The Mismeasure of Our Economy

GDPIt is hard to believe that a book about the Gross Domestic Product could be interesting, important and occasionally amusing, but Diane Coyle has succeeded in all of this with GDP: A Brief but Affectionate History. It has two very salient takeaways for politics, one practical and one philosophical. First, GDP has become less and less good at capturing positive changes in human welfare. As a result, the lower growth in GDP in the last few decades is less troubling than it is often made out to be.  Second, GDP is a measurement of the government that has inherent biases that one might expect from a metric devised by the government.  Classical liberals should thus be careful to separate their respect for market freedom from any worship at the altar of GDP.

Coyle shows that GDP was designed for a  time when most of the economy consisted of the production of materials, not intellectual property or services. Indeed, because it was formulated at the time that government came to seen as responsible for the economy, its underlying image is that of a machine.  Put so much capital and labor into the economy and get out such much output of goods.

But of course today much of the economy does not lie in the production of material goods. And that means changes in GDP do not reflect all of our economic growth. Take services for instance. We could measure output by simply by seeing how many patients a doctor saw or even what his salary is, but that would not tell us much about the increase in welfare he provided to his patients. And in fact, medical advances have been huge, both in extending life and improving its quality. This fact underscores an essential truth revealed by Coyle: GDP cannot function as a measure of human welfare. And the disconnect between material production and what the economy actually delivers makes it ever less so.

As Coyle notes, GDP also has trouble capturing innovation. Each year’s output has to be compared to last year’s to gauge growth and that requires measuring a standard basket of goods from year to year. But as technology accelerates, the comparison is harder and harder to make, because there are so many new things in the basket.  Smartphones replace phones, for instance, and  the internet becomes an ever greater source of services. These innovations are related to yet another difficulty: nonmonetary activities, like surfing the internet, become more salient to the economy and yet are harder to price.

Another problem with using GDP to gauge growth is that it does not catch the ever greater variety of goods within a category. Coyle shows that of late variety has been increasing enormously in everything from cereals to fashion styles.  Greater choice contributes substantially to well-being. Interestingly, the difficulty GDP has in measuring increased innovation and choice may also bear on debates on inequality. Customization is far more available today than it was in decades past when it was the purview of the rich. Innovations create more and more free things.  While, according to GDP, the music industry has shrunk, that is because more free good stuff is widely available.  These phenomena help the many, not the one percent.

This last point underscores why classical liberals should be careful not to be imprisoned by particular metrics of statistics (a word itself that is cognate with state). To be sure, GDP growth may provide a rough and ready proxy for economic success from one year to the next, but over time it is no substitute for thinking more imaginatively about economic health, particularly given the huge benefits of medical and digital innovation (which will soon be intertwined). And while the United States economy has been growing faster than continental Europe for decades according to GDP per capita, the more persuasive evidence of its comparative beneficence is that more Europeans want to come here rather than the other way around. No metric can replace the evidence of choices made possible by freedom.

Reader Discussion

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on February 04, 2015 at 12:24:57 pm

Cool. So, any alternatives to GDP on offer? Should we conclude that relying on a flawed measure is worse than relying on no measure?

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on February 04, 2015 at 12:55:24 pm

Well some folks have already created and implemented an alternative - "freedom from offense" I suppose this is in recognition of the fact that it is too hard to measure happiness - but one can always perceive an offense and like GDP used to do - it is always growing - comes now news today that "single-ism" is to be added to the list in reaction to marriage privilege!! My god, this measure could show more growth than that dopey ole GDP.
I'm all in!!!

I wonder if McGinnis was thinking along these lines when speaking of the difficulty of true measurements.

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on February 05, 2015 at 08:39:01 am

Yes, GDP is a misleading measure of well-being. That's why we have "happiness" economists. But seriously, it's a poor measure even of beneficial economic activity. Fixing broken windows increases GDP. An increase in Federal spending increases GDP.

A better measure? If we're interested in measuring realized economic opportunities, how about (a) rate of new business formation plus (b) rate of increase in nominal wage divided by the inflation rate?

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Image of Adam1776
on February 23, 2015 at 23:10:46 pm

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