It measures material production, which is a key feature of capitalist economies, centered on the accumulation of material wealth. It was not designed to measure everything. Certainly not sustainability. Or happiness, for that matter. And although Diane Coyle, author of the book, suggests that it can't be used as a measure of well-being, GDP per capita is certainly employed as an index of welfare, even though no serious (I don't mean mainstream) economist would take GDP per capita as the only indicator of development. Finally, it isn't a measure of inequality, but functional income distribution, the shares of labor and capital compensation in total GDP, is actually one of the best measures of inequality. So yes, GDP does have its flaws (for an accessible discussion of the limitations of GDP go here, and for my views here).
Note that Kuznets apparently was against including government spending, in particular defense expenditures, as part of GDP, according to Coyle, since in his view it didn't increase well-being. That proposition is not uncontroversial. A lot of government spending, including in defense, is central for technological innovation, and, hence, for higher productivity growth and increasing living standards. The internet (as well as driverless cars and many other things) that I'm using to post this piece is the result of DARPA's investment -- the Defense Advanced Research Projects Agency, a defense department agency.
This suggests to me that we owe more to the British Keynesians, Richard Stone and James Meade, that basically created the methodology of of the National Accounts during World-War-II, than to Kuznets (all three won the Sveriges Riksbank Prize, by the way, but Meade's wasn't related to national accounting). And, in a sense, it is what Coyle suggests when she argues that:
“It [Keynesian economics] became the basis for a more interventionist approach to government economic policy from the 1940s onward, using both fiscal policy (the level of tax and spending) and monetary policy (the level of interest rates and availability of credit) to target a higher and less volatile rate of growth for the economy. The use of these tools was developed more fully by other economists after Keynes’s early death in April 1946. Postwar policymakers still bore the scars of the Great Depression and pounced on the economic theories of Keynes and his successors as a means of averting a repetition of that crisis. Crucially, the development of GDP, and specifically its inclusion of government expenditure, winning out over Kuznets’s welfare-based approach made Keynesian macroeconomic theory the fundamental basis of how governments ran their economies in the postwar era. The conceptual measurement change enabled a significant change in the part governments were to play in the economy. GDP statistics and Keynesian macroeconomic policy were mutually reinforcing. The story of GDP since 1940 is also the story of macroeconomics. The availability of national accounts statistics made demand management seem not only feasible but also scientific.”This is essentially correct, yet it might be misinterpreted as suggesting that the National Income and Product Accounts (NIPA) are intrinsically Keynesian, as some far right supply-siders have argued. Nothing in the NIPA implies that causality goes from autonomous spending to income, as in Keynes' Principle of Effective Demand, and the accounts are compatible with a model based on Say's Law (not that I personally think that's a good idea).
It only means that by the time the National Accounts were developed, a version of Keynesian economics, as it turns the Neoclassical Synthesis, had more or less become the mainstream interpretation of how the macroeconomy works. The same is true of say econometrics, and macro econometric models, like the Klein-Goldberger, which was Keynesian, and would not lead a reasonable person to conclude that econometrics is Keynesian (Keynes was, in fact, skeptical about it).
«Note that Kuznets apparently was against including government spending, in particular defense expenditures, as part of GDP, according to Coyle, since in his view it didn't increase well-being. That proposition is not uncontroversial. A lot of government spending, including in defense, is central for technological innovation, and, hence, for higher productivity growth and increasing living standards.»
ReplyDeleteThis is based on the usual unhelpful confusion as to what GDP properly defined measures, and in the article you mention it is reported that:
«As Steve Landefeld pointed out to me, Kuznets worried that the nation’s economic activity might be mistaken for its citizens’ well-being.»
Because is not at all about well-being, the goal is to measure gross (of depreciation) value added, and thus it is supposed to be gross (of depreciation) *final* production in a given period, a vector of physical quantities like number of cars manufactured, hours of medical services delivered, etc.
Since the goal is to estimate value added, the big questions arise as to what "*final*" means, because counting production that is not final means double counting it, as itself and as part of the final output it gets incorporated as.
Therefore is seems quite absurd to merely state that:
«A lot of government spending, including in defense, is central for technological innovation, and, hence, for higher productivity growth and increasing living standards»
Because if «a lot of government spending» (or private spending) indeed results in «technological innovation» and does in fact at some point later cause «higher productivity growth» then it is already accounted for in GDP thanks to the higher final output resulting to the higher productivity. Indeed not being final output that spending ought to be subtracted from GDP to avoid double counting. Just as the tyres put on newly built cars are subtracted from tyre production because they become part of car production.
