Some issues with GDP

Recently Peter Cresswell from Not PC asked me if I understood the difference between production and consumption.  I know that consumption is what we value and I know that production is what we do in order to achieve consumption.  As a result, I see production as a means to an end – the costly process we take on in order to get what we want.

This brought to my mind some of the issues we need to discuss when looking at Gross Domestic Product.  GDP is a measure of the production in society over a given period of time.  Real GDP gives us a “volume” measure of production, which tells us the quantity of stuff we make in the arbitary prices of some point in time.

Since we value consumption not production we need to remember:

  1. The lifetime consumption associated with a durable good is recorded all in one period – the period it is purchased.  However, the actual value of such a good remains.  During this recession the sale of motor vehicles has collapsed as people have kept driving their old vehicles, as a result GDP states overstate the loss of “motor vehicle consumption” during the recession.
  2. There are many activities that are not recorded in GDP, but provide satisfaction.  Black market drugs, cleaning your own house, and helping your neighbour move are all examples that spring to mind.
  3. In a small open economy like NZ we have a lot of exports and imports.  Now when the terms of trade increases we make relatively more off our exports (and/or pay less for our imports).  GDP does not capture this directly.  For example, if our TOT increases and we just buy imports with the increase in income GDP is unchanged – however, people are getting to consume more because of higher incomes!
  4. GDP is a “flow” of production – not a stock of produced goods in the economy.  It is what we are adding to the set of already produced goods out their (durable goods).  As a result a BOOST or SLUMP in GDP could be the result of timing – not some brilliant/terrible event.

We all overuse GDP.  It is a useful stat, but it is important to keep in mind what it is actually saying, and what society actually wants, before leaping to policy conclusions.

In the housing example this still leads me to believe that house building has a purpose.  Are there enormous issues in the housing market – yes.  Have many households overexposed themselves to housing as a retirement nestegg – yes.  Has NZ inc “over-invested” in housing by borrowing from overseas – at the moment the data suggests not.

I completely agree with many criticisms out there about the NZ housing market, but saying that the countries terrible debt position is the result of a “housing obsession” seems off the mark – as we don’t appear to have overbuilt.

In reality the data seems to indicate that NZ inc has borrowed to fund a whole bunch of business investment that has turned sour – plant and machinery investment has been through the roof and we haven’t done much with it.  Unfortunate, but C’est la vie.

  • Regarding bullet point (2), couldn’t you go further. Even for consumption in the current period, GDP doesn’t include consumer surplus. Thus it undervalues the benefits of current consumption. Obviously it’s not intended to value surplus, but that’s another reason why it is a poor measure of welfare.

  • @rauparaha

    Indeed, good point in so far as the price of goods does not represent the full satisfaction gained from the trade of a product.

    However, at least with this we know that (as long as relative prices are unchanged) the two measures move in the same direction.

  • swan

    Regarding the example of motor vehicles in point 1. In Europe there are car ‘scrappage’ schemes at the moment in order to help the car industry. This is where you trade in a car and that car gets crushed, and the government gives you a subsidy on the purchase of a new car.

    Whilst the value in a subsidy to encourage consumption is arguably a good thing in a recession*, the idea of crushing a perfectly good car seems absolute madness – the ongoing value of the car is not being taken into account.

    *For the avoidance of doubt, I think the subsidies are a bad idea as well!

  • @swan
    Ah, but crushing it generates GDP which holding on to it wouldn’t! Isn’t that the beauty of measuring welfare via production rather than consumption: you can always make it bigger by breaking stuff 😛