Book Review: GDP

GDP: A Brief but Affectionate History by Professor Diane Coyle offers an interesting popular history of the concept of gross domestic product (GDP). GDP is a mental construct, and is the result of somewhat arbitrary decisions. The book discusses the history of the idea, tied in with economic history as well as the history of economics.

Book Description

The book was first published in 2014, with the revised and expanded paperback edition published in 2015. The paperback edition is 145 pages (excluding end matter).

Diane Coyle is a professor at the University of Manchester, and runs the website Enlightenment Economics.

What is GDP?

One of the basic questions that always arises in discussion of economics is: how is the economy doing? Gross Domestic Product is an attempt to create a summary statistic of "the economy." However, what we include in that measure determines the answer.

The importance of such a summary cannot be ignored. Coyle on page 13 (all page numbers are for the paperback edition):

President Herbert Hoover had made do with the incomplete picture painted by industrial statistics  such as share price indexes and freight car loadings. This information was less compelling, as a call to action, than an authoritative figure showing the halving of the whole of national economic outputin the space of just a few years.

That is, if the only information you get about the aggregate economy is share prices, you end up caring about what stock investors think. "What's good for the S&P 500 is good for America!" (Many modern economists with a fixation on expectations have fallen into that trap.) Furthermore. since individual economic time series normally diverge, it is always possible to cherry pick data that fits a pre-determined conclusion.

However, what activity you include in your aggregate may determine what picture it paints. Prewar attempts at national accounting did not include government expenditures; they were essentially "private sector GDP." Coyle (page 14):

The trouble with the prewar definitions of national income was precisely that as constructed they would show the economy shrinking if private output available for consumption declined, even if government spending required for the war effort was expanding output elsewhere in the economy. The office of Price Administration and Civilian Supply, established in 1941, found that its recommendation to increase government expenditure in the subsequent year was rejected on this basis.

The need for massive government expenditures during World War II, and the rise of the Keynesian welfare state ensured that GDP was defined in a way that government expenditures were included in the aggregate. Therefore, GDP was yet another innovation that arose as the result of World War II.

The book discusses GDP calculations in general terms, with only a decomposition equation showing up to scare people. I would have appreciated a technical appendix offering more details on the calculations, but the publisher (Princeton University Press) apparently disagreed. The lack of technical details would likely be welcomed by most readers. but I found myself still confused by the discussion of finance in GDP. (The modern treatment of finance in under international standards appears confusing, but probably the only way to understand it is probably going to require going into the details.)

GDP is one of three aggregates that are theoretically equal to each other (in practice, there is a statistical discrepancy, since they are based on three different input data sets):

1. The sum of all production in the domestic economy.
2. The sum of all expenditures in the domestic economy.
3. The sum of all incomes in the domestic economy (Gross Domestic Income, or GDI).

The domestic economy qualification distinguishes GDP from Gross National Product (GNP). Coyle distinguishes them as follows:

GDP counts all the economic output generated within the nation's boundary. GNP counts all the economic output generated by national entities. some of it occurring overseas.

(Update: I changed the previous text to use the quote from the book.) In places like Ireland (where multinationals launder all their profits), the gap between GNP and GDP can be large.If you go back to the literature of the 1960s. GNP was referenced more often than GDP, but modern statistics focuses on GDP.

Furthermore, we can break down GDP growth into nominal (current values) or real (inflation-adjusted) components. The calculation of the price deflator again requires somewhat arbitrary decisions to be made. If the central processing unit (CPU) of a standard computer is 10% faster, but the price is the same, what does that tell us about the generic price of computers?* When price indices are only infrequently updated, the changes can result in massive upward revisions in GDP.

Defects of GDP

The discusses a number of problems with GDP as a concept.

• Comparisons across countries and time are difficult. In particular, the adjustment for exchange rates is difficult. In developing countries, exchange rates often reflect the competitiveness of traded goods industries; otherwise everything else seems cheap to visitors. Whether or not a country is eligible for certain classes of loans from supranational bodies depends upon their per capita GDP levels.
• How to account for increased customization of goods? GDP calculations work best on standardised goods and services.
• What to include? Under-the-table and illegal activity are generally ignored, although estimates of illicit activity are now being incorporated. (The book details the somewhat amusing roundabout methods national statisticians use to estimate such activity, without themselves getting arrested.) Production from within households is ignored. As the book notes, if a widower marries his housekeeper, household production might be unchanged, but measured GDP is lower.
• GDP is not a measure of well being (welfare). There are various methods for measuring well being or happiness, but how one weights the various components is arbitrary. (Since GDP is measured in dollar amounts, weightings in nominal are determined by activity.)
• GDP has had an unhealthy influence on economists. The level of GDP growth is an obsession, and the book is critical of the attempts of the "hydraulic Keynesians" to micro-manage GDP growth (which was the fad in the 1960s-1970s). Some Keynesian readers might object to those passages, but I am not a fan of attempts at economic fine-tuning (following Minsky).
• GDP does not take sustainability into account. If we are just extracting a fixed amount of resources faster, we may be putting our descendants into a deeper hole.

The book describes these issues, but does not offer radical solutions. "Of course, it is a flawed measure" (emphasis in the original) is the best summary of the usefulness of GDP. We just need to supplement with other measures, and have policymakers focus on objectives that matter for citizens (not just the donor class).

Focus on Gross Domestic Income

I believe that a lot of the kvetching about GDP would disappear if we got rid of it, and replaced it with Gross Domestic Income. Since the two values are theoretically the same, we would be theoretically in the same boat. However, economists would be less hung up on their theoretical preconceptions.

If we look at production, economists fixate on the Solow growth model (or some equivalent), and spend their time pontificating on productivity. We end up getting regaled with the tautological advice: in order to raise per capita incomes, we need to raise per capita output! Then, whatever random policy that is favored by CEO's is then presented as a national necessity, since CEO's know all about productivity!

If we dropped production from the story, we are less likely to fall into that trap. We know that we can compare incomes within a country at a certain time quite well, but comparisons across countries and widely separated times are suspect. 

My personal experience of this was when I moved to England in the early 1990s. Like other North American students, I found that prices in England were puzzling: many things I took for granted were relatively expensive, yet others were relatively cheap. (Absolute price comparisons were suspect, as the GBP-CAD exchange rate was swinging around like a drunken monkey.) After a year or so, the answer came to me: living like a Canadian in England was expensive, but living like a Brit was cheap. This appears to me to be a general experience, and makes the idea of international price and wage comparisons highly suspect.

We can use GDI to tell us something useful: has the economy fallen into recession? But we are less likely to waste our time on pointless exercises like wringing our hands over average growth rates per decade, or trying to get an exact estimate on the ratio of the per capita GDP of Canada and the United States (or China). If someone wants to claim that some policies will raise "growth rates", force them to explain exactly how this magic is going to occur.

My suggestion if you read the book is to keep this income/production distinction in mind. My feeling is that many of the issues outlined by Professor Coyle would disappear if we keep gross domestic income in mind.

Concluding Remarks

GDP is a good light read, and offers an interesting take on the development of economics. 

Footnote:

* Before Quantitative Easing, the adjustment of price indices to account for improvements in computers was the thing that got Austrians mad. In their view, it just was a way to artificially raise American GDP growth rates versus other countries (as the book notes, the Americans were the first to adopt these quality adjustments - hedonic pricing.) In my view, they had a point: processing speed is a lousy metric to take into account when judging the usefulness of computers. Whatever advantages the faster CPU gives us are taken away by bloat in the operating system.

(c) Brian Romanchuk 2017