Calculating the GDP

What is wrong with the GDP?  Although it is acknowledged that the GDP is not a perfect measurement tool, many professional economists take the following as a universal truth: a higher level of economic growth as reflected by an increase in the GDP is good for a country.  Therefore, if there are two countries with equal sized economies, the country that experiences a larger annual jump in GDP is clearly doing better.

Taking the time to revisit basic truths is not elementary, but fundamental in any discipline.

Throughout this discussion, I will refer back to previous articles that related the current schism we face as individuals who are both citizens and consumers.  Sometimes what is best for us as consumers erodes civil society and our ability to play meaningful roles in self-government.

I will begin with a source that is pessimistic towards the continuation of capitalism and its role in our society and then compare this source with Joel Kurtzman’s optimistic view of our future in the United States.

Carlos Taibo explains well his objections to how the GDP is measured in the chapter “La Crítica del Orden Existente”.  I will quote some parts of his argument verbatim and then summarize them in English.

“El primero señala que el PIB tiende a privilegiar la actividad económica de las ciudades e a rebajar, en cambio, la del medio rural.  En las ciudades casi todo lo que se consume procede de fuera y acrecienta, de resultas, el producto interior bruto; no sucede así, en cambio, en el campo.  Las ciudades propician, por añadidura, el transporte de larga distancia, favorecen los intercambios comerciales y estimulan el consumo material, por mucho que sea verdad, también, que permiten economizar en materia de calefacción y, en lo que respecta a los desplazamientos cortos, de energía.  El segundo rasgo sugiere que nos hallamos ante un indicador manifiestamente masculino: fue ideado por varones, en el decenio de 1930 se vinculó estrechamente con el designio de movilizar recursos para la guerra y, en fin, aunque contabiliza los bienes generados por las economías domésticas, no hace otro tanto, en cambio, con los servicios, generados fundamentalmente por mujeres.  El tercer lugar, y último, rasgo anunciado obliga a anotar una realidad bien conocida, el PIB no mide en modo alguno unas desigualdades que en los hechos procura ocultar, circunstancia singularmente gravosa que se une a su incapacidad para dar cuenta, en paralelo, de la calidad de vida y de la sostenibilidad” (p. 31-32).

Here Taibo discusses how economic activity favors the city over towns and rural areas.  This encapsulates the idea that the cities buy inputs from the country and produce goods and services by first acquiring debt.  This is in contrast with the economic activity of towns and rural areas, some of which is never calculated by the GDP.  In these areas, social ties are stronger and, efficient or not, goods and services can be bartered or gifted, and as a result.  This means that these goods and services are never directly exchanged for a monetary value.  Likewise, a home can produce food for its own consumption.  Auto consumption is not calculated in the GDP and can even be considered “inefficient” since these individuals are not specializing in one type of economic activity (salesperson, farmer, banker, etc.).   Concerns about local or national food security are not given a value.

The second reason for doubting the GDP returns to its origins as a measurement tool.  In the 1930s, the growing reality of “total war” forced governments to take greater interest in their accounting systems.  Since all resources would have to be used in fighting a sustained conflict, preference was given to those activities that produced goods and services that could be directed towards a war effort.  Refer to this blog article by the Economist titled “How Countries Calculate their GDP”.

Taibo’s third major issue with GDP as a measurement is that it does not consider negative externalities of “productive” activities.  Pollution, illnesses, unhappiness, etc. are not subtracted from the benefits of economic production.

This conversation is continued with more specific examples.

Una de las discusiones mayores que rodea a índices como el PIB es la relativa a en qué medida retratan de manera convincente el grado de felicidad que se revela en una sociedad.   Parece demostrado que el bienestar depende en un grado u otro de factores varios que guardan una relación innegable, pero no lineal, con el crecimiento económico.  Esa relación se va desvaneciendo, como veremos, cuando los niveles de riqueza son cada vez más altos.  Estoy pensando en factores como el respeto del medio natural, las condiciones de vida y de trabajo, la igualdad o la calidad del sistema educativo… (segundo hay ejemplos de todo citado encima)… Hemos asistido en los últimos decenios, por lo demás, al llamativo despegue de dolencias como la depresión, los trastornos bipolares y la esquizofrenia” (p. 34-35).

Essentially happiness and health are not directly associated or correlated (depending on if these terms take on qualitative on quantitative values) with economic growth.  Countries with GDPs far inferior to ours have achieved similar or better results when observing a variety of factors such as “happiness”, access to quality education, healthcare, environmental conservation, etc.

