GDP – Flaws

At present, GDP is universally taken to be not just a measure of national output but also shorthand for national well-being

Richard Tomkin, assistant director of the ONS (Office for National Statistics), which collects all the base data, says: “GDP is used as an all-encompassing proxy for people’s living standards although never designed for this”

Essentially, GDP growth is determined by just two factors – population and productivity growth and as nations become developed economies, so their populations tend to stop growing  – this means they then become totally dependent on productivity improvement if their children are to even equal what their parents achieved, never mind do better as was expected in the olden days

Why so:

  • Because, when productivity is improved, unit costs and real prices usually fall, including when unit quality improves
  • So if more people don’t buy more, GDP will fall 
  • So, for GDP to rise, we need to consume more existing stuff and/ or new stuff on offer
  • But there comes a time when most of us don’t want more existing stuff on offer – we have enough and only replace worn out stuff
  • So, for GDP to grow Then GDP will slowly fall as populations peak – as they always do as nations develop/ mature and birth rates fall to below replacement levels
  • And this will increase as our values change from material to mental stuff

So, just as birth rates fall the more developed a nation becomes, so GDP will also fall

And if and when GDP stalls, as now, central bankers can consider national capacity to be fully utilised and so expect prices to rise as demand exceeds supply – given this would lead to inflation rising above target, currently 2% per annum, they raise interest rates to deflate such extra demand – the result is borrowers, especially those with mortgages, suffer, sometimes harshly

But what if those GDP measures were flawed – what if central bankers and government ministers were being misled by them?

Indeed, it was the late Robert Kennedy who said: “GDP measures everything except that which makes life worthwhile”

We agree, and question why GDP is even used by anyone, especially our leaders deciding policies affecting everyone – claiming it’s the only measure they have is not good enough, just as a flawed ‘fix’ on a chart can lead a ship to steer confidently onto rocks

So why is GDP well past its usefulness date:

  • First, it does not measure everything:
    • Much countable economic activity is not counted
    • More is deemed uncountable
    • Much is spent on failure and putting things right, examples being repairing or replacing shoddy goods, repeat visits to doctors or hospitals to be cured or dealing with youth suicides, exam failures or litter louts and fly-tipping
    • Much that enables people to live lives that are meaningful and satisfying goes uncounted – worthwhile modern living is much more than just consuming goods and services

 

Governor of the Bank of Canada, Stephen Poloz, agrees – he doubts the appropriateness of GDP and whether we are accurately measuring economic activity in the digital age, saying:

  • “Traditional measures were developed to measure the manufacturing-based economy of old – to count the number of widgets produced in a factory by the workers employed there
  • But the economy has become a very different animal, dominated by services, and those services are hard to measure and properly value – digital services in particular”

 

The overriding concerns now are whether the gains from technology are being fully captured by GDP statistics – whether the apparent decline in advanced country national productivity levels over the last decade or so is because of slow economic growth or other valuable activity is being overlooked

At present, we guestimate the composition of any developed economy’s GDP to be as follows:

 

                                    COUNTABLES       UNCOUNTABLES                           

COUNTED                 A =  50%                      B = 20%

                                    ________________________________________                        

UNCOUNTED          C = 15%                      D = 15%           

 

A. Counted Countables (50% – trend flat):

  • Private sector goods and services all have a selling price – customers assess the VFM on offer, some buy – those sales are counted, albeit some are fraught with errors
  • Public sector services usually don’t have a price – input costs are thus assumed to be equivalent to notional output prices paid and so the value obtained by tax-payers – N.B. if one pours extra tax-payers’ money into such services, GDP rises so the economy and national productivity appear to improve when the opposite may be the case
  • Professor Hal Varian, Chief Economist at Google commented on the impact of technological progress in this quadrant:
    • “In 2000, there were 80bn photos taken worldwide – now, it’s about 1,600bn i.e. 20 times as many
    • The cost of each photo, the film, developing and printing was about 50p each – now it’s effectively zero, resulting in a decline in GDP but a huge increase in enjoyment”
    • Thus, if technological creative destruction keeps reducing unit costs of existing stuff, even if it keeps increasing the quality and so value offered, overall GDP will be reduced
    • Equally, if technology keeps replacing much existing stuff – for example, smart phones replacing files, letter paper, envelopes, postage stamps, diaries, watches, atlases, cameras, video-recorders as well as old phone, then GDP again will fall
    • Hence, for GDP to grow, nations must either sell more volume of existing stuff at existing or higher prices and/ or sell new stuff as well
  • Brent Moulton, formerly of the US Bureau of Economic Analysis which collects US GDP data, has two further concerns:
    • How to account for the effects of innovation on new products and quality changes
    • How to measure price changes – how much of any change in the sales of a particular good or service is due to price inflation and how much due to changes in real output, either the quantity or quality of that good or service
  • Conclusion – The scope to under or double-count in this quadrant is considerable, especially when outsourcing abroad or several suppliers are involved for the one product – it’s not just assumptions, estimates and forecast errors that muddy these waters

