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Monday, August 10, 2009

Response to a critic of GDP

Eric Zencey, in an op-ed in today’s (8/10) New York Times, makes (yet another) argument against using Gross Domestic Product as a key measure of how the economy is performing. Early on, he writes:

“G.D.P. is one measure of national income, of how much wealth Americans make, and it’s a deeply foolish indicator of how the economy is doing…gross domestic product excludes a great deal of production that has economic value. Neither volunteer work nor unpaid domestic services (housework, child rearing, do-it-yourself home improvement) make it into the accounts, and our standard of living, our general level of economic well-being, benefits mightily from both.”

Well, yes and no. Let’s start with a standard definition of GDP. GDP is the market value of all goods and services produced for final use in an economy in a defined time period, usually a year. It explicitly does not include goods and services that are produced but not offered, or intended, for sale. It is related to our national income, but it is not a(complete) measure of economic well-being, nor was it ever intended to be.
It was intended to be, and it is, a measure of how much we produce.

Economists recognize this as a shortcoming of GDP as a measure of economic well-being. Here’s Timothy Taylor, in his
on-line macro text (pp. 399 ff.):

“However, “standard of living” is a broader term than GDP. GDP focuses on production that is bought and sold in markets. Standard of living includes all elements that affect people’s happiness, whether they are bought and sold or not…[Examples follow]…GDP includes spending on recreation and travel but does not include [the value of]leisure time..GDP includes what is spent on environmental protection, but it does not include actual levels of environmental health, cleanliness, or learning…GDP includes spending on medical care, but does not address whether life expectancy or infant mortality have risen of fallen…it counts spending on education, but does not address directly how much of the population can read, write, or do basic mathematics…GDP has nothing to say about the level of inequality…GDP has nothing to say about what technology of products are available…In certain cases it isn’t clear that a rise in GDP is even a good thing. If a city is wrecked by a hurricane and then experiences a surge of rebuilding construction activity, it would be peculiar to claim that the destruction [caused by]…the hurricane was therefore beneficial. If people are led by a rising fear of crime to pay for the installation of bars and burglar alarms on all their windows, it is hard to believe that this rise in GDP has made them better off…"

Taylor goes on to argue that we cannot necessarily conclude that an increase in GDP represents an increase in economic well-being.

I’m not sure that Zencey has anything really to add here to what Taylor says. And what Taylor says is typical of intro econ textbooks.

Zencey does make an additional, and somewhat interesting, argument:

"Nor does it [GDP] include the huge economic benefit that we get directly, outside of any market, from nature. A mundane example: If you let the sun dry your clothes, the service is free and doesn’t show up in our domestic product; if you throw your laundry in the dryer, you burn fossil fuel, increase your carbon footprint, make the economy more unsustainable — and give G.D.P. a bit of a bump...In general, the replacement of natural-capital services (like sun-drying clothes, or the propagation of fish, or flood control and water purification) with built-capital services (like those from a clothes dryer, or an industrial fish farm, or from levees, dams and treatment plants) is a bad trade — built capital is costly, doesn’t maintain itself, and in many cases provides an inferior, less-certain service. But in gross domestic product, every instance of replacement of a natural-capital service with a built-capital service shows up as a good thing, an increase in national economic activity."

I think there’s some value to this point. But consider. Natural fisheries can be—and are—over-fished, and thus are not necessarily sustainable. Sun-drying ones laundry works well in the spring and summer and on sunny days, but not so well in Chicago in January. “Natural” flood control, which usually (as Dan Drezner snarks) often means allowing floods to occur, and (my point) would make a lot of land that is currently used for agriculture or for urban uses unavailable. (One can argue about whether that would be good or bad, but it is a fact that flood plains would be less available for other uses.) "Natural" capital is neither necessarily as productive nor as universally available as "man-made" capital. And "natural" capital is also not necessarily any more sustainable.

Zencey then commits this fallacy:

"In summing all economic activity in the economy, gross domestic product makes no distinction between items that are costs and items that are benefits. If you get into a fender-bender and have your car fixed, G.D.P. goes up."

