Essay on GDP and Government Statistics

The Truth About the GDP

There is one quality more important than 'know-how' and we cannot accuse the United States of any undue amount of it. This is 'know-what' by which we determine not only how to accomplish our purposes, but what our purposes are to be.
Norbert Wiener, 'The Human Use of Human Beings', 1954


Economists have suggested that increased Gross Domestic Product is the standard by which government should be judged and progress measured. However, the GDP is a poor way to indicate economic well-being.

Without a sensible way to measure progress, a country can go wildly off course. Many have noted that the GDP is a wacky compass – fatally flawed and misleading. Senator Byron Dorgan (D-ND) put it this way:

'We are told daily that the Gross Domestic Product in America is up, our economy is moving forward and we are doing so well. But why, when Americans are working longer and harder just to keep up, why are we told that things are so good, that the GDP is a measure of enormous progress?

The gross domestic product adds up everything Americans spend and declares that as the total good. As a result, the hundreds of billions of dollars that Americans spend to cope with crime, the lawyers, and social breakdown costs, is all GDP – car crashes, fender benders in front of the Capitol. Mr. President, two hundred billion dollars a year in repair bills and hospital bills give this country a real boost.”

Speech on floor of U.S. Senate by Senator Bryon Dorgan (D-ND),
October 17, 2020

A Genuine Progress Indicator

There have been several initiatives for replacing the GDP as the national economic indicator. Fordham University's Graduate Center calculates an Index of Social Health, using such factors as infant mortality, child abuse, poverty, suicides, drug use, drop-out rates, average salaries and health insurance coverage.

The Fordham Index shows a generational decline in American social health of forty-five percent, from 73.8 in 1970 to 40.6 in 1993.

The need for a Genuine Progress Indicator has been cited by people on the right and on the left, from Robert Kennedy to William Bennett, and economists like Herbert Simon, a Nobel laureate, and Robert Eisner, former president of American Economics Association.

However, there is little chance that the GDP will be replaced in the near future. Too much intellectual and political capital has been invested in this number for it to be easily discarded, no matter how bad it may be.

Besides, GDP substitutes, like Fordham’s Index of Social Health, are too touchy-feely to impress the pseudo-scientific community of macro-economists that make a living by massaging the GDP and national income accounts.

Total Sales, But of What?

The economists who recast the Federal Reserve flow of funds accounts from the earlier, more useful bookkeeping basis, to the Keynesian national income model, were part of the long undertaking that elevated the GDP to its current pinnacle.

The GDP is a fine indicator for those who need to figure out how much the government can raise from sales and income taxes. Politicians also love the GDP because it can be presented to show good results even in bad times. However, using the sum of all money income (GDP) as a surrogate for economic progress leads to absurdities:

Bad News is Good News. Escalating costs of crime (increased security, prisons, public defenders), divorce (lawyers, alimony, two households), and natural disasters (rebuilding after hurricanes, floods, volcanic eruptions) are signs of progress.
Latch Key Children are a Good Portent. When both parents need to work, GDP increases, not only from two salaries, but from the added cost of child care, two automobiles, eating out, and psychological counseling.
Depleting Natural Resources is Positive. The GDP, unlike business accounting, does not deduct the cost of natural resources that are used to generate income.
Costly Mistakes are Worthwhile. When housing projects are built and then torn-down as a bad idea, both the cost of building and destruction go into the GDP. When a factory creates a toxic waste dump that later must be cleaned up, both the cost of creating the dump and the cleanup go into the GDP.
Tort Lawyers are Good for the Country. A ridiculously high settlement in a medical malpractice case will result not only is big fees for the lawyers, but also higher health insurance premiums, doctors fees, and malpractice insurance – all of which boost the GDP.
Inflation Improves Performance. The GDP increases with the cost of goods and services (inflation). Most of this income is produced by the top twenty percent of the population. By adjusting the GDP for costs on only the lower, poorer sectors of the economy, government economists can come up with a false measure of progress that most people will not notice.
Shoddy Goods and Poor Service are Wonderful. When automobiles and consumer durables wear out faster and need more frequent repair, the GDP increases. The cost of managing junk yards and recycling of waste and garbage is also positive. When public schools do a poor job teaching, requiring parents to hire tutors or send their kids to private school, the GDP goes up.
Increased Taxes Are Good. When taxes increase and more people in each household work to make ends meet – as has been the case since the 1970s – the tax money (which is not counted in the CPI) is spent again by public employees, thereby increasing the GDP.
Borrowing from Foreigners is a Sign of Progress. With the dollar as the international currency, it is easy for Americans to borrow from abroad to buy goods produced in foreign factories. The merchandising of these goods through domestic stores increases the GDP, as does the need for Mom to work outside the home to compensate for the loss of a highly paid factory job by Dad, formerly the sole family breadwinner.
Eat Like a Pig for Uncle Sam. The large number of overweight Americans are good news for GDP watchers. Not only does the cost of this excess food puff up this symbol of progress, by so does the cost of weight reduction classes and special diet foods, slimming books, liposuction, eating disorder clinics, and medical procedures that curtail digestive tracts and clamp stomachs.
Columbian Drug Lords Help Us All. President Clinton disbanded the White House Anti-Drug Program in his first week of office, perhaps recognizing the contribution of the drug trade to increasing the GDP. The multi-billion dollar cost of border interdiction, drug clinics, anti-drug campaigns, needles, syringes, methadone, public defenders for pushers, prisons, rehabilitation programs, money-laundering fronts, armaments for the drug cartel, and myriad drug related products and services would disappear from the GDP if Americans stopped using illicit drugs.

The GDP and Capital Markets

Since GDP represents total sales of goods and services in the national economy, and since business profits, in the long-run, can only be a fraction of the GDP, just as corporate profits can only be a fraction of corporate sales, we may conclude that the rate of growth of the GDP is a useful indicator of limits to the rate of growth of corporate profits.

During the more than half century 1950-2003, the average annual increase of the GDP was 7.1%, not adjusted for inflation.

In comparison, during the period 1985-2003 that took in the Great Bubble of the 1990s, the average increase in GDP, unadjusted for inflation, was only 5.6%.

This suggests that, even without looking at the financial statements of the companies, there is little reason to suspect that corporate profits were particularly strong during the Great Bubble.

We should view with suspicion a rise in equity prices that exceeds growth of the GDP

Certainly in the last half of the 1990s, when stock prices were rising more than twenty percent a year, from already high levels, the contrast between stock price inflation and the growth of the GDP should have sent a signal that the market was mad, especially considering the high price-earnings ratios that served as the base from which price rose.

The concept of supply of equities in terms of total corporate profits suggests that we should view with suspicion any general rise in security prices that is faster than the annual increase in the GDP, unless, of course, the prices are rising from a low base.

Because of substantial uncertainty regarding the rate of inflation (see the essay: 'Fiddling the CPI'), and because of the lack of qualitative significance to the GDP number itself, as mentioned above, the excitement and publicity given by Wall Street to periodic releases of GDP statistics is somewhat difficult to classify as rational behavior.

July 25, 2020

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