One of the Key Errors with GDP as a Measure of Economic Health

Great article highlights the problem with GDP in an easily digestible way. I think misunderstanding and misuse of GDP as a measure of economic health is a major cause of wasteful stimulus spending; basically the concept that any activity is good activity. It also, I think, makes people fear recessions more than they should. Maybe sometimes we should just let GDP contract, if it actually means that the economy is just burning off wasteful activities, rather than supporting value-destructive activities and actually promoting more destructive economic activity via government sponsored easy money.

Anyhow, the following sums up one of the key errors with GDP quite nicely. Remember GDP measures activity, not necessarily long term value-producing activity.

Whichever approach is taken, the key point is that the measure is made of activity, and therein lies the problem. A whole host of factors might determine activity, but they offer no indication of the health of an economy.

For example, if we look back to the devastation of Hurricane Katrina, there was a massive programme of rebuilding following the destruction of so much infrastructure. The infrastructure that was destroyed represented an accumulation of investments being destroyed, or the destruction of wealth represented in infrastructure. However, the replacement of the infrastructure would be represented in activity such as construction and cleaning up the areas of devastation. This would, in turn, feed into the GDP figures, such that GDP would see a rise as a result of the devastation of a city. As such, whilst GDP does indeed represent activity, it can not be said to mean 'growth in the economy'. In other words, can replacement and cleaning up of this destroyed infrastructure represent economic growth?

If such a view of economic growth is taken seriously, then the logic of the measure would suggest that a good way to achieve economic growth would be to destroy infrastructure such as factories, roads, bridges, houses etc.

Comments

[Dave Wrixon:]

The bottom line is that if you support bad activity, it puts an intolerable burden on the good activity which then implodes. The problem is that in the short-term just about all government activities are an intolerable burden on the weakened engines of the economy. Longer-term, however, they can support the environment in which the wealth generators can operate securely. Certainly it is pointless pouring money into basket case industries such as Real Estate and Retail. Not just money down the drain but a dagger to the heart of the innovation and entrepreneurialism that just may secure the future if it nutured to produce the green shoots everyone is so desperately seeking.

Jul 13 08:43 AM

[Graham and ...:]

Yeah, like Mao Tse-tung's Great Leap Forward in the 1950s, and the experiment with producing "steel" from furnaces built in people's backyards. Tear down the existing infrastructure, put the stuff through the backyard furnaces, double "steel" output, while lowering its value and quality.

Jul 13 09:37 AM

[Gregman2:]

Isn't the key...investment in future value? Isn't this why investment in education makes sense? Yes, even a massage parlor can add to the GDP, but does it actually add to the long-term wealth of a nation? (North Korea's Kim Jung Il would argue...yes, it does.;-) But fact is, it
does not help to more efficiently feed more people or distribute energy more efficiently, etc.

Jul 14 12:57 PM

[Vincent Fer...:]

Gregman, I have actually thought about a similar question in the past. What kind of economic activity creates "real" value? Some are pretty obvious, such as making food more efficiently, but others are not, such as designing a really cool looking watch (or having a massage parlor as you mention). The funny thing is that some of the most hard to gauge activities also tend to be the higher priced, which indicates that demand is pretty strong for them. Like buying renowned art. Or Michael Jackson creating a song. And this seems very strange since one might say a lot of the higher priced products/services out there don't create "real" value. Thing is, I think they do, it's just that human needs can get pretty complex once food & shelter are covered for. And meeting human needs is what value is about. So in short, I think it's very hard to know what activity creates real long term value and what doesn't, but that a lot of seemingly esoteric types of economic activity actually do create value. It's not a short term fluke that people will pay up for, and find they need, things like fashion, music, art, good tasting food, and yes massage as you say. I think humans have been feeling they need these things for quite some time. So as odd as some forms of economic activity can seem, I think most create real value for the economy. Perhaps they provide inspiration for new ideas, inventions, or simply make the motivation to working harder, it's hard to know exactly but I think long term willingness to pay up for them shows there is value. Human needs, and thus value is pretty complex once we pass the basic ones. And for most people the basics are covered for quite easily.

Jul 14 11:44 PM