Finally, I will include Tiabo’s thoughts about consumption and its effect on us.

“Las cosas como fueren, a los ojos de muchos ya no somos trabajadores.  Ni siquera ciudadanos.  Somos meros consumidores y usuarios.  Para qué preguntarse por qué hay que comprar y qué necesidad tenemos de lo que adquirimos.  Y para qué preguntarse por qué hay tantas gentes que no pueden comprar nada.  Vivimos en una sociedad caracterizada al tiempo por la ilimitada persecución de la satisfacción de deseos e por una inagotable insaciabilidad, por el deseo permanente y por la frustración no menos permanente.  La generación artificial de necesidades provoca que nunca estemos satisfechos, y ello afecta tanto a los más ricos, que quieren resaltar sus marcas como tales, como a los más pobres, que desean imitar a los pudientes.  ’El mecanismo principal de crecimiento estriba en esta huida hacia delante, generalizada, que estimula una desigualdad deliberadamente mantenida’ escribió André Gorz.”

Here as we experience economic growth, as measured by the GDP, we never achieve an economic equilibrium, but rather permeate in disequilibrium.  This inability to reach an equilibrium is deliberate and perpetuates the continuous desire to consume.  As we forfeit our ties in civil society and our roles as “citizens”, we are transformed into simple consumers and users.  Although this may increase economic growth, we lose something in the process that ends up prejudicing the “success” we achieve.


 

Next I will review and dispute a few of the ideas offered by Kurtzman in his book Unleashing the Second American Century: Four Forces for Economic Dominance.  His thesis is that the the following four forces for economic growth will drive another renaissance of American growth (our time is not over):

  •  creativity,
  • the exploitation of new and existing energy sources within North America,
  • the second advent of manufacturing, and
  • abundant capital

Kurtzman reminds us that most of the projections for the United States’ GDP growth do not include the possibility that we could become energy independent or even a net exporter of energy.  He describes the research facility green shoots and the excess of capital that is waiting to be reinvested.  Kurtzman also reminds us that the United States does produce things, even though most of these items go unnoticed by the average American.  The items we produce here are goods that not all of us use or buy often.  Lastly, and what intrigues me most, is his description of the new American factory that will return to the United States.  This factory will be automated and use intelligent robotics, some of which will be autonomous.

Currently I am finishing an audio version of this book.  Therefore, it is difficult to cite with precision the exact page number where certain issues are mentioned.  I also thoroughly enjoyed this book, but I do have my reservations.  My disagreements come from the perspective of a 25-year old male (me).

My first reservation is the notion that citizens have been “sitting on their cash”.  I think this should have been analyzed in accordance with age cohort and socioeconomic class.  I can assure older generations that my age cohort, however you define it, does not have a supply of  M1 or M2 available.  We are basically a generation who was sold on the ideal of further education without fully internalizing what this sacrifice would mean after graduation.  Any consumerism that occurs from our age cohort will be purely out of necessity unless it is fueled by further debt.

Personal debt may be wiped clean, but student loans are an important exception.  As of 2013, household debt (minimum debt payments) to income payments might be 10.3%, but this is still significant.  This lumps all personal debt together, without fully understanding the impact and the effects of personal debt on my generation.  After all, it is my generation who buys new houses, cars, raise families, and is generally responsible for making all of the fundamental purchases as dictated by consumerism.  Older generations also make purchases, but they also have higher investment rates and savings.  To see the velocity of money increase and to reach (an accurately calculated) full-employment, our personal debt must also be reduced.

Our generational debt also dampers our ability to assume more risk.  Young Americans may have innovative ideas, but we lack the capital to put them into practice.  These are important issues that were not considered in depth.

The debt argument centers around the notion that debt is more or less held constant while income is variable.  Increased productivity will grow the economic pie and GDP and it will make our debt decrease in relative terms.  This might be true if debt purchases do not increase in the interim period and given that interest rates are fixed for all the loans currently used to fund further education.  The solution offered by the book was “increase the GDP really quick and the debt will disappear”.

This is a great idea in theory, but it forces the younger generation to pursue activities that are purely lucrative.  We will drive economic output and increase the GDP, but we will give less thought to activities that do not have such a short-sighted objective.  Volunteering, donating, or spending time with family members does not directly increase the GDP.  We may be indirectly helping others succeed, but this is not guaranteed, nor accounted for, in the GDP.  We might want to wake up an hour early every day to collect trash from the beach.  This helps the environment and makes the shore more aesthetically pleasing for others.  Unfortunately, this does not directly generate economic output and is deemed “unproductive” or an “inefficient” use of time.  Lastly, spending time with one’s parents or grandparents might also be nice, but it does not grow the GDP.  In economic terms, it is better if these family members hire home care services than to spend time with you.  The former puts more money into the economy, the later hinders your ability to produce.  No serious consideration is given to the implications these choices have on the people who contribute to the GDP.  Eventually the economic output of today may be reversed by the mounting negative externalities from these actions tomorrow.

