Opinion & Commentary
GDP no real guide to wealth or welfare
After the tsunami slammed the Japanese coast, economists were scrambling to update their forecasts for Japan’s GDP. A major investment bank cut its 2011 growth rate from 1.5% to 1.4%, but ratcheted up its 2012 forecast from 2.1% to 2.5%.
If that forecast turns out to be correct, by 2012 Japan’s economy will be ‘bigger’ than it would have been without the disaster. Sure, the tsunami would retard factory output in the short-term owing to power shortages and crippled infrastructure, but vast rebuilding efforts would stimulate demand for machines and workers, wrenching Japan from its economic slump.
Australia’s floods and New Zealand’s earthquake have prompted similar arguments. “Natural disasters can spur growth”, said a headline in The Australian on 24 March.
If disasters like these spur the economy, why not have a more systematic program of destruction, without the human cost? One day each year could be set aside for economic stimulation – say GDP Day. With citizens out of harm’s way, local governments could carefully blow up a bridge or flatten a building. In keeping with the spirit of Earth Hour, families could break a household appliance.
GDP day would create jobs, bolster construction, and promote retail sales. Economic benefits seemingly abound.
Clearly this is ridiculous. Yet attributing economic silver linings to disasters like tsunamis and earthquakes is no less so.
The confusion about what makes a country prosper arises from our fixation with GDP, which is a misleading metric of economic performance that no entity would pay to calculate itself.
GDP is the estimated total value of final expenditures in a given period. It is ‘gross’ because it takes no account of depreciation of machines and infrastructure. If a country suddenly loses $200 billion worth of public goods in a day or two, as the Japanese painfully have, GDP is not reduced.
This loss of wealth is ignored. But the cost of reconstruction boosts GDP.
Moreover, because GDP adds up the values of expenditures without considering their rationale, it encourages belief in the broken window fallacy – that destruction of goods can stimulate commerce.
As Frederic Bastiat pointed out in the mid 19th century, smashed windows might be good news for glaziers, but they are bad news for the window’s owner and everyone else. The owner could have spent his money on a new suit, invested the money in his own businesses, or put it in a bank for another business to use. The owner’s preferred use of his money never eventuates; the suit maker never realises his loss. Likewise, businesses in Japan, Australia and New Zealand that benefit from reconstruction are absorbing funds that would have been directed elsewhere.
Followers of GDP are often considered to be hard-headed free-marketeers, derisive of soppy ‘happiness indices’ and the like. Yet ‘the national accounts’, from which GDP is calculated, were developed to facilitate government control of the economy.
The world wars, the growing welfare state and the arrival of Keynesian economics massively expanded the size and scope of government in the early to mid 20th century. Governments craved a statistical dashboard that they believed would enable them to ‘manage’ and monitor their economies. The system of national accounts emerged in the United States in the 1930s to assist the Roosevelt administration administer the New Deal.
The intellectual justification for government intervention in the economy waned in the 1980s, but the system of national accounts has thrived as a source for economic commentators.
Perhaps its popularity should be no surprise. GDP provides a ‘free’, quick and simplistic summary of economic performance, notwithstanding the warning of Nobel Prize winner Simon Kuznets, one of the developers of national accounting, that national welfare could “scarcely be inferred from” GDP. Moreover, thousands of bureaucrats, academic researchers and economists rely on the publication and attraction of GDP to sustain their jobs.
GDP is not only causing smart people to misdiagnose the economic impact of disasters and fanning fallacies. It has become so entrenched as barometer of ‘growth’ that policy is being judged not by its effect on prosperity but its ability to boost GDP.
Take the Australian government’s Building the Education Revolution programme of 2009. This entailed borrowing about $16 billion at about 5.5% interest per annum and building school halls no-one had asked for in a short space of time. Clearly, this was a wasteful use of money that will have questionable educational dividend. However, a flurry of activity in the construction sector increased GDP when other expenditures were thought to be flagging. Australia therefore avoided a ‘recession’ – a state determined solely by what GDP does over a six month interval.
In Germany and the United States, ‘cash for clunkers’ programmes have overseen the destruction of millions of cars in order that their bought replacements will boost GDP.
Debates about a carbon tax and emissions trading scheme are being couched around the impact on GDP, even though the very point of a carbon tax or ETS is to reduce the value of expenditures that encourage use of carbon!
The spate of Asia-Pacific disasters has undermined the credibility of GDP a measure of economic performance. However, we should not replace one set of overblown statistics with another. Frequent calls to replace GDP with some ‘happiness index’ should be ignored. We do not want a statistic that provokes emotional stimulus packages; the fiscal variety are enough already! To paraphrase British economist Charles Goodhart, when a statistic becomes a target it ceases to become a measure.
Adam Creighton is a research fellow at The Centre for Independent Studies.