The difficulty Kuznets had with government spending was I suspect not that «didn't increase well-being» but that it is very difficult to measure which part of government spending is value added (*final* production). There is a similarly large difficulty in measuring which part of service spending is value added.
These two difficulties are usually "massaged" by government economists with various "methodologies" that allow them to make up "estimates", which is particularly significant as government and services account currently for the vast majority of reported GDP.
Joseph Stiglitz acknowledges some of these issues here:
http://host.madison.com/ct/article_71fad514-9caa-11de-9a00-001cc4c03286.html
«For example, while GDP is supposed to measure the value of output of goods and services, in one key sector – government – we typically have no way of doing it, so we often measure the output simply by the inputs. If government spends more – even if inefficiently – output goes up. In the last 60 years, the share of government output in GDP has increased from 21.4 percent to 38.6 percent in the U.S., from 27.6 percent to 52.7 percent in France, from 34.2 percent to 47.6 percent in the United Kingdom, and from 30.4 percent to 44 percent in Germany. So what was a relatively minor problem has now become a major one.
Likewise, quality improvements – better cars rather than just more cars – account for much of the increase in GDP nowadays. But assessing quality improvements is difficult. Health care exemplifies this problem: Much of medicine is publicly provided, and much of the advances are in quality.»
Hi Blissex. Thanks for the comment. Not sure what you see as absurd in the comment. Government spending is part of demand, one of the ways of measuring GDP. It adds to material production of final goods and services. I think it's a mistake to cut it. What Coyle seems to indicate is that Kuznets wanted GDP to be a measure of welfare and on that basis cut defense spending. I merely suggested that even on that account is not clear that government defense spending is negative.
Delete«Not sure what you see as absurd in the comment. Government spending is part of demand, one of the ways of measuring GDP. It adds to material production of final goods and services. I think it's a mistake to cut it.»
DeleteOh please, I understand that it is a "technicvality", but GDP is not a sum of all possible "demand" iterm, but only *final* ones. *Final* demand and production. Perhaps I have to say it again: *final* demand and production (gross of depreciation).
It is absurd to consider *all* government spending as *final* demand, because a lot of just is not.
If you want to argue along with "supply-side" Economists that GDP should be redefined as monetary flow of funds, that's your privilege; but if you accept the old definition that GDP is *final* production, that is value added, gross of depreciation, it is absurd to treat all government spending as final demand, because otherwise we get a lot of double (or more) counting.
There was actually an argument that most if not all government spending is intermediate demand, and should be *subtracted* from GDP, because government spending existed mostly to further private production. But it is fairly obvious to me that inasmuch government is a group purchase scheme, its group purchases should count as final demand.
So for example if government funds the production of music with grants to the arts, or builds parks, that can legitimately count as final production, but R&D funded by the government for example until; recently counted (correctly) as intemediate production, not final.
Oops. This comment fell through the cracks. In all fairness, I find this one even more absurd. Government consumption and investment is for the most part on final goods and services, unless you're in a command economy in which the government buys intermediate goods to produce final goods. So you're concern is with what, the Soviet economy? And yes you may have a discussion on were to place certain categories, like R&D, but once you accept that buying certain things is part of the GDP your case is illogical.
DeleteThere are unsurprising aspects of discussions of GDP, such as the constant attempts to redefine the concept to measure something else than final production gross of depreciation, in order to make it look bigger. Thus a lot of methodological changes in the past few decades have all been about increasing the opportunities for double counting non final production and for boosting reported production with "hedonics".
ReplyDeleteWhat surprises me in the discussion of GDP vs."well being" is that nobody seems to suggest that what we should be using is not Gross Domestic Product but *Net* Domestic Product.
Because depreciation is actually really important, and using GDP means that liquidating capital gets counted a production, which is quite bad.
This would address without many fundamental changes the issues mentioned in the article you refer to:
«Another fix might be to cease giving only positive values to events that actually detract from a country’s well-being, like hurricanes and floods; both boost G.D.P. through construction costs.
The second group of critics, meanwhile, has sought to recast the criticism of G.D.P. from an accounting debate to a philosophical one. Here things get far more complicated. The argument goes like this: Even if G.D.P. was revised as a more modern, logical G.D.P. 2.0, our reliance on such a measure suggests that we may still be equating economic growth with progress on a planet that is possibly overburdened already by human consumption and pollution.»
Because each of this issues is about capital liquidation.
Sure, there are large practical issues in calculating depreciation of the capital that delivers domestic product, but I think that they are rather smaller than the issues about measuring value added of government and service sectors, and yet the latter are merrily included in GDP for propaganda purposes.