Tuesday, July 8, 2014

Stop bashing GDP!

So everybody hates the Gross Domestic Product! The New York Times and the Financial Times have recently published articles criticizing the main measure of production in the economy. This is certainly not new, and criticism of the value of GDP for certain purposes, as a measure of well-being, for example, have led in the past to the creation of other variables like the United Nations Development Programme's Human Development Index, which includes GDP per capita (actually Gross National Income per capita), life expectancy at birth and average years of schooling for adults.

In fact, the NYTimes article basis for the supposedly dramatic "Rise and Fall of the GDP" is it's inability to measure well-being, and in it the author emphasizes its disadvantages when compared to the HDI. The NYTimes piece quotes Sen, the godfather of HDI, complaining about the "silliness about identifying growth with development." Of course, since GDP is only about the material growth of the economy, it would be an incomplete measure of development.

The most common type of critique is that GDP does not count many things, like environmental degradation, or happiness (yep, I know; check Putnam's ideas in the NYTimes piece; talk about silliness), or almost all non-market transactions for that matter, or is slow to adjust to new products and services introduced in the market, and that it's not particularly good for understanding inequality (Robert Reich's complaint in FT's piece; check the full list of complaints in both articles linked above). The best defense is provided by William Nordhaus, who argues compellingly that: “if you want to know why GDP matters, you can just put yourself back in the 1930 period, where we had no idea what was happening to our economy.”

First, GDP is not a measure of everything, and it certainly has limitations. But it does measure relatively well the material production in a given year, and provides the basis for understanding the process of accumulation, which is central for understanding the dynamics of capitalism. And actually, if you look at functional distribution of income in the National Income and Product Accounts (NIPA), which are used to calculate GDP, you do have one of the best measures of income inequality! Yes growth of the flow of goods and services produced in a country in a year is not tantamount to development, but without growth developing countries cannot achieve the levels of well-being of advanced economies, so growth is kind of a pre-requiste (and yes, growth involves environmental degradation, and we should try to minimize it). Further, with GDP one can obtain a fairly good measure of productivity (labor productivity), which is the basis for the Wealth of Nations, if you believe that dude Adam Smith.

My beef with the profession is not the use of GDP growth as a measure of material progress, but the fact that a limited, supply-constrained, individual maximizing utility, market-friendly, neoclassical version of the process of growth and development is the dominant one. But GDP is fine. Like price indexes, which also are limited and sometimes inaccurate, is an essential tool for understanding the real world.


  1. This is a great piece, Matias. An excellent counterpoint to the growing opposition to the use of GDP as an effective measure for economic growth and development, in particular by sociologists and those who are adherent to Sen's Capability Approach (who by the way naturalizes impersonal institution of market exchange in his classic book "Development and Freedom").

    1. Capabilities is another name for Human Capital. Oh well.

    2. Indeed, and the Sen adherents treat it as such, which, in the final instance, assumes a reconstructed production function, which, by implication, succumbs to the inherent problem circularity - capital debates.

    3. Matias and Anon,

      II do not think it is correct to say that capabilities is synonymous with human capital. Capabilities are the actual, realizable options available to someone, which could be dependent on both personal attributes (human capital) and external factors (economic and political conditions, etc). For example, imagine a (admittedly simplified) situation in which an aid program raises education levels, but there are insufficient skilled jobs for these newly educated people. This situation would not, in my opinion, be rightfully considered an expansion in capabilities.

      For this reason I think the comment that a capabilities approach assumes a production function is also inaccurate. I do not understand the capabilities approach as defining the means to development, but rather the ends. It is not a recipe, but a description of the goal. You write "Of course, since GDP is only about the material growth of the economy, it would be an incomplete measure of development." Exactly! But if development is not "just" economic growth, then what is it? The capability approach is an attempt to answer this question, not to explain what causes economic growth (which is how I would characterize human capital theory).


  2. Arguably the problem is just the opposite -- GDP includes lots of things that are NOT market transactions, but are included because of their supposed contribution to wellbeing. The flow of services fro owner-occupied housing is the big one, but there are others. In the US, about 10% of measured GDP is imputed values for various nonmarket activities.

  3. «First, GDP is not a measure of everything, and it certainly has limitations.»

    Perhaps the idea of GDP is a good one, but the limitations of how it is measured in practice is terrible, because J. B. Clark, and you make some really disagreeable statements, the reasons why they are terrible are very interesting:

    «But it does measure relatively well the material production in a given year»

    First it measures the price-weighted sum of "material production".

    Second it measures that in either nominal prices, which means GDPs for different periods are incommensurable, or in deflated prices, which means that they are also incommensurable, but across longer periods, because the composition of the deflator changes quite a bit over time.

    Even better, the deflator usually includes lots of "adjustments" which have _essentially always_ the effect of underestimating, in order to make "real" GDP growth looks larger than it can be reasonably estimated. The Soviet Union were accused to flatter their reported GDP thanks to the Gerschenkron effect; ironically the Gerschenkron effect is one of the most basic techniques used by some "first-world" countries. Depending on how you feel, these techniques lead to overestimating "real" GDP by 1% to 2% (or more...).

    Third, and even more importantly, it is the price-weighted *value added* in goods *and services*.

