When it comes to economics the one single issue that seems to get everyone in a room in agreement is that GDP is trash. Here is a transcript from a typical conversation between me and an individual who hears I’m an economist:
Individual: “You are an economist! You must agree that GDP is crap.”
Nolan: “Ahh well, ummm, what question are you asking?”
Individual: “What, it is just crap though, you must agree that it is rubbish”
Nolan: “Well it depends on your question, why are we measur …”
Individual: “Come on, it is just rubbish, everyone agrees it is rubbish. I mean we care about so many other things”
Nolan: “Ahh so your question is about what we should value. Ok yeah it doesn’t measure all social value but …”
Individual: “Yeah, it’s rubbish, exactly”
I don’t have enough fingers and toes to count the number of times I’ve had this conversation – but in truth GDP is really good at measuring what it is supposed to measure … the problem is that people keep using it as a measure of something else.
But it is hardly the individual’s fault that they have come to this conclusion. Decades of GDP fetishisation by policy makers combined with economists who spend more time talking about (and in the extreme teaching) the shortcomings of GDP than actually teaching what GDP is supposed to measure has provided this great rule of thumb that people follow to understand what is going on.
So in this post let me do something novel – let me stand up for GDP.
What is GDP
Say that you were sitting around doing your nails and the government suddenly contacted you. They said “Dear TVHE reader, we really want to know the aggregate final production of goods and services that is taking place in the nation, can you help us”.
As you are the type of person who reads this blog, you are also the type of person that would know how to answer that question – you would tell them to go onto that statistics agency website and download the latest GDP data.
GDP is a measure of the market value of production in final goods and services that takes place in a period of time.
Ok, why are we using market value – is it some type of conspiracy? No. We use market value as a way of aggregating things that are otherwise incomparable – when thinking about production it is pretty hard to add up a chair and a haircut. By using the market price we are also incorporating the idea of the full set of resources used to construct it – if factor prices do not change, then this price tells us how much of one good could be translated into another. Of course, factor prices do change if we change relative demands so this isn’t a thought experiment we should push too far in any case.
Why do we care then? You know that circular flow we are all taught in stage one economics, the one that people keep making fun of saying we need to “include an ecosystem” or “include the value of social connections” or “make it into a doughnut”, it is those FLOWS that GDP is measuring.
I’m not saying that including other things is bad – they’re cool especially when there are feedbacks between these systems. Such modelling is completely legitimate (although lets note that it also requires measurement, not just pictures). What I am saying is that GDP is an aggregate that describes a very specific system. It measures that very specific flow, as it was that flow at a point in time that Kuznets was aiming to measure. As in the circular flow, GDP is measuring the monetary flow associated with the real flow of the production of goods and services (expenditure GDP) or the monetary flow associated with the real flow of factors of production used to make goods and services (income GDP) – in so far as we care about measuring this flow, and a question that deals with this flow in isolation, it is a brilliant measure!
Now if you are about to launch into a discussion of the fact that Kuznets was discussing National Income and that GNP was the original measure not GDP that is all good [great posts on it here and here] – I don’t disagree, and in a country like New Zealand the differences between these measures matter when truly considering access to resources, hence why trends in GNDI are what are often recommended by NZ economists. But these measures are all looking for the same core set of concepts – the market value of production (by national borders or national citizens) for a given nation – it is just that GDP does it most directly for the production flow.
What is it (GDP) good for?
Well GDP is good at measuring that flow we just talked about – or measuring the market value of production within national borders at a point in time. Why would we care about this measure?
- If we have a way of working out aggregate production we have an idea of how much stuff there is – if we were say, fighting a war, the countries capability to produce is something of interest.
- If we have a measure of aggregate production that abruptly changes it tells us that something funky might be going on – such as a Great Depression.
- If we have a measure of aggregate production we can try to figure out why it differs between nations, and how policies we introduce change it. This allows us to work out trade-offs that may exist for policy aims between the amount of output produced and other measured aggregates (unemployment, average water quality, life expectancy, average skirt length).
