Why Measure GDP?

EconoSpeak writes,

The questions we need to ask are: What do we really want to know and why? What purposes were we pursuing when we sought to measure economic activity? Is measuring GDP helping to achieve those purposes? Are those purposes still our priorities? If not, what should be? What different institutions might we invent to achieve our purposes as we NOW understand them?

Pointer fromMark Thoma, whose column stimulated the post quoted above.

Some possible reasons to measure GDP:

1. To provide an indicator of the economy’s capacity to produce the goods needed to win a war (including necessary consumer goods as well as arms).

2. To provide a measure of the economy’s ability to provide for consumer welfare.

3. To compare productivity across countries and over time.

4. To indicate the extent to which an economy is in a recession.

5. To measure economic activity at market prices.

I think that (1) would have been most useful around the time of World War II, when the outcome was very much affected by this sort of productive capacity. It probably is less useful today.

I think that (2) is a very interesting measure. But (a) why not just focus on goods and services consumed? (b) you need to think a lot harder about how to measure consumers’ surplus (c) you have to think a lot harder about how to measure the consumption services from durable goods, particularly housing (d) you need to think a lot harder about what Thoma refers to as “bads,” like pollution.

I think that (3) is useful, but stop pretending that you can be accurate to at least two significant figures. When someone says that productivity growth changed from X over a five-year period to Y over the subsequent five-year period, their view of the signal-to-noise ratio in the data is much more optimistic than mine.

I think that (4) relies too much on the AS-AD framework, to which I do not subscribe.

I think that (5) is useful, but our current approach is wrong. Most government services are not sold at market prices, and so I would exclude them from this sort of measure.

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15 Responses to Why Measure GDP?

  1. Adam says:

    It’s useful to remember that GDP and other national income accounting metrics were originally constructed in order to give governments a reasonable estimate of the resources available to bolster their war-making capabilities.

    • Sandwichman says:

      Paul Samuelson, in “Evaluation of Real National Income,”1950 presented a rationale that is the mirror image of that purpose:

      “Production possibilities as such have no normative connotations. We are interested in them for the light they throw on utility-possibilities. This is why economists have wanted to include such wasteful output as war goods in their calculations of national product; presumably they serve as some kind of an index of the useful things that might be produced in better times.”

  2. Scott Gustafson says:

    I think that 2 is correct, but we must realize that GDP is merely a proxy for household well being. 2 leads to 3 since we would like to know which policies increase well being over time. I agree with your point on time frame and accuracy.

    In regards to 4, it seems to me that what really matters is employment and GDP is secondary. We may need a new definition of a recession. The NBER folks have moved in this direction.

    1 and 5 look the same to me although they differ slightly in focus. I agree that we make a measurement error when we value government expenditures at cost rather than market value.

  3. cfh says:

    GDP is an index, not a measurement. Like the DJIA, it is a summation of arbitrary and disparate parts. Space, time, and mass are things we can measure. They have number-like traits: two feet are twice as long as one foot.
    Two GDP is “more” than one GDP only in a quite non-eudoxean sense. Unfortunately, this basic conceptual error (called “rigor” by economists) of treating indices like measurements, is necessary for the construction of models, so I don’t see it going away soon.

  4. Roger Sweeny says:

    6. To know how much governments can tax.

    • Sandwichman says:

      Mainly.

      Although including all government expenditures in GDP (a.k.a. double counting in many cases) gives an inflated index of how much government can tax.

    • Thiago Ribeiro says:

      We alreadly had profits, income, expenses, imports, savings, all the categories government needs to tax people.

      • Sandwichman says:

        Aggregating all that information into a single number is about being able to assess the limits of expanding taxation. One might expect that small government conservatives would be very suspicious of the intentions behind national income accounting. Instead we see the legacy of Laffer curve sophism — tax rate cutting as a disingenuous proposal to “increase revenues.”

  5. Devin Helton says:

    For 1) it would make much more sense to measure this by simply looking at the raw output of the goods you would need, or goods that proxy for what you would need (for example, cars might proxy for humvees, since factories can be converted to produce the latter). It is completely absurd to measure this via a GDP statistic that includes hedonics, includes the service economy, etc.

    2) This seems to be what “Real” GDP actually purports to do. But the methodology is hopelessly flawed. There are a thousand subjective judgements embedded into translating dollars and cents into “well-being”, and thus the process is ends up just reflecting whatever the statisticians feel is the right answer.

    3) NGDP adjusted for exchange rate can do a passable job at this. It is not perfect, since it can be impacted by natural resource demand and capital inflows. Also, exchange rates can be propped up by limiting imports.

    4) Recessions are fundamentally a phenomena of utilization. If a cities economic output declines because an earthquake wipes out a bunch of factories, that is not a recession. Thus, they should be measured by utilization. Use numbers like the unemployment rate, percent of hotel rooms being booked, factory utilization rates, etc.