    That is phenomenally important because modern economies are mostly services and it is exceptionally difficult to measure the value added of services, both conceptually and in practice.

    This is a little known aspect of reported GDP. How many people realize that most of GDP is the value added of services and ask themselves what does that mean?

    Many national statistical agencies don't even try to estimate the value added of services, which is by far the overwhelming component of GDP, but simply make it up, and many others use extremely simplistic and usually misleading estimates.

    «and provides the basis for understanding the process of accumulation,»

    Reported GDP is particularly bad for understanding accumulation because it does not include the depreciation of many important aspects of capital stock, for example land fertility and other natural resources, thanks to the great efforts of J. B. Clark to ensure that such issues were not mentioned in polite company.

    «which is central for understanding the dynamics of capitalism.»

    Accumulation is pretty central for understanding the dynamics of the *industrial system* which is phenomenally important but not quite the same as "capitalism".

    Properly speaking "capitalism" is a political system, often happening along with industrial system modes of production, but perhaps not necessarily, and is characterized by the paramount political power of the owners or the controllers of capital.

  4. «NOT market transactions, but are included because of their supposed contribution to wellbeing. [ ... ] about 10% of measured GDP is imputed values»

    Not to wellbeing, but to *value added* whatever that is defined to be.

  5. «modern economies are mostly services and it is exceptionally difficult to measure the value added of services, both conceptually and in practice. [ ... ] particularly bad for understanding accumulation because it does not include the depreciation of many important aspects of capital stock, for example land fertility and other natural resources,»

    Those two points I wrote may well be related...

    Modern economies perhaps, and I dearly hope it is not true, may be regarded as having a "productive" part, mostly "agriculture" (including natural resources like oil), that does stuff that people actually need, and a "fantasy economy" part, where the majority of people are underemployed, that is they have what Graeber calls bullshit jobs, that is jobs that don't produce value added, but only redistribution, and probably a log of jobs in services, and particularly in finance and "entertainment".

    If that's the case a tiny number of first world design engineers plus a small number of hicks on farms and a somewhat larger number of coolies in 3rd world sweatshops produce value added; and the numbers involved are small because high energy density, low cost fossil fuels enable 1 hick and 1 coolie to do the work of many in farms and sweatshops.

    The rest may be playing a crazy game of "fantasy economy", which exists purely to keep them busy and to redistribute the surplus generated by hicks, coolies and oil, so hoi polloi don't go wild with boredom, cutting each other's hairs, or advertising to each other, or making each other's meals etc.

    Including many in a huge game of "fantasy finance", doing economically empty bets on "derivatives", and trading pieces of paper with each other, in a huge circular flow with the only effect of enabling them to skim bonuses, commissions, two-and-twenty off the top of that flow.

    Wall Street and the City of London may be playing a giant game of "Monopoly" but with "real" dollars as the "play money", so they can actually spend their winnings on real stuff.

    Then if only a few people and natural resources account for almost all surplus, and the others are playing a make-busy game in the "service economy" to distribute it without overtly giving everybody a citizen income, or cutting drastically work hours as Keynes envisaged, the rate of depletion and the depreciation of those natural resources really matters, because it shows how much of GDP is actual value added and how much is just drawing down and destroying existing capital.

  6. Nuno, for some reason this comment was deleted. I'm reposting it on your behalf. My apologies.
    Nuno Martins has left a new comment on your post "Stop bashing GDP!":

    “In looking for a fuller understanding of the role of human capabilities, we have to take note of: 1) their direct relevance to the well-being and freedom of people; 2) their indirect role through influencing social change; and 3) their indirect role through influencing economic production. The relevance of the capability perspective incorporates each of these contributions. In contrast, in the standard literature human capital is seen primarily in terms of the third of the three roles.” (Sen 1999: 296-297)

    “do you really believe that having only one homogeneous capital good will permit you to derive a rate of profit purely from the technical relationship between homogeneous capital and output? … Suppose you do get the value of the marginal product of capital in terms of output of consumer goods. In what units will it be expressed? Physical units of additional consumer goods per unit of additional homogeneous capital. But the rate of profit is a pure number. Surely you will need something more in going from the first to the second to reflect the relative price of the capital good vis-a-vis the consumer good. But the equilibrium price of capital in units of consumer goods depends on the rate of profit used for discounting, and a variation of the rate of profit can involve a variation of the value of the same physical capital in units of consumer goods. This difficulty is not eliminated by having one homogeneous capital good.” (Sen 1984: 163)

    “It was argued by development economists that neoclassical economics did not apply terribly well to underdeveloped countries. This need not have caused great astonishment, since neoclassical economics did not apply terribly well anywhere else.” (Sen, 1984: 487)


    Sen, Amartya (1984), Resources, Values and Development, Cambridge (MA); London, England, Harvard University Press.

    Sen, Amartya (1999), Development as Freedom, Oxford, Oxford University Press.

  7. OK, thanks. Those are just three quotes by Sen on:

    1) Capabilities vs human capital
    2) Neoclassical production function
    3) Neoclassical theory in general


Trade and Finance

Teaching a course on international economics (trade and finance) for international relations students. More on that later. Just wanted to p...