Everything You Always Wanted to Know about GDP (but were afraid to ask)

1. Everything You Always Wanted to Know about GDP (but were afraid to ask) CLAS Mini-College Presentation 24 May 2010 Professor Joshua L. Rosenbloom

2. Economic Measurement Issues • Some types of measurement seem simple—e.g., length • But others entail summarizing multiple dimensions • This is usually the case in economics • How, for example, do we summarize the activities of an entire economy? • Economists have developed a range of indicators • GDP • CPI

3. GDP is used as the conventional measure of economic growth From the New York Times, 26 March 2010

4. “No measurement without theory” • Every measurement answers a particular question • The question arises in the context of a theory • To understand the measurement we must • Understand the theory • Know what question the measurement answers

5. Today’s take home lessons • GDP and other economic statistics are grounded in economic theory that provides a rationale for their construction • It is possible for reasonable people to disagree about the choices that underlie the construction of these statistics • Understand what choices are embodied in official GDP statistics and why they matter

6. Agenda • Brief history of income measurement • Formal definition of GDP • Adjusting for the cost-of-living (real GDP) • Interpretive issues

7. A brief quiz Questions Answers $14.26 Trillion $46,400 $8.79 Trillion (Purchasing Power Parity) Or $4.81 Trillion (Official Exchange Rate) $6,600 (PPP) • How big was U.S. GDP in 2009? • What was U.S. GDP per capita in 2009? • How big was China’s GDP in 2009? • What was China’s GDP per capita in 2009 Source: CIA World Fact Bookhttps://www.cia.gov/library/publications/the-world-factbook/index.html

8. Measuring the National Economy • GDP seeks to answer the question: “How Big is the Economy?” • Efforts to answer this question began at least as early as 1665 with Sir William Petty in England • He adopted a broad definition seeking to to measure the “Annual Value of the Labour of the People” and the “Annual Proceed of the Stock or Wealth of the Nation.” • Others adopted a narrower definition • In France Quesnay (1764) believed only agriculture produced a net product

9. Modern Era of Measurement • There was no continuous, real-time measurement of GDP before the 1930s • Several American efforts in the 19th century • Seaman in 1952 • King 1915 • National Industrial Conference Board began to produce annual estimates in 1920 • About the same time the National Bureau of Economic Research produced retrospective estimates for 1909-19 • The first government effort was produced by the FTC in 1926 • In 1932 the Senate Called on the Secretary of Commerce to produce estimates for 1929-1932 and then to continue these going forward • Intellectual leadership was provided by Simon Kuznets

10. Modern Definition of GDP • GDP is defined as the market value of all final goods and services produced within a country during a specified period of time • Note that GDP is a • Monetary quantity – it is measured in dollars • Flow -- dollars spent per unit of time

11. Key features of GDP: market prices • Market prices reflect the opportunity cost of purchasing an item • Money spent on one item is not available for other things • So market prices tell us the relative value that all consumers place on different products

12. Key Features of GDP: Final Goods and Services • Final goods and services are those used by their ultimate consumers • Distinct from intermediate goods purchased by one producer from another • This avoids double counting

13. A Simple Example

14. Key Features of GDP: Within a Country • GDP focuses on the location of production • GNP measures income of American citizens wherever located

15. Key Features of GDP: Gross Product • Gross vs. Net • Refers to treatment of capital depreciation • Net product subtracts an estimate of investment needed to maintain the capital stock • Gross product reflects focus on total available production • It is not the best measure of sustainable consumption

16. Three Routes to GDP • We defined GDP as a measure of goods and services produced, but… • Production = Income • Production = Expenditures • So Production = Income = Expenditures • We can measure the same concept in three different ways • System of National Accounts provides these different perspectives

17. Real GDP • Because GDP is measured in $ it depends on both • Physical production • Prices • To isolate changes in the physical quantity produced economists us real GDP • To do so we use a constant set of prices • But the choice of what prices can have a big effect

18. Calculating Real GDP

19. How much did GDP grow?

20. The Conventional View of Economic Activity in WW II

21. But the Definition of GDP Matters • Kuznets, National Product in Wartime • National accounts are based on definite assumptions about the “purpose, value, and scope of economic activity.” • War magnifies these conceptual difficulties by “raising questions concerning the ends economic activity is made to pursue…” and the “distinctions between intermediate and final products.” • “War and peace type products…cannot be added into a national product total until differences in the valuation due to differences in the institutional mechanisms that determine their respective market prices are corrected for.”

