An article by David Pilling in last weekend’s FT Magazine reported on expert views that gross domestic product (GDP), the most popular way of measuring output, was misleading.
“GDP is a made-up entity,” Pilling quoted economist Diane Coyle as saying. “It is an artificial construct … an abstraction that adds everything from nails to toothbrushes, tractors, shoes, haircuts, management consultancy, street cleaning, yoga teaching, plates, bandages, books and all the millions of other services and products.”
The first attempt to construct national accounts in the way we understand them was made by the US federal government in 1942. Nobel-Prize winning economist Simon Kuznets, then associate director of the Bureau of Planning & Statistics in the War Production Board, was asked to develop a way of measuring national income, principally as a means of identifying possible bottlenecks and other supply chain deficiencies.
This involved deciding which activities to count. Kuznets wanted to measure only those that contributed to human welfare. He thought spending on weapons should be excluded together with advertising, speculative trading and government spending which he argued was simply recycled taxation.
Kuznets was over-ruled. It was decided that GDP is simply the total monetary value of everything that has been produced in a given period, regardless of whether they were good of bad.
The question of what should be included in GDP and the challenge of possible double-counting continues, however, to dog the concept. Issues include:
- the exclusion of non-traded activities. The most notable one is housework done by women. Pilling shows that this makes little sense by imagining a situation where women with unpaid housework hired themselves out to the next door neighbour to do their houswork for say $50 a day and paid a similar amount to their neighbour for similar services for the same pay. If every woman in Britain with housework were to do that, there would be an immediate spike in GDP. But it’s questionable whether any additional output is involved. The quality of it might well fall.
- the failure to deal with innovation. GDP is purely based on the market price of a final product and the costs involved with producing it. So the production and sale of a new version of a popular cellphone with radically upgraded services would be deemed to add nothing to GDP if it wasn’t sold for a higher price.
- the failure to take into account sustainability. The way GDP is compiled makes no difference between renewable and non-renewable products. So the production of $100 of fish is treated the same as the sale of $100 of hairdressing services. The reality is that there is nothing in the pricing to reflect a long-term sustainability factor, only the normal, short-term marginal cost factors.
- the challenge of complex products. GDP calculated using the output methodology is involves working out the value-added of each product and aggregating them. This is comparatively uncomplicated with simple products. But others, like motor vehicles, rely on complex global supply chains. “No wonder the UN System of National Accounts, a how-to GDP manual, runs to more than 700 pages,” Pilling noted.
- The measurement of quality. “Take a table setting of a knife, fork and spoon,” Pilling wrote. “In output terms, a setting of three spoons is equally good.”
Finally, Pilling turns to intangibles. “…one of the biggest failings of GDP is how atrocious it is at capturing services,” he wrote. “That is a bit of a problem given that services now account for two-thirds of the output of many advanced economies. Statisticians are pretty good at measuring things you can drop on your foot, such as bricks and iron bars. But they struggle to measure intangibles such as landscape gardening, jet-engine service contracts or synthetic derivatives.”
Economics2030 argues that Pilling does not go far enough in his critique of conventional economics and the use and abuse of GDP data by the IMF and other organisations dispensing economic policy advice.
GDP is more than atrocious at capturing the value of services. It totally fails. And that’s not because of the measurement techniques. It’s because services are intangible and their value is unquantifiable and incommensurable. You can’t measure a service created in one service interaction with another. They are unique to the participants. And the amount of money paid is not a price in the conventional sense of the word. It’s the liquidation of a personal obligation to the supplier of the service that lays the foundations for further, satisfactory service interactions.
GDP is a measure designed to deal with an economy wholly or largely dominated by the production of tangibles, things that can be measured in some way that are exchanged as commodities in mass markets. It was always unsatisfactory as Kuznets himself acknowledged since the subjective is present in every tangible transaction. There’s always been an intangible component to economies dominated by farms, factories and mines.
The applicability of the concept to economies like the UK’s where services account for 80 per cent and more of output and employment is rightly open to serious question. As Pilling’s article shows, policymakers basing their decisions on GDP will almost always get it wrong.
Economists, spurred by their need to prove they are scientists, are seeking to develop alternative measures of the output including the Human Development Index, which captures data about a range of services including education.
Economics2030 argues all these efforts will ultimately fail. Value created in economies dominated by services is intangible and only subjectively perceptible at the level of the individual. Any attempt to aggregate their value using price or an analogue will fail and lead to bad policy-making.
Value-creation in services can’t be measured or stimulated by corporations, whether they are government-owned or privately-owned. Only the individual freed to make a wider range of choices about what he or she does with his or her intelligence and skills can create value. Corporations can help, but their role is supportive at best. Often, it is counterproductive.
The right response to the Pilling challenge is not a better measure of output.
It’s a better way of understanding what value is and how it’s created in economies dominated by services.
You can find the FT article here: http://www.ft.com/cms/s/2/dd2ec158-023d-11e4-ab5b-00144feab7de.html#axzz36lAYI9Jj