Why GDP Is Useless and Deceptive

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by: Econophile

We have not recovered from the Great Recession, and thus our current economic stagnation is less a new event than a continuation of the original collapse. The basis for the so-called "recovery" was a rise in GDP, that measure of what we have spent in the economy. It's a fairly useless bit of data.

As we all know, GDP measures private Consumption, plus gross private Investment, plus Government spending, plus eXports minus iMports. It is a simple formula:


According to Ludwig von Mises:

It is possible to determine in terms of money prices the sum of the income or the wealth of a number of people. But it is nonsensical to reckon national income or national wealth. As soon as we embark upon considerations foreign to the reasoning of a man operating within the pale of a market society, we are no longer helped by monetary calculation methods. The attempts to determine in money the wealth of a nation or of the whole of mankind are as childish as the mystic efforts to solve the riddles of the universe by worrying about the dimensions of the pyramid of Cheops.

If a business calculation values a supply of potatoes at $100, the idea is that it will be possible to sell it or to replace it against this sum. If a whole entrepreneurial unit is estimated $1,000,000, it means that one expects to sell it for this amount. But what is the meaning of the items in a statement of a nation's total wealth? What is the meaning of the computation's final result? What must be entered into it and what is to be left outside? Is it correct or not to enclose the "value" of the country's climate and the people's innate abilities and acquired skill? The businessman can convert his property into money, but a nation cannot.

Human Action, 4th ed., p. 217.

At best, GDP is a defective measure of a nation's economic productivity. It isn't as if the "economy" is a thing that produces stuff. Nations don't produce anything, people do. I don't know any business owner who uses GDP to tell him anything about his business. (I'm not talking about you traders.) Let's face it, one can't get any real important information by averaging the prices of Diet Coke and memory chips.

What does this mean:

Not much, yet that is what the GDP calculation does.

Let me give you another example of the problem in trying to measure economic growth. If GDP measures spending, then does the introduction of more fiat money into the economy represent organic economic growth or is it just a measure of the influx of new dollars? If we all wake up the next morning and find that our money has magically doubled and we go on a spending spree, does 2X spending mean that GDP has increased 100%? I think we know the answer to that. That is why economists and statisticians use deflaters to discount the impact of monetary inflation on prices. [1] As Rick Davis of Consumer Metrics Institute points out, the inflation rate Bureau of Economic Analysis uses for the deflater is behind the curve, and if revised upward to reflect the current CPI-U, it would put GDP at a 0.73% annualized rate.

Even if you believe that you can measure "the economy" why does government spending get as much credit as private spending and investment? Talking about a deflater, it's like comparing FedEx with the UPS in terms of efficiency and productivity. One could effectively argue that much of what the government spends is wasteful, since they produce nothing. Yet, an important part of GDP spending measures.That is why GDP doesn't yield any useful information.

I don't wish to get into the entire Austrian theory methodology (methodological individualism, as Mises put it), but it is an important concept in order to understand where I am going with this article.

The concept of GDP was developed during the New Deal by economist Simon Kuznets, a pioneer in econometrics. The New Dealers liked the concept because, as advocates of central economic planning, they believed they could control the economy and needed something to measure the efficacy of their meddling. Austrian theory economics rejects the notion of "national accounts" and the government's ability to "manage" the economy. This argument goes back almost 200 years, but let's say that history has not been very kind to economic meddlers. Especially to Keynesians.

What it all comes down to is the Keynesian belief that a lack of spending is what ails the economy, and conversely, spending, any spending, is good for the economy. If we consumers aren't spending enough, according to this idea, it is the duty of the government to spend in our stead. And if the government doesn't have the money, it is OK to borrow and spend. Economic growth doesn't start with spending: it starts with saving and production and ends with spending. And that is why we should not rely on GDP to measure the health of the economy.

If spending were the key to economic growth, then, after running Federal deficits of more than $4.8 trillion since 2008, why haven't we recovered? According to Keynesian theory, at least as defined by Paul Krugman, Brad DeLong, Ben Bernanke, Larry Summers and Tim Geithner, it should have worked. Of course Krugman would say that we haven't spent enough, but he always says that when evidence shows that it doesn't work.

So when the conventional wisdom says that the economy recovered in June 2009, it didn't. There are a number of other ways to measure this, and the dollar volume of industrial production and unemployment are two ways.

Here is an unemployment chart comparing various recessions:

courtesy Calculatedriskblog.comCourtesy Calculated Risk

This chart shows that since the official NBER dating for the beginning of the recession, December, 2007, to the present, we have 41 months of high unemployment. Compared to past recessions, we can see this event is far more serious. We are at 9.1% unemployment now, a rate that is far higher and far longer than in the past.

Another measure to look at it is industrial production:

The dollar measures of industrial output, especially the private ones (such as the ISM and NFIB business surveys), reveals that it is stagnating, which doesn't give you a warm fuzzy feeling about the "recovery." While we have the same problem in measuring industrial production that we do in measuring GDP, it does measure a specific sector of the economy, (some) manufacturing, which is a capital intensive business, and is a fair proxy for capital investment. Industrial production and unemployment measures are real indicators of economic health. So how can we have a recovery when unemployment is still very high and industrial production is falling?

The same factors that caused the so-called 2007-2009 recession still exist. Thus, papering over the problems with fiat money and stimulus spending just gave the appearance of economic growth but it wasn't real. That is why we have economic stagnation: the problems were still there when the money stopped.

Stimulus spending and fiat monetary expansion don't create organic economic activities. That is, once the federal stimulus spending stops or the money "printing" stops, the economic activity they supported stops. Whereas in the private sector, assuming a business is doing something right, customers will come back and the business continues, jobs are created, and profits are made.

The lesson to take away from this is that you can't trust GDP numbers to tell you anything important about the quality of the economy. It is a fiction created by economists who believe that the formulas of econometrics is a valid way to understand our behavior. It is even worse than that, because they use such data to further meddle with the economy by targeting interest rates, to set money supply goals, to formulate fiscal policy and to pass laws they think will make the economy grow. What they miss are the real causes of economic prosperity.

In order to make the economy grow again we need to liquidate the projects that were built on fiat money during the boom years. We need to liquidate the debt attached to these malinvested projects. It's called 'bite the bullet and take the pain.' We need to build up new capital through savings so that we can invest in new productive enterprises and create jobs that aren't built on money steroids. This is what people (the economy) do when they aren't being manipulated by government actions.

If you wish to place blame, then start with the Fed and your federal government. High unemployment and stagnation are painful to real people, not the "nation," yet it is government policies that prolong the problems. That is a cruel thing to do to our fellow Americans.

If you made economic decisions on the back of these GDP reports, that would be a mistake. More often than not, these numbers are false flags of growth. You may have bought a home based on a tax credit last year only to find that your new home is worth less than what you paid. You may have been an employer who hired new staff members based on tax credits only to find that demand has not materialized. You may have bought commercial real estate thinking the economy had turned around, but you will find your turnaround period will be far longer than you thought. You may have bought financial assets such as stocks based on a market that was inflated by QE money, and as money growth slows down the markets will suffer.

Caveat GDP.

This article originally appeared in The Daily Capitalist.


Footnote 1. Here is a thought. If Dr. Bernanke thinks that a little price inflation is good for the economy, then why would he or any economist believe in using a deflater for any data? If inflation "works," as they believe, isn't such "growth" always real and thus doesn't need adjustment? Turning that argument around, if they don't believe price inflation is good for calculating GDP because it isn't "real" why would they believe it is good for the economy?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.