So if your car is damaged in an accident, which makes you better off—getting it repaired or not getting it repaired?

We see Zencey’s argument made, as well, about prisons or about health care (indeed, he goes on to make it). If no one ever got in an automobile accident, we would not produce as many auto repair services. But—in a world in which auto accidents do occur, are we better off, or worse off, to produce those repair services? If no one ever committed a crime, we would have fewer prisons (and police officers and judges and courthouses…). But—in a world in which crime does occur, are we better off or worse off with police forces and judges and courtrooms and prisons? If no one ever got sick or injured, we’d have fewer doctors and nurses (and other health care professionals) and fewer hospitals and clinics. But—in a world in which people do get sick and injured, are we better off or worse off to have health care workers and facilities?

More broadly, suppose that we did not need to produce auto repair or health care or crime prevention/control. Would the resources we currently use to do that go unused? No, we’d use them to produce other things instead, and GDP would be, as measured, about the same. Zencey’s actual argument is that the things we are producing aren’t really “goods,” not that GDP is a bad measure.
Then, we get this:

“If we don’t count ecosystem services as a benefit in our basic measure of well-being, their loss can’t be counted as a cost.”

That’s just a non-sequitur. GDP measures production, not benefits and costs. We can certainly—and we do certainly—count the benefits of ecosystem services as benefits and the loss of them as costs in our environmental regulations.

And now, something just flat-out wrong:

“If you kept your checkbook the way G.D.P. measures the national accounts, you’d record all the money deposited into your account, make entries for every check you write, and then add all the numbers together.”

No. GDP measures the value of what we buy. We argue that the value of what we buy and the value of our incomes must be the same (there’s an accounting identity here, really, like the balance sheet identity that says that the value of Assets must be equal to the value of Liabilities plus the value of Net Worth.) Zencey appears to be saying that we compute GDP as Income plus Expenditures. Really, we argue that GDP equals Income equals Expenditures.

We begin to reach a conclusion:

“Because we use such a flawed measure of economic well-being, it’s foolish to pursue policies whose primary purpose is to raise it. Doing so is an instance of the fallacy of misplaced concreteness — mistaking the map for the terrain, or treating an instrument reading as though it were the reality rather than a representation.”

He concedes that such measures have been proposed; what he doesn’t point out is that one of the most prominent of these measures—Net Economic Welfare—was proposed by two prominent economists, William Nordhaus and James Tobin, in 1972. Measures like this have not been widely adopted for the very reason Zencey cites—that they can be highly "subjectiv[e] — for the expression of personal values, of ideology and political belief..." [Oddly, Zencey even wants to create such a measure (“Call it net economic welfare”), apparently not even realizing that it’s already been done.]


“Common sense tells us that if we want an accurate accounting of change in our level of economic well-being we need to subtract costs from benefits and count all costs…”

The problem is to decide what is a benefit, and what is a cost. For Zencey, if I get my car repaired after an auto accident, that’s a cost. As far as I’m concerned, that’s a benefit. Which of us is right? And, if we can’t agree about that, then how can we agree on his sort of measure? GDP doesn’t even try to argue about that, it says, “What’s the market value of what we produced?” Zencey wants a measure that does more than this, and criticizes GDP for not being something it has never been designed to be—a measure of economic well-being (and he even quotes Simon Kuznets, the founder of national income accounting, to this effect). But what he proposes is not really an improvement, if only because it allows (as he even concedes) for our measure of well-being to be determined by “subjectivity — for the expression of personal values, of ideology and political belief.”

I can agree with Zencey that using GDP as a measure of economic well-being is not something we want to do. I (and everyone I know who teaches intro economics) make this point in my classes. We can be sensitive to the shortcomings of GDP as a measure of economic well-being (and, for that matter, as a measure of production), while retaining it for the purposes for which it is well-suited. Zencey’s error is to mistake the measure for something it is not, and, in many ways, to miss what it can and does achieve. I’m not sure he points us to something that would be an improvement.

Hat tip to Dan Drezner
for mentioning this op-ed.


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