- Very importantly, if we want to discuss flows of money and monetary policy Nominal GDP is measuring exactly this flow in the circular flow diagram … which is fundamentally a model for monetary policy!
GDP is surprisingly nifty for these things … as long as we don’t always start with the unconditional prior “more GDPs are good”. We need to ask “what is the trade-off that creates this GDP”. Furthermore, even if no other observed variables change when GDP goes up this still doesn’t imply rising GDP is good (note no observed changes, so higher GDP implies higher income for everyone) as it may be the result of unmeasured non-market activities being measured (eg illegal drug sales, raising of children) or market activities with an unmeasured negative externality.
So just enjoy it for what it is!
What about those shortcomings!
We can split the short comings in two – the shortcomings for measuring what it is supposed to, and the shortcomings associated with being a measure of “progress” or “wellbeing”.
As a measure of production aggregation is problematic. If a table is $50 and a TV is $200 our nation is unlikely to be able to say “I will stop building 40,000 tables to build 10,000 TVs”. However, it offers the best way I can think of to aggregate output at a point in time.
Furthermore, unmeasured output and externalities are missed. This is mostly problematic when we want to compare over time and the coverage of GDP or social environment has changed. For example the rise of the second earner has seen more household services provided by the market sector, increasing GDP although no more is really being produced. However, if we want to talk about it in terms of “consumption value” the externality issue becomes key.
Now what happens when we try to talk about GDP in terms of wellbeing. Ummm well GDP measures the flow of production created in national borders. If we were a factory owner that would be fairly useful, but also limited – but we are an entire nation in this discussion!
If we make more things then this is an intermediate target towards some true goal – life satisfaction. Now economists tend to frame all of these as “consumption opportunities”, but we aren’t talking about consuming more physical things per se – it is all different ways of an individual spending their limited time that give them satisfaction. This is complex both philosophically (what is wellbeing), practically (how do we influence wellbeing), and in terms of measurement (how do we measure wellbeing – pro-tip we can’t directly) so we use these intermediate values as heuristics for some underlying whole.
People want some set of consumption opportunities, and they always do want more (non-satiation). However, the value they receive depends on what others have, what they have, and it is far from just measured in terms of GDP – especially when things like community spirit are part of this consumption!
GDP measures a sub set of the consumption opportunities of individuals – yes more GDP with no change in other opportunities is great, I would appreciate a world where I had a better can opener or another pair of socks. But this alone is so far from the final set of consumption opportunities that greet me on a daily basis with all my choices (“if I do this how will it influence my relationship with my boss”, “should I go to this party to engage with this group, or stay home and spend mental health time with my toy dog”) for me to view it as a sole measure of wellbeing!
Note: This isn’t me accepting that policy “should” target some mythical goal of well-being … we are going to get back to this in the future, as there is a lot of ground to cover before we can get there.
We need wellbeing measures damnit!
Now there is your issue – you want an aggregate to tell you the world is getting better. The world is more complicated than that, with the way we value things that are not clearly comparable the biggest issue (eg comparing the wage in your job to the value of a second blanket on a hospital bed).
Yes, economists can lean towards markets to provide this information (given the way people make choices when facing trade-offs). But even this preference doesn’t lead to economists saying GDP, as a measure of market activity, measures anything like well-being.
The fact GDP doesn’t do this isn’t GDP’s fault – it is your fault for asking it to do this! It is policy analysts and politicians fault for focusing on the lazy way of describing progress. It is the public’s fault for not educating themselves on these measures. I realise people including myself have an incentive to avoid thinking, but that isn’t an excuse for it.
Honestly, if people want to describe what is going on and how it fits their own value system they have to do a lot of work – no-one can add it all up for you as only you know your values!!
