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 Facts & Figures
 
GDP Fetishism
Library Of Economics And Liberty, United States Monday, March 01, 2010


When economics professors teach the basics of Gross Domestic Product (GDP), we usually caution our students that it is not a good measure of welfare. Unfortunately, many economists go on to give GDP far more credit than it deserves, writes David R. Henderson in Library Of Economics And Liberty.

When economics professors teach the basics of Gross Domestic Product (GDP), we usually caution our students that it is not a good measure of welfare. Unfortunately, many economists go on to give GDP far more credit than it deserves. They tend to consider fiscal and monetary policy positive if these policies increase GDP, but they often fail to ask, let alone answer, whether those same policies increase or reduce welfare. I have a term for giving GDP such a sacred a place in economists' reasoning: GDP fetishism.

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To see why GDP is not the same as wellbeing [I use "welfare" and "wellbeing" interchangeably], consider the definition of GDP. One of the most careful definitions is in The Economic Way of Thinking, 10th edition, by Paul Heyne, Peter Boettke, and David Prychitko. They write: "The gross domestic product is the market value of all the final goods produced in the entire country in the course of a year."1 Most economists would agree with this definition. It turns out, though, as Heyne et al. point out, that even this careful definition does not accurately characterize GDP, let alone wellbeing. It is inaccurate in two ways. First, because there is usually no market for the things that government produces (the U.S. Postal Service being one of the exceptions), government spending on goods and services is valued at cost rather than at market prices. Second, because many goods and services are not bought or sold, even though they would have a market value if they were, these goods and services are not counted in GDP. In early editions of his best-selling textbook, Economics, the late Paul Samuelson gave his favorite example of this pitfall in GDP accounting. Samuelson pointed out that if a man married his maid, then, all else equal, GDP would fall.

These two inaccuracies in themselves mean that actual GDP is not a good measure of wellbeing. Take the first inaccuracy—the valuing of government-provided goods and services at cost rather than at market prices. Many government programs actually destroy value rather than create i

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Consider the other inaccuracy that makes our measure of GDP not quite live up to its definition: the failure to value non-market transactions at market prices. Take Samuelson's example of the man marrying his maid. Samuelson's point is that the new bride continues doing the housework without being paid. But that would not mean that the work suddenly had no market value. So, in this case, GDP actually understates the market value of all final goods and services because this particular service is no longer exchanged on the market. Because many valuable goods and services are not exchanged on the market, this inaccuracy imparts a downward bias to measured GDP as a measure of actual GDP.

But even if our measure of GDP actually measured what the definition says it does, there would still be a major problem with GDP as a measure of wellbeing. That problem arises because GDP does not take into account the value of leisure.

To see why this is a problem, consider what would happen if the productivity of an economy magically doubled, so that each person could produce twice as much per hour of work. Consider two extreme responses to this change, although the likely response would be between the extremes. In extreme case one, everyone works half as much and produces the same amount. Real output remains the same and, if the government's price index is accurate, real GDP will be constant. But suddenly people's leisure has increased. People value leisure.

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It became clear to me during two nationwide discussions of economic policy over the last two years that focusing on GDP can lead us astray from sound economic reasoning. The first discussion was of the wisdom of Keynesian fiscal policy—having the federal government spend money to add to GDP. Advocates of such policy often argued that there was a substantial fiscal policy "multiplier."
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Take an extreme case: the government spends $10 billion to pay people to dig holes and then refill them. The result is that the $10 billion produces something worth zero. A

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And, of course, we haven't even mentioned the loss in wellbeing due to two interrelated factors.
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A more-specific recent program, besides the general program of added government spending, illustrates how economists can forget (or ignore) that GDP and wellbeing are not the same. That was the so-called "Cash for Clunkers" program that the federal government ran during the summer of 2009. Under this program, if people owned a car for at least a year, and if that car got fewer than 18 miles per gallon, they could turn in the car as trade toward a new car and get a payment of up to $4,500 from the dealer. The dealer then destroyed the engine to take it out of circulation and then was reimbursed by the government.

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If, instead of seeking GDP, we ask of each government policy, "What will it cost and how much value will it create?" we will come up with better policies. The concept of GDP, handled carefully, can be useful. But for many people, and even many good economists, GDP has been used to judge wellbeing even when using it that way leads to highly misleading conclusions.

 

 

This article was published in the Library Of Economics And Liberty on Monday, March 01, 2010. Please read the original article here.
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Tags- Find more articles on - GDP | government | keynes | multiplier | Paul Samuelson | spending

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