A final thought about debt is how the author puts it all into a larger perspective.  Our comprehension of debt is based on acquired learning hundreds of years ago.  When annual productivity was stagnant, debt was more dangerous.  It was nearly impossible to recover from a failure since you could not produce much more than you did the year before.  I agree, but all things are relative as well.  If levels of depth grow at the same speed as improvements in real productivity, the status quo does not change and debt remains constricting.

One of the reasons for the return of manufacturing plants is that American workers have benefit from higher endowments that make them more productive.  This productivity combined with cheaper transportation costs, outsets the initial value of producing a good with lower labor costs.  The installation of highly technical plants will require an educated workforce to operate them.

As factories return, it will be a net gain for the United States.  Previously these industries outsourced their production facilities and extended their supply chains throughout other parts of the world.  It will also be easier for us to absorb the creative destruction that occurs as simple input roles are replaced by autonomous robots.  The robotization will initially displace foreign workers outside of the U.S. borders.  The United States will have the available private capital to invest in this robotization of the manufacturing industry while other countries may not.

One of Kurtzman’s most powerful arguments is also one that has been permeating the headlines ever since the oil boom in North Dakota.  By some it is projected that North America has a large enough supply of natural gas and oil to become self-sufficient, or even a net exporter.  Natural gas also currently costs half the price of oil.  The production of either would increase consumer purchasing power both directly (at the gas station, on the heating bill, etc.) and indirectly by cost decreases in transportation and inputs (the cost of food, clothing, plastics, etc.).

However, investments in converting car engines and service stations to natural gas will need to be large.  It would also be important that even though fuel becomes cheaper, that the government or automobile makers implement more rigorous mile-per-gallon standards.  The increased production of bio-fuels might be good for the economy, but it is still damaging to the environment.  The environment is a public good that does not have an economic vote.  It is also a good that does not add to the GDP, so its importance is marginalized.

One of the easiest and most practical ways to reduce our debt would be to force other countries to protect their own oil sources and supply chains.  Kurtzman references Roger J. Stern’s work “United States’ cost of military force projection in the Persian Gulf 1976-2007”.  As other countries free ride on our military forces keeping open the strait of Hormuz, the American taxpayer pays the bill.

He criticizes our relationship with countries that do not share our democratic ideals.  Even though this may be true, not enough consideration is given to our relationship with Saudi Arabia.  At any moment, Saudi Arabia could stop selling its oil denominated in dollars with third parties.  This is one of the reasons why the U.S. dollar retains its value.  If our currency experiences a sharp devaluation, the $400 billion dollars in private capital reserves will have a far less impact on reinvesting into the U.S. economy.


 

At first thought, a work of Melitz and Redding might not seem to belong in this post.  After all the initial intent of this article was an attempt to highlight how current calculations of the GDP are taken “as is”, or rather, without criticism.  Other conceptions of welfare or success are marginalized to those that produce immediate and direct economic output, regardless of the associated negative externalities.

If I have time, I hope to revisit this paper in a future article.  For now, I simply want to point to a very specific part of their proof in the section titled “2.2 Open Economy Heterogeneous Firm Model”.  Proof (16) equates “open economy welfare” as “the mass of varieties available for consumption” and “the weighted average productivity of these varieties”.

 

Melitz & Redding variable definitions

 

The issue now is not how to define productivity, but rather the implication of the term “welfare”.  Sure the open and closed models may have different welfare implications with increases and reductions of trade costs dependent on the model being open or closed.

The problem is how welfare is defined.  If welfare is reduced to meaning “the mass of varieties available for consumption”, all other considerations are left unaccounted.  Is the welfare for the American citizen also improved, or we only benefit as consumers?  Does the improved welfare of today booster the GDP, but later cause environmental degradation and medical issues for those who live there?  If so, this welfare or happiness measurement is short-sited.

To be fair, this paper was never designed with this very specific purpose in mind.  The goal is to see how firms respond to trade liberalization under different model types.  The point I am making is that in the new century it is important to give value to those things that benefit us as people and citizens that are worthless in GDP calculations.

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One response to “Calculating the GDP

  1. Pingback: Continuing Education | peterabraldes

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