September 2012
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Chasing GDP

According to wikipedia, Gross Domestic Product (GDP) can be calculated a number of ways. I’d like to pick out (on?) the most common one for this rant.

GDP = private consumption + gross investment + government spending + (exports − imports)
= C + I + G + (X – M)

Economists (since Keynes) have preferred to split the general consumption term into two parts; private consumption, and public sector (or government) spending.

I will follow in that tradition, only to highlight the error of it’s ways. Let’s pick apart each component.

First, the term (X-M). I find this term clear an uncontroversial. If we are interested in just the GDP of a single country which trades with its neighbors, then only the differential between imports and exports contributes. That is, only the excess production which is sold to trading partners counts towards GDP.

Second, I, the gross investment. I’m not wholeheartedly behind including this term. One one hand it’s difficult to distinguish between investment and malinvestment. The government could easily, via a ridiculous law, encourage over investment in certain areas; momentarily raising this term of the GDP. On the other hand, a corporation might make a malinvestment due to a lack of market data, ignorance of market conditions, unanticipated market changes, etc. We should certainly regard any malinvestement, for whatever reason, as a product expense. That is, all investments cost money, while only some pay off (in the future). I’m willing to allow this term because it represents the affordability of this expense.

Third, C, private consumption. Again, not quite the ideal term. The ability of individuals to consume certainly implies the production of the good being consumed. However, not all goods are obliterated during their consumption. For example roads and buildings both last quite some time. The investment expenditure is counted as an investment expense in the year the construction is completed, but the consumption isn’t tracked (until repairs are made as an investment expense). In the other direction, one time use goods, such as plastic containers and packaging, are trashed. The consumption model for these items would imply that the lack of recycling is a net benefit to GDP.

Fourth, and most problematic, G, government spending. I simply cannot believe that this term figures so prominently. So many government operations (think DMV) are so mindbogglingly inefficient that simply having a government must be a net economic loss. This term implies that when the government spends two men to dig a trench and a third to fill it back in is a positive factor to GDP. Government spending is determined through a political process. According to public choice theory, government completely lacks any of the internal mechanisms that would lead it to spend money in a productive manner. I’m willing to take it on argument alone that government spending is a wasteful endeavor, but I found a list of failed energy companies sponsored by only this past administration (Obama, first term). Having government spending as a term in GDP implies that when the government steals (through taxation) money from profitable enterprises and spends it on failures we should consider that a gain in GDP. Nonsense.

According to this formula, government spending is a positive for GDP. No wonder the Keynesians think we should print money. Their formula hides the reality: The very structure of government guarantees that it will misallocate the money it extracts. Yes, government spending raises this GDP figure, but it does so at a cost to real wealth. For the past 4 decades we’ve sought to elevate the GDP figure by increasing both government spending and short-sighted consumption. We’ve financed this endeavor with
bonds and loans, so that we now find ourselves awash in debt and bankruptcy. Raising one year’s GDP figure has been an exercise in spending future growth for such a long time, that we’ve restructured our economy. It’s now so completely focused on these two terms that we are structurally unprepared for the correction.

Under the assumption that all (non-coercive) transactions are profitable for the parties involved, we are really interested in measuring the aggregate marginal increase in utility over all exchanges. GDP doesn’t even approach this measure.

Although there are several proposed alternatives to GDP, such as the Genuine Progress Indicator (GPI), let me now propose my own: Net Corporate Profits.

Aggregate all the profits over all the companies in the economy. Given that the IRS already collects this information, it would be dead simple to calculate. Plus it more closely tracks the actual gains experienced by the total market. There is an issue regarding the “exports – imports” aspect, because domestic companies routinely profit from wage and commodity price differences between countries. There is also an issue regarding government distortions which might increase short-term profitability at the expense of sustainable practices (i.e., corporate welfare). But, given the under-reporting that companies engage in when communicating this figure to the IRS and the complete absence of individual profits, it low-balls the ideal metric considerably. Despite obvious failings, I think it’ll still be more informative, and make for less damaging policies, than the GDP formula above, because it discourages spending for spending’s sake.

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