22. Kuznets’ revised wartime GDP

23. Higgs’ revision of Kuznets

24. Which is the correct picture? • There is no one correct answer • It depends on the question we want to answer • The official series captures wartime mobilization of resources • Clearly the economy was capable of marshalling substantial resources • But not all of these were devoted to final goods and services that directly raised welfare • These are illustrative of broader conceptual issues that have been raised by critics of GDP

25. Allen Field House – March 18, 1968

26. Kennedy’s Critique of GDP Too much and for too long, we seemed to have surrendered personal excellence and community values in the mere accumulation of material things. Our Gross National Product, now, is over $800 billion dollars a year, but that Gross National Product - if we judge the United States of America by that – that Gross National Product counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage. It counts special locks for our doors and the jails for the people who break them. It counts the destruction of the redwood and the loss of our natural wonder in chaotic sprawl. It counts napalm and counts nuclear warheads and armored cars for the police to fight the riots in our cities. It counts Whitman's rifle and Speck's knife, and the television programs which glorify violence in order to sell toys to our children. Yet the gross national product does not allow for the health of our children, the quality of their education or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our wit nor our courage, neither our wisdom nor our learning, neither our compassion nor our devotion to our country, it measures everything in short, except that which makes life worthwhile. And it can tell us everything about America except why we are proud that we are Americans.

27. These themes have been echoed by others • Not everything included in GDP appears to enhance well-being • Locks for our doors, jails, etc. • There is no deduction for environmental damage or resource depletion • Pollution, the destruction of the redwood • It fails to count things not traded in markets • The beauty of our poetry, the strength of our marriages

28. The Genuine Progress Indicator • Produced by Redefining Progress • Begins with the official GDP data • Makes a series of adjustments • Deducts expenditures judged unproductive • Deducts estimates of the cost of pollution and resource depletion • Deducts for reductions in leisure time • Adds an estimate of unpaid family and household work • Adjusts for negative effects of inequality

29. GPI and GDP per capita, 1950-2004

30. GDP and GPI are answers to different questions • GDP asks how much is produced? • It accepts the value of those goods and services to the individuals who purchased them • It doesn’t attempt to account for environmental consequences • Nor does it attempt for the most part to value non-marketed goods • The GPI asks how does this production relate to welfare? • It is one possible answer • But because it inserts judgments based on non-economic considerations it is possible to question many of these • There is no one right answer

31. Conclusions • There is no measurement without theory • GDP is founded on microeconomic theory • This theory justifies the use of market prices • And the focus on goods and services exchanged in markets • But it also accepts the limits that this theory imposes • It cannot adequately incorporate non-market transactions • Most importantly our transactions with the natural environment • There is a need for better measures of sustainable production

32. Further Reading • U.S., Dept. of Commerce, Bureau of Economic Analysis. Measuring the Economy: A Primer on GDP and the National Income and Product Accounts (Sept. 2007) http://www.bea.gov/national/pdf/nipa_primer.pdf • Carson, Carol S. “The History of the United States National Income and Product Accounts: The Development of an Analytical Tool” Journal of Income and Wealth (1975), 153-181 • Krueger, Alan B. Measuring the Subjective Well-Being of Nations: National Accounts of Time Use and Well-Being (University of Chicago Press, 2009 • Stiglitz, Joseph E., Amartya Sen, Jean-Paul Fitoussi, “Report by the Commission on the Measurement of Economic Performance and Social Progress” http://www.stiglitz-sen-fitoussi.fr/en/index.htm • Redefining Progress, The Genuine Progress Indicatorhttp://www.rprogress.org/sustainability_indicators/genuine_progress_indicator.htm