 

B. Counted Uncountables (20% of GDP –  trend flat):

  • There are a few significant but uncountable private sectors where the ONS  estimates their GDP value, including:
    • Drug dealing – apparently worth some £4.4bn to GDP
    • Prostitution – which clocks some £5.3 bn
  • Apparently some ONS investigator, maybe team, was able to establish that the average price of a prostitute in the UK was, at the time, £67, but sadly gives no more detail
  • And then they ask us to believe their official GDP statistics are accurate to within 0.1%

 

C. Uncounted Countables (15% of GDP –  trend rising)

  • New 21st century economy activities, including:
    • Millions of us now use our computers and mobile phones to complete clerical activities once done by secretaries, typing pools, bank and insurance clerks, even stockbrokers – what once cost money and counted for GDP is now done for free and doesn’t count
    • Many organisations get their customers to do, for free, much of the admin paperwork once done by paid staff e.g. HMRC and tax returns, supermarkets and self-server checkouts
    • Much R&D investment is made hoping to find new products and services for later years – GDP measures only the R&D costs and any revenue obtained from products and services this year
  • Long standing ‘white economy’ activities, including:
    • Housework – cleaning, cooking, DIY, gardening
      • The ONS says the value of unpaid housework is £1.25 trillion p.a.
      • This is bigger than the output of the non-financial sector and equivalent to some 2/3 of total UK GDP
    • Hobbies, arts, music
    • Charity work e.g. RNLI lifeboatmen
    • Most child and elderly care
    • Ferrying family members to/ from school, shops, friends, healthcare
    • The unregistered unemployed earning a few bob
  • ‘Black economy’ activities, including:
    • Moonlighting
    • Working for cash
    • Crime – fraud, muggings, black markets
    • Tax avoidance
    • Hidden incomes

 

D. Uncounted Uncountables (15% of GDP –  trend rising):

  • Environmental benefits:
    • Costs to ensure the sustainability of the environment – not having to later repair damage done now e.g. from pollution, global warming, atomic waste, less bees for pollination
    • Free enjoyment of the countryside, seaside, fresh air, clean seawater, diversity of flora and fauna
    • More trees, less flooding – introduction of beavers on floodplains
    • Better infrastructure e.g. transport convenience and speed, broadband capacity
  • Physical benefits:
    • Longer lives
    • Healthier lives
    • More caring/ altruism/ concern for others
  • Mental benefits – aka ‘consumer surpli’:
    • More/ better leisure/ pleasure – more choice, better quality
    • Less tedium/ slog doing boring work
    • More contentment if not happiness
    • Better educated/ more skilled
    • Better informed, and quicker, so can make better decisions
    • Better/ quicker diagnoses of illnesses
    • Better/ quicker searches of legal precedents before court cases
    • More social connectivity
    • More working from home – less stress, less wasted commuting time

 

Given the above, one is minded of what the famous economist Joseph Stiglitz said: “What we measure affects what we do, and if our measurements are flawed, decisions may be distorted”

The good news is this may all give cause for optimism – people may be much better off now than official statistics would indicate

Indeed Charlie Bean, economist and ex Deputy Governor of the BoE (Bank of England) sides with us by saying: “The UK economy may be growing 0.75% per annum faster than official figures say”

CONCLUSIONS

  • Developed G7 nations continue to count GDP using flawed old-world measures of physical/ tangible goods and services – they also make huge assumptions about the value of public services offered – at the same time they miss many other equally valued outputs or outcomes producing  intangible benefits which make peoples’ lives worth living
  • The result is GDP, and thus national productivity figures, can be dangerously misleading, especially to governments who determine economic policies and tax regimes based on them

 

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