    5) It would seem better to do this using total taxable income, since the IRS already has an interest in getting these calculations accurate.

  6. Andrew' says:

    I get suspicious now that people are suggesting we reduce our interest in GDP now that GDP is going to stagnate.

  7. Kevin Dick says:

    It would be interesting to see to what extent the free market would provide a substitute for the GDP as an index if the government stopped tracking it.

    This brings up another possibility for GDP that is somewhat related to (4) and (5)–as an input into individual and consumer economic planning.

    I imagine the market could probably find a more optimal index (or array of indices) given the chance.

  8. Sandwichman says:

    Rates of Growth
    Henry Hazlitt.
    August 25, 1958

    Is it true, as we are now so frequently told, that Communist Russia’s economic “rate of growth” is faster than ours, or that we cannot survive unless we increase our own “rate of growth”? There are at least five main reasons why rate-of-growth comparisons are untrustworthy.

    1—In the midst of daily glib comparisons of national income and particularly “gross national product,” or GNP, it may come as a shock to many to learn that these figures are in large part arbitrary. It is impossible to compare the national income of Russia with that of the U.S. We do not know whether the Communists are telling the truth about specific output figures. Even if they were, their figures would have little comparative meaning. They have no true market prices, but only arbitrary government prices and wages. The production of specific goods is not determined by consumer demand. The comparative purchasing power of the inconvertible paper ruble and the U.S. dollar can only be guessed at.

    2—It would take a book to describe all the arbitrary judgments and guesses that enter into even our own national income figures. They measure only the values that pass through the market. When a man marries his cook, for example, the money value of her services disappears from the national-income accounts. Inflation constantly changes the value of the dollar in terms of which everything else is measured.

    The President’s last annual Economic Report boasted in its opening paragraph that the nation’s output of goods and services in 1957 totaled $434 billion, “5 percent larger than in the preceding year.” Only later in the report were we explicitly told that “four-fifths of this increase was accounted for by rising prices,” and that therefore “in physical terms, the increase was only about 1 percent.” This July, however, all national income estimates were revised again. It seems the government statisticians now think our GNP in 1957 was not $434 billion but $440 billion and that our 1956 GNP was not $415 billion but $419 billion. Yet in “1957 prices” our 1956 GNP was $435 billion.

    3—It may be thought that we can make meaningful comparisons between the Russian economy and our such as pure metals in ingot form, this may be possible. But in most things there are enormous qualitative differences that never get into quantitative statistics. Not how much clothing but what kind of clothing; not how many square feet of housing but what kind of housing; not how much food in bulk but in nutrition, variety, flavor, and quality is what counts for economic welfare. Even in military weapons, quality may be the decisive factor.

    4—Prof. G. Warren Nutter has pointed out that there is “a long-run tendency . . . for the industrial growth rates to slow down, or retard, as the level of production gets higher.” There are several basic explanations of this. One has to do with a trick of percentage figures. Another has to do with a physical satiety point in human needs. If only one family in a country has a bathtub, and the next year 50 families get one, the rate of growth is 5,000 percent. But when everybody has a bathtub net growth stops. This principle applies to houses, automobiles, radios, television sets, and so on.

    5—Here we come to a more subtle point. Larger crops often have a smaller total dollar value than smaller crops. (Hence crop-restriction schemes.) But this merely illustrates a wider principle. Economists have pointed out since the time of Adam Smith that it is not “value-in-use,” but scarcity, that determines “value-in-exchange,” or money price. Water is an indispensable commodity that ordinarily commands no price at all. If more and more things became plentiful (except dollars), the national income, as measured in dollars, might begin to fall. If we could imagine a situation in which everything we could wish for was in as adequate supply as air and water, we might have no (monetary) national income at all!

    Let’s stop making a fetish of national income statistics and percentage rates of growth.

  9. Jack PQ says:

    I think there is a key one missing: GDP measures market economics, not home economics (broadly defined). This is a feature, not a bug, because comparative advantage tells us we become more prosperous through specialization and trade, i.e., markets. So we want a measure that focuses on that, and not on work we do for ourselves, even if useful.

    Another, speculative way to put it: non-market work is like zero-Net Present Value projects. They precisely break even. Market transactions can have positive or negative NPV. We hope they are mostly positive, and then the country becomes more prosperous. When they are mainly negative, we have recessions. I think this is consistent with Dr. Kling’s PSST.

    • Sandwichman says:

      Are you saying that something is a feature, not a bug because in complies with your theoretical preconceptions?

      Don’t you need more empirical support for the proposition that market provision of goods and services is always superior to direct household provision? Does this principle apply to child care, socialization, meals, intimate relations?

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