Taking the P out of GDP

Feels good to be out of recession, doesn’t it?   For thosewho kept their jobs, chances are that a smaller pay rise is about as bad as itgot.   Others would have been hit harder, losing their jobs and may be eventheir houses.   Being told by government officials that the recession has endedwill be of small comfort to the second group.   Recessions always create winnersand losers, which is why we have a welfare system to smooth part of theburden.   But at least society as a whole is now getting wealthier again right?

Unfortunately it’s not quite that simple, and economistshave taken the 0.1% growth recorded in the June quarter with a grain of salt.  The main reason for this skepticism is that GDP, the most quoted economicstatistic, has some serious limitations.   These limitations are well understoodby economists, but not often talked about in the wider media.

Headline GDP figures don’t really say anything about howproduction is used or how it is funded.   The current housing bubble demonstratesthat how we fund production is important, and the following example aboutelectricity will demonstrate that how we use production is also important.

Luck (even bad luck) had a lot to do with why New Zealandemerged from recession three months earlier than most people expected.     One ofthe major boosts to GDP during the June quarter was higher electricityproduction, bought on by the unusually cold winter.   Welfare would have beenhigher had the winter been warmer, but instead resources were diverted to heatcolder houses.   The seemingly contradictory result was that this extra activityboosted GDP and we got to officially wave goodbye to the recession.

How production is funded affects the sustainability ofgrowth.   Behind strong GDP growth we may find excessive plundering ofnon-renewable resources, depreciation of a capital stock, or large amounts ofdebt.   The ability of people to borrow against their house to fund theirlifestyle has boosted New Zealand’s GDP in recent years.   If a society borrowsto consume they forgo future consumption plus interest, whereas borrowing toinvest should increase the amount you can consume in the future.   In animpatient society, some level of borrowing for consumption may be optimal.   Butthe boost such borrowing brings to GDP can lull us into a false sense ofsecurity about our ability to pay it back in the future.

Another limitation to GDP is that it can only measure thingsthat the bean counters in Wellington know about.   To take a timely example, anecdotalevidence suggests that more people are taking up edible gardening since therecession hit.   Vegetable gardening comes with many benefits, but nothingproduced at home for one’s own consumption shows up in GDP.   A society in whichthis behavior is common is seen as poorer than a society which works longerhours and buys all their vegetables at the supermarket.

If gardening isn’t your thing then don’t worry; you canstill beat the national accountants by taking up another hobby or simply takingsome extra time off work.   Leisure time is a major consumption good, but it doesn’tshow up in GDP.   After all, leisure has a price just like any other indulgence,the only difference is that you don’t hand over cash but rather give up incomeyou would otherwise have earned.   For some people, working overtime is just notworth the extra cash so they chose more leisure time.   Individual welfare isenhanced by this decision, yet the more people who chose this lifestyle, thelower national GDP.

Any economist will tell you that GDP is a terrible measureof true welfare, and the French have been working hard on an alternative.  Non-GDP related measures of welfare have been tampered with for years bystatistical organizations worldwide.   Moving away from measuring production asa proxy for welfare usually means asking people subjective questions.   There isa famous definition in medicine which states that pain is whatever the patientsays it is, and this approach also seems appropriate for measuring welfare.  But subjective measures have their own limitations, and GDP remains the easiesttool to understand and apply in most economic analysis.

GDP remains the best singular indicator of a society’sability to consume that we have available to us.   But GDP figures can easily bemisused when trying to measure economic progress or the welfare of a society.   Thedeveloped world has just finished off a decade of unprecedented GDP expansionwith a serious economic crisis.   New Zealand should not become so focused on growingGDP that we don’t care where the growth is coming from, and end up walkingheadlong into another crisis.

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