Take the World Economic Forum, an organisation packed with economists who are infinitely smarter and more successful than I’ll ever be:
Is our love-affair with GDP coming to an end? As the business landscape reinvents itself, demographics shift, inequality expands, climate change gets worse and technology continues to advance at breakneck speed, Gross Domestic Product is struggling to stay relevant. In order to keep up with the changes wrought by the Fourth Industrial Revolution, many are arguing that we need to find a new measure to assess the health of our economies and – more importantly – the people living in them.
This is followed by the selection of five “indicators” which are, somehow, supposed to give an “alternative”.
Can no-one else see how utterly incoherent this framework is. GDP is a single measure of a single thing. Values are complicated. As a result, our solution is to pick random things that we can add up (let’s not pretend that they aren’t hinting we just add the five measures together with equal weights in that post – not saying it directly doesn’t change hinting it hard) so we feel like we have a measure of a complicated issue …
If you want to work out whether society is “progressing” you have to do work with value judgments. If you want to answer a smaller question you have to do the same.
Look it is about policy, we use GDP to tell if policies are good now and we shouldn’t
Hey ok, that is a good way of reframing the debate. So you are admitting GDP is fine, but it has excessive importance when we have policy debates as other things we value are not measured as well or as publicly.
Wait a second, what happens if we do measure those other things well and just describe the trade-offs when faced with an actual policy question?
Wait another second, what do these alternative measures we want to replace GDP with actually measure? A dashboard of incomparable statistics doesn’t measure anything let alone tell us anything?! We need a policy question and a way of describing trade-offs between outcomes!
Wait a third of these seconds, I don’t actually think I hear real life people talk about the consequences of policies on GDP or funky looking aggregate measures that much during an election – they will talk about take home incomes, often keeping GDP fixed. They will talk about investment in health and education because we see those as things we desire. They talk about jobs because people want to have the opportunity to work.
I find when I talk to non-economists/non-policy people they articulate their values in terms of these consequences, income, jobs, quality of life – and policy arguments based on those outcomes matter. They are interested in the distribution of outcomes, winners and losers, and they want quick ways for this information to be articulated. They realise not everything they care about can be cleanly quantified, and demand to be told about things they care about that we cannot measure as well.
Given this it isn’t clear that GDP is the issue, but instead people who aren’t able to persuade the public to agree with what they want have decided they need to create esoteric measures of “wellbeing” to convince others to agree with them 😉
I love the idea of measuring things better and giving more information by doing so. I love the idea that the public looks at more than just one measure to understand the society and economy around them. But GDP is actually one of the measures that fits within this concept, when many of the arbitrary aggregates being create to “replace it” – which don’t clearly measure anything – don’t.
In truth asking if we have “progressed” is subjective to the point where telling people we have measured it with an aggregate is misleading/misinformation. If someone has a question about specific policy aims (is there less crime, are we wealthier, what is happening with social activities) we should be able to pull together measures to give them an idea of that outcome – and that’s that.
Ramming together a measure to tell people if “the world is better” at a single viewing isn’t helpful – it is merely making a series of hidden value statements and telling people “believe them, it is data”. If you think that is persuasive, useful for the public, and useful for good policy making then I must say that I am far from convinced of your position so comment below 😉
Before you get angry at me
First off you may be frustrated by the way GDP has been used and obsessed with my policy makers and politicians. And you know what, hell yea I agree with you completely here – the “moar GDP” justification for policy always wound me up too! But I’m saying that maybe there is a lesson that single measures of progress are inherently flawed, and that we have a measure for a specific question – rather than this being a suggestion that GDP is rubbish and we just need some new measure to save the world.
You may have an alternative measure that you believe fairly represents a different question, say about social progress. Or a dashboard that you think articulates the varying outcomes society values clearly without imposing unnecessary value judgments on them. If that is the case link it below and make a little case for it in comments – as that sounds really cool and I’d love to learn about it.
I was just making an argument for GDP and for current data against the idea of an arbitrary dashboard such as that used by WEF – I have no doubt there are much better efforts out there that articulate important information clearly. I am open to your persuasion 🙂