The Problem with Emphasizing GDP

August 10, 2009

The New York Times ran an interesting op-ed this morning by Eric Zencey (professor, DailyKos writer, and more) on the problems associated with Gross Domestic Product. Even if you do not agree with his conclusion (and I don’t agree with everything Zencey says), it is nice to see this issue explained to the general public in a mainstream newspaper. It’s taught in any intro macro course. Here’s an excerpt:

To begin with, gross domestic product excludes a great deal of production that has economic value. Neither volunteer work nor unpaid domestic services (housework, child rearing, do-it-yourself home improvement) make it into the accounts, and our standard of living, our general level of economic well-being, benefits mightily from both. Nor does it include the huge economic benefit that we get directly, outside of any market, from nature. A mundane example: If you let the sun dry your clothes, the service is free and doesn’t show up in our domestic product; if you throw your laundry in the dryer, you burn fossil fuel, increase your carbon footprint, make the economy more unsustainable – and give G.D.P. a bit of a bump.

I don’t know if I would go as far as Zencey does in this article and send GDP to the grave as a measure of economic performance. The problem doesn’t lie with the people who know what its limitations are using it. The problem lies with those who don’t understand its limitations using it (or those who understand it trying to use it to manipulate those who don’t understand the limitations). Furthermore, some of the problems that Zencey points out are not problems with GDP per se but just how BEA measures it.

But Zencey is getting at something when he suggests that we may be better off with a better measure of economic well-being. This argument is even more persuasive given the abuse of the concept on two recent policy issues.

First, on the stimulus package, supporters of government spending programs will point to the fact that such programs have a higher multiplier than tax cuts. That’s true because BEA automatically counts all government spending as being valued at costs. If the government starts a Ditch Digging Program to pay Bob to dig up the ditch and Mike to fill it back up, BEA will count that activity as “production.” On the other hand, if the government just sent Bob and Mike checks (or gave them equivalent tax credits), this “spending” would not be counted in GDP because no “production” took place in exchange for that money. In reality, because the societal value of the ditch digging is zero, society would be better off if Bob and Mike got to sleep all day and still received the checks instead of having the disutility (e.g. pain, tiredness, etc.) that comes with the ditch digging and filling.

Second, on the issue of the environment, critics will often cite how much GDP will drop from the enactment of a carbon tax or cap-and-trade system. But GDP does not count the benefit that is the entire purpose of the cap-and-trade system: improvements in environmental quality. Assume property rights were fully enforceable (i.e. a Coase agreement was possible) with regards to the environment. So I care about the environment and pay you to stop emitting waste from your production. In that world under a better measure of GDP, your “service” to me of not producing something in exchange for money would be counted in GDP just like my contract with the landlord to provide me with housing in exchange for a rental payment is counted in GDP. But such an economic agreement would likely not be counted first off and does not even exists due to transactions costs of property rights enforcement when it comes to the environment. But if such an agreement could take place and GDP were counted properly, one would see that GDP would actually increase from the agreement (or else it wouldn’t have taken place). But under the traditional GDP measure like that which Zencey criticizes, GDP falls. In reality, if government enacted an environmental carbon tax or cap-and-trade policy that was socially optimal, it would produce the same social welfare outcome as the hypothetical Coase case. Hence, under a definition of GDP that was closer to economic welfare, GDP would increase under a properly designed cap-and-trade or carbon tax system.

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