Thursday, August 25, 2011

Why do we care about GDP?

In Bob Murphy's post on the broken window fallacy, Robert Fellner asks why we even care about GDP. He writes:

"So why are we so obsessed with GDP?! And I think the above definition of “economic growth” is more than just unfortunate, its entirely inaccurate.

I really don’t get this. I thought economics was about the study of people making decisions and dealing with scarcity via division of labor etc. Instead it seems like well sure that world is made poorer, but in our fictionalized “economy” increasing spending is a sign of growth. We even have a statistic called GDP that goes up when spending does, so all we need to focus on is increasing GDP because that represents “economic growth”. But that doesn’t mean anyone is actually better off! So why is this our goal?!"

He also writes a blog post about it here, where he spends a lot of time presenting what is essentially Higgs's critique of government spending in GDP.

I basically agree with his analysis in the comment (not his analysis on his own blog), but disagree with the conclusions he's drawing from it. No, of course GDP isn't a measure of "wealth" - that can be dismissed entirely. It's not a measure of the health of the economy either. I don't know what a "healthy economy" means or should mean, but if it means anything I'd imagine economic health would have to do with total welfare, and as anyone who's identified the producer and consumer surplus in a supply and demand graph knows, PQ does not equal total welfare.

So what is GDP? PQ, basically. Why do we care about it? Because we highly evolved apes spend a lot of effort producing and exchanging things, and the behavior of production and exchange seems amenable to scientific study. That's why we care about it scientifically. I think what Fellner is getting at is why we care about it socio-politically?

I don't think this is all that hard. Is it a measure of total economic health? No. But it is a measure of how much people earn or how much people spend in a given time period. If your earnings dropped 6% next year would you care? Yes. If you spent 6% more next year would you care? Yes. I think we have our answer. No, GDP is not a measure of health or wealth. Of course not. It's a measure of gross domestic product. Must we only care about ultimate ends? Can't we care about our income level? After all, while income is not health/happiness/welfare, these things are certainly a function of income.

The other important thing that's relevant now, of course, is that in a market economy we make our way in the world through wage labor. Not only is that how we support ourselves, but it's become a major facet of our identity (what jobs we hold). For good or bad, it's a big deal. Demand for goods is not demand for labor, but that doesn't mean it's irrelevant. Employment tracks output quite closely, for obvious reasons. If you care about working people you're going to care about economic output.

When economists talk about "growth" it's usually a reference to GDP growth. If we had a metric for welfare or if wealth statistics were more readily available, we'd probably have to be more explicit when we use the word "growth". But we don't, so it is what it is. GDP definitely seems like something worth studying, and it also seems like something worth caring about too.

A lot of this broken window fallacy talk has revolved around the obvious point that disasters make us less wealthy. So you might say "well shouldn't we be worrying about wealth"? Yes. Of course. If you think somebody hasn't been worrying about wealth, you're misreading the situation. This is why Krugman has not proposed going around breaking windows. It's quite possible to care about both GDP and wealth. But wealth is hard to track because your wealth is largely dependent on the market value of your stock of stuff. And of course, the market value of that stuff is largely dependent on movements of the market - i.e. - GDP. So even if we'd like to track wealth, that's hard (it's done, to be sure, but it's hard). If you want to track econoimc welfare or well-being, forget about it. When neuroeconomics really gets off the ground maybe we'll have something on that, but not right now.


  1. I dislike the net exports part of GDP.

    People don't become poorer by consuming foreign products. Wouldn't we want to consume as much as we produce domestically without sending it abroad and also get to consume what we get from abroad, and send back less to them in return? People can't eat, drink, or wear foreign exchange reserves, and they can only be denied use of what is bidded away abroad.

    Reasonable objection: "But that imported output is not produced at home. That's why it is called a domestic product." Well, that's why it's trivial, this net exports thing. There is a need for a statistic that takes in the benefit of foreign investment and the benefit of foreign goods.

  2. re: "People don't become poorer by consuming foreign products."

    Prateek - GDP is not a measure of how poor you are.

    re: "There is a need for a statistic that takes in the benefit of foreign investment and the benefit of foreign goods."

    Wouldn't that just be "foreign investment" and "imports"?

  3. My conclusion is that economics is far too important to be left to economists.

  4. Blogger needs pingback (too long for a comment):

  5. Daniel,

    Thanks for taking the time to address this.

  6. One thing I would add is that there does seem to be a very large amount of economic reporting/analysis that mentions growth in GDP in a way that seems to imply that the topic being analyzed was a net positive. So I think that's where most of the confusion comes from. If in every discussion that referenced an uptick in GDP there followed commentary like yours above, there would be no problem.

  7. Well, growth in GDP is positive wouldn't you say?

    If some things come along with that growth that aren't positive they oughta be reported on as well. But I don't see any reason why we should doubt that growth in GDP is generally positive.

