed from abroad as reductions. If the borrowed money is used for investment, the negative effects are canceled out. But if the borrowed money is used to finance consumption, the GPI declines."

Posted by: Beezer | Link to comment | Sep 09, 2009 at 12:07 PM

Arthur Fullerton says...

GDP measures activity, not benefit -- as such the problem is not so much the measurement of GDP as it is the meaning invested in the statistic. If we equate GDP growth with benefit and GDP decline with detriment, then we fall into the old trap of confusing means with ends.

Think of the GDP of an economy as being analogous to an engine's RPM. We do not confuse a car's RPM with its gas mileage or its creature comforts. Similarly GDP is not a measure of an economy's efficiency or efficacy.

Developing alternative measures and managing to maximize other outcomes is perfectly appropriate, but the shortcoming is not in the GDP statistic, rather it lies in how people misuse the statistic as a proxy for benefit.

Posted by: Arthur Fullerton | Link to comment | Sep 09, 2009 at 12:26 PM

SS says...

The United Nations Human Development Report:
http://hdr.undp.org/en/reports/global/hdr2007-2008/
and Human Development Indicator (therein) do an excellent job capturing health, access to potable water, air quality and other indexes of a countries well being.

SS

Posted by: SS | Link to comment | Sep 09, 2009 at 12:50 PM

paine says...

ah joe

like ferdinand the bull..chasing butterflies

when he could toss giants on his horns

Posted by: paine | Link to comment | Sep 09, 2009 at 01:00 PM

William says...

Stiglitz made a big huff about "Green net national product (Green NNP)" in his book Making Globalization Work. Surprised he didn't mention it.

Posted by: William | Link to comment | Sep 09, 2009 at 01:59 PM


 

It's pretty funny the cult of GDP was one of the most distinctive features of the USSR economic life.

For the US also serves as an economic fetish (especially for Fed and related agencies).

I would suggest term "Junk GDP" which like the term "junk food" reflects dubious or explicitly harmful for the society activities included in GDP.

For example excessive monetization of services harms the society (as health insurance costs can attest)

I would suggest that the USA has the highest percentage of junk GDP among developed nations. May be higher then 30%.

Among most obvious candidates are FIRE, military-industrial complex, junk food industries, junk medicine, junk drags (aka big pharma).

Posted by: kievite | Sep 09, 2009 at 05:27 PM

Rosenberg On A Flat Normalized GDP Number zero hedge

Yesterday, the market moved on what was the double whammy of the government's own rather fluid favorable interpretation of what was essentially the government's very own stimulus. Yet others can play, and unwind, the number fudging game too. According to David Rosenberg, absent the now declining impact of the massive governmental stimulus, GDP would have been flat if not negative. So much for bickering over whether GDP was 2.7% or 3.5%: at the end of the day, on a normalized, non-stimulus inflated basis, GDP was flat, and if the equity market cared about isolating non-recurring items such as excess government spending driving a collapsing economy, the stock market reaction would have been quite the opposite.

From Rosenberg:

Never before did a gap between a 3.2% consensus GDP forecast and an actual print of 3.5% manage to elicit so much excitement in the equity market. It just goes to show how speculative the stock market has become. The question is why it is that the economy couldn’t do even better?

Historically, the auto sector adds 0.1 percentage point or 0.2 percentage point to any given GDP report. In the third quarter, courtesy of cash-for-clunkers, the sector added 1.7 percentage points to the headline figure, which is less a than 1-in-10 event in terms of probabilities. Tack on the rebound in housing and government spending and the areas of GDP that received the most medication from public sector stimulus contributed almost all of the growth in the economy. You read this right. If not for all the government incursion into the economy in Q3, real GDP basically would have stagnated.

Because of the housing and auto subsidies, the personal savings rate plunged to 3.3% in Q3 from 4.9% in Q2 — in the past quarter-century, there have been only four other times that the savings rate went down so much in one quarter. If not for that plunge in savings, real GDP actually would have contracted fractionally last quarter. The entire GDP growth was funded by a rundown in the savings rate that occurs less than 5% of the time.

Moreover, what is normal in that first positive post-recession GDP release is a 5% annual rate of growth. That puts 3.5% in Q3 into a certain perspective, especially when you consider the massive amount of stimulus that underpinned the latest batch of data.

What is normal in this first positive post-recession GDP release is a 5% annual rate of growth, not 3.5%

The parts of the economy that did not receive government support didn’t fare too well in the third quarter. For example, total business spending (on structures, equipment and machinery) actually contracted at a 2.1% annual rate — the fifth decline in a row. State and local government spending also fell at a 1.1% annual rate. Since there was no cash-for-clothing program, spending on apparel slipped at a 1.5% annual rate. The economists had all been talking about an inventory cycle taking hold and yet there was an additional $130 billion of de-stocking in the third quarter.

a critical question that nobody seems to be asking: how are companies reacting to this presumed economic rebound? If CapEx, inventories and lending, corporations are the only ones who seem to be willing to think about the facts behind the hype:

The question has to be asked, if companies, both non-financial and financial, are big believers in this new post-recession V-shaped recovery that seems to have the hedge funds and most strategists excited, why are companies still cutting back in capital expenditures and inventories and why are banks still cutting back on lending at an unprecedented 15% annual rate.

David concludes with a point that he tried to highlight on Fast Money yesterday, if only he wasn't caught up in futile debates over trivial data points:

While it seems very flashy, 3.5% growth is far from a trend-setter. Let’s go back to Japan. Since 1990, it has enjoyed no fewer than 19 of these 3.5%-or-better GDP growth quarters. That is almost 25% of the time, by the way. And we know with hindsight that this was noise around the fundamental downtrend because the Japanese economy has experienced four recessions and the equity market is down more than 70% from the peak. What is important for the future is whether the U.S. economy can manage to sustain that 3.5% growth performance in the absence of ongoing massive government stimulus. In other words, it may be a little early to uncork the champagne.

From our lens, the big risk going into Q4 is a renewed contraction in real final sales. That is not priced into the various asset classes right now.

For more relevant economic observations, Rosie's morning piece is a captivating read.




Etc

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The Last but not Least


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Last modified: February 19, 2014