How GDP figures have much hype built around them, when they have their own downsides and convey little
One of the major reasons why people don't like reading articles on business, economics and finance is because they are full of jargon. The writers of these articles seem to be comfortable catering to the small audience that understands their jargon-laden writing.
John Lanchester writes in How to Speak Money, 'As your vocabulary becomes more specific, more useful, more effective, it also becomes more exclusive. You are talking to a smaller audience.
Lanchester then goes on to explain how this process works itself out. 'There are a lot of things...in the world of money where the explanation is hard to hold on to because it compresses a whole sequence of explanations into a phrase, or even just into a single word,' writes Lanchester.
Take the case of GDP or gross domestic product. This abbreviation (actually, we can even call it a word, given how often it is used without its full form) is widely used these days. But do people actually understand what it means?
Simon Kuznets, a Belarusian-American economist who won the Nobel Prize in economics in 1971, developed a system of 'national income accounts'. Tim Harford explains the term in The Undercover Economist Strikes Back. As he writes, 'Kuznets developed a system of 'national income accounts', a logically consistent framework for adding up all the income in the economy--or all the production, which turns out to give the same result. The centrepiece is a number called the gross domestic product or GDP. This measures the total value of all the stuff that is produced in the economy.'
The total GDP of the world amounts to around $70 trillion and this, as Harford writes, includes 'all the smart phones and tablet computers, barrels of oil and kilowatt-hours of wind energy, haircuts and Brazilian waxes, sacks of rice and cartons of fried chicken wings, and everything else produced in the entire world.'
The trouble is that GDP looks at value and not worth. As Harford puts it: 'A Brazilian wax might have the same monetary value as the cost of a week's food for a poor family.'
Further, lots of good things do not add to the GDP. As John Kenneth Galbraith writes in The Economics of Innocent Fraud, 'Good performance is measured by the production of material objects and services. Not education or literature or the arts but the production of automobiles, including SUVs...The best of human past is the artistic, literary, religious and scientific accomplishments that emerged from the societies where they were the measures of success.'
Galbraith gives several examples of the success he is talking about. 'The art of Florence, the wonderful civic creation that is Venice, William Shakespeare, Richard Wagner and Charles Darwin, all came from communities with a very low gross domestic product.'
While a lot of good things don't add to the GDP, a lot of bad things do. As Lanchester writes, 'The famous-to-economists example is divorce: When people get divorced, they pay lots of lawyers' fees. This adds nothing to anybody's happiness except the lawyers', but it adds plenty to GDP.'
Since we are talking about divorces here, what a homemaker does in order to keep the home running and manage the kids doesn't get added to the GDP. Nevertheless, if the couple divorces and the former husband hires his former wife as the housekeeper, the salary that he pays gets added to the GDP. The vice versa also stands true.
This is a controversial area when it comes to measuring the GDP. As Harford puts it, 'Household production has long been one of the most controversial omissions from GDP. Simon Kuznets...was keen to include estimates of it. He thought that would make GDP a better measure of national welfare.' But that never happened.
Let's talk about houses now. As Lanchester writes, 'Your house has just burnt down, and you've lost everything? That's too bad; on the other hand, it's great for GDP because you're going to have to rebuild it and re-buy all stuff.'
The irony here is that the value of a new house is being added on without taking into account the value of the old one that has been destroyed.
Hence, building of a new home leads to a faster growth in GDP, even if there are enough homes going around already for people to live in. As George Akerlof and Robert J. Shiller point out in Animal Spirits, 'Residential investment (mostly construction of new homes and apartment building as well improvements in existing homes) rose from 4.2 per cent of the US GDP in the third quarter of 1997 to 6.3 per cent in the fourth quarter of 2005, and it had fallen to 3.3 per cent by the second quarter of 2008. Thus, it has been a significant factor in the recent US economic boom and bust that followed.'
Nevertheless, once people stopped buying homes, builders stopped building them and the GDP growth collapsed.
Further, GDP is what Lanchester calls a 'rough-and-ready tool'. This means it doesn't get around to measuring everything correctly enough. Harford provides the example of the financial services sector in Great Britain. As he writes, 'Andrew Halande of the Bank of England points out that in the UK banks made their largest ever contribution to GDP growth in the final quarter of 2008 - the quarter immediately following the collapse of Lehman Brothers and implosion of the banking system across the world. This quite obviously reflects the fact that we don't do a good job of measuring the value of banking.'
Also, too many economists and media reports link the growth in GDP to welfare of people. These are two different things. As Kuznets put it, 'The welfare of a nation can scarcely be inferred from a measurement of national income as defined by GDP...goals for 'more' growth should specify of what and for what.'
There are many such issues surrounding the GDP. To conclude, the next time you read or hear the abbreviation, remember there is much more to it than what seems to be.
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