The Poverty of GDP
The Economist recently ran a piece criticizing the suitability of GDP as a measure of economic development and material progress. In the past, the publication has touched on various other weaknesses of this aggregate measure—including the fact that it is not a timely and reliable indicator that can guide economic policy—as well as suggesting new measures for prosperity.
As expected, none of these articles discuss one main drawback of the GDP aggregate—the inclusion of government spending. In America’s Great Depression, Rothbard removed the G component to suggest the Gross Private Product (or the netted version, the Private Product Remaining) as a better gauge of the material progress of a nation. Professor Herberner has also pointed out various important economic aspects that GDP, as a rough aggregate measure, leaves out. Moreover, professor Salerno has also shown that a reduction in the GDP—as it is calculated today—via a reduction in government budgets and taxation would in fact be underlined by an increase in the capital stock, a rise in the economic welfare of producers, and a higher real standard of living for the entire population.
Nevertheless, the most recent Economist article does draw attention to a fundamental problem of using such aggregate measures to estimate economic development over time. The author explains the difficulty of comparing “hand-held e-mail with fax machine, self-driving cars with jalopy, vinyl records with music-streaming services and custom-made prosthesis with health-service crutches” in order to capture average gains in living standards. But this problem is not restricted to the use of GDP. It extends to capturing the evolution of economic inequality over time, and most importantly, the evolution of price inflation, both of which are currently at the center of fiscal and monetary policies. As Mises explained in relation to index numbers used to depict average price variations of a basket of goods over time,
The farther we went back in history, the more we should have to eliminate [from the basket]; ultimately it seems that only those portions of real income would remain that serve to satisfy the most fundamental needs of existence. Even within this limited scope, comparisons would be impossible, as, say, between the clothing of the twentieth century and that of the tenth century… But even if we were to ignore all these considerations …changes in ways of living, in tastes, in opinions concerning the objective use-value of individual economic goods, evoke quite extraordinarily large fluctuations here, even in short periods.
Ultimately, Mises argued, the choice between various ways of ‘measuring’ such economic variations (and gauging their causes from these measurements) is arbitrary from an economic point of view, and becomes a largely political endeavor:
There are many ways of calculating purchasing power by means of index numbers, and every single one of them is right, from certain tenable points of view; but every single one of them is also wrong, from just as many equally tenable points of view. Since each method of calculation will yield results that are different from those of every other method, and since each result, if it is made the basis of practical measures, will further certain interests and injure others, it is obvious that each group of persons will declare for those methods that will best serve its own interests.
This underscores the important fact that, while they may be useful in discussion, figures cannot be the core of our practical and policy considerations—and that the search for better measures of economic development is, in a sense, fruitless. The focus should rather be on the institutions that underlie our economic system, such as property rights and the price system, and on how changes to these institutions profoundly affect human welfare.
Ultimately, the phone in your hand—created by entrepreneurs and bought voluntarily by a consumer—says far more about growth and progress than any report on the latest GDP figures.