The Mismeasure of the Economy

Economic growth and inequality are among the political matters most discussed these days. It is often thought that economy is more stagnant compared to the  buoyant days of the middle of the last century and economic inequality much more pronounced. Politicians offer new government programs as remedies for these perceived reversals.

My skepticism about such claims has a common core. The government has difficulty measuring economic growth and inequality, particularly in an age of accelerating technology. A centralized decision maker cannot create a set of rules to pin down an ever changing and dynamic economy.

Famously, socialist governments in the last century wrongly thought they could calculate the appropriate prices for goods. Today calculation problems also beset government  measurement of growth and inequality. In this post and in the next, I will take up economic growth. I will then discuss economic inequality.

Measuring the real rate economic growth requires the government to calculate the rate of inflation. That determination in turn requires the government to calculate the change in the price of a basket of goods that people buy. But the goods in the basket are changing as well. Unless the basket reflects the added value of innovations, inflation will be systematically overstated and growth systematically understated.

In a static world where goods did change much, correcting for innovation may not have been difficult. But we live an age of technological acceleration. Computer chips double in power every two years. The result of such exponential growth  is a rapid introduction of new products, like tablets and smart phones. Moreover, computation transforms  ever more products. Cars, for instance, now add new computerized features every year, from automatic parallel parking to adaptive cruise control. Cars are becoming computers on wheels and in the next decade will be autonomous.

How can government decision makers accurately compare the value of such devices to those they replace, particularly when they are so innovative that they have no close substitutes in the previous era? While the comparisons may be relatively successful year to year, even small mistakes repeated over time can seriously distort long-term measurements.

Let me close with two concrete examples that suggest the degree to which computational technology is making us better off—one small and one large. In 1973 my father gave me an HP-35 calculator costing 400 dollars (2000 in today’s dollars). I can download an essentially equivalent calculator for nothing. (For those less interested in mathematics, substitute access to free and ubiquitous music of your choice).

For me and for many other Americans the internet may be the most transformative good of all. Americans spend about thirteen weeks online. The internet permits us to work and play connected to others as never before. When I was young, I would have dismissed the idea of the internet as something akin to magic.  Magic is hard to measure.

In the next post, I will argue that government calculated growth rates do not capture the improvements in health care and respond to a few potential objections.