    To know that there are always exceptions (what if GDP grew next year but consisted entirely of rubber chickens?) is good, but lets not hypotheticalize ourselves into a useless silence. GDP growth is good. It's just not the only good.

    Reporters always need to be watched closely. God bless em. They have to translate all kinds of details and nuance into something the public can understand - and usually on a deadline. But they still need to be watched closely.

  8. Daniel_Kuehn, you're still ignoring my central criticism (as well as those that echo it): when a metric is no longer approximating the more fundamental concept you want to measure, you should focus more on finding a _better_ metric to match that concept than on finding a more airtight proof that, yes, you do in fact get a useless and counter-intuitive result by applying this metric where the relationship between the two breaks down.

    To the extent that "maximize GDP" tells us to break windows so we can fix them, we should be saying, "so GDP isn't the right metric here", not "yup, that shore do help GDP", as you / Krugman / DeLong / Yglesias / Callahan / et al are wont to do. This is what's wrong with your approach, not the literal truth of whether you can goose a metric in precisely its domain of uselessness by doing ... useless things.

    Are we in agreement on this?

  9. Silas if you don't care about what GDP is measuring, don't talk about it. Many people still think it's a valuable metric for other things even if it isn't a metric for everything we might want to measure.

    If we had a reliable measure of economic welfare or economic health I would still use GDP as a metric for precisely what we're using it now for.

    Everyone understands what you're saying. It's not particularly complicated. If you really think it's so useless, then don't talk about it. I'm not stopping you.

  10. Sheesh, and Bob said *my* posts were exasperating!

    You're still not getting the point, Daniel_Kuehn: One can recognize GDP as a useful *general* measure, while recognizing it as unhelpful in a specific case and therefore -- *gasp* -- not applying it in that case as if the same conclusions would hold.

    Get that? You can recognize the general merit of GDP -- and use it generally -- while still recognizing that you shouldn't be applying it to a specific case once you see your grounding assumptions aren't valid.

    You seem to be stuck in this mentality that says you have to use (and therefore try to maximize) GDP everywhere, or nowhere. But no, if you have sufficient IQ and understanding, you can recognize that the metric doesn't work for its intended purpose in *some* cases (like when it would justify breaking a window so you can fix it), while still using it for other caes.

    As for why I'm getting involved in these discussions "even though" I don't recognize the merit of the GDP metric in these cases: it's precisely because some people are too stupid, or too poor in understanding, to be able to trace a metric back to its original intended purpose and check for agreement with the task under consideration. And the ability to do so is sorely lacking, as judged by the Keynesians remarking on this topic.

    Gee, I wonder if they have have similar deficiencies in their understanding on other economic topics ...?

  11. Bob was right.

    What case am I applying it to inappropriately Silas? I'm not using it how Robert Felner complained about its use. My whole complaint is that Krugman and Yglesias and others don't use it in that inappropriate way but are reacted to as if they have.

    re: "You seem to be stuck in this mentality that says you have to use (and therefore try to maximize) GDP everywhere, or nowhere."

    Umm, no.

    re: "As for why I'm getting involved in these discussions "even though" I don't recognize the merit of the GDP metric in these cases: it's precisely because some people are too stupid, or too poor in understanding, to be able to trace a metric back to its original intended purpose and check for agreement with the task under consideration."

    If we abandoned every piece of valuable terminology that ran the risk of being misunderstood we would have nothing left to talk about, Silas. People misunderstand things. You're going to figure out how to cope with that. One strategy I use is starting a blog and having a dialogue about these things.

  12. FFS, Daniel_Kuehn, I'm not saying to *never* use GDP, as you're now reading me. I'm saying that GDP is a loose approximation to something more fundamental (how productive an economy is), and in _some_ cases, you have to recognize that typical reasoning about productivity, if it uses GDP as the proxy, does not work.

    One such case is the "GDP" from fixing deliberately-broken windows. In that case, you should be capable of saying (rather than being dragged kicking and screaming to the conclusion) that the GDP pumped up this way _does not_ reflect the kind of "productivity", "growth", or whatever economic goodness that we care about, and therefore the GDP growth should not be regarded as a sign of improvement. Even if you tag on the caveat that you "don't advocate breaking windows"!

    This isn't simply a matter of distinguishing stocks from flows. Here, stock determines your ability to flow. The less capital stock you have, the less productive you can be. An economy where people don't have to rebuild a window is less productive than an economy that has the window already intact -- because the latter doesn't have to draw down its resources to rebuild the window first.

    But no, Daniel_Kuehn -- go ahead and assert that I'm advocating abandoning some terminology in toto simply because I suggested -- *gasp* -- not using it where it will fail to accomplish its intended purpose. That is _totally_ productive to the discussion and not at all exasperating on your part. I'm confident that your economic understanding isn't littered with the problems I'm criticizing.

  13. I agree with Silas Barta, I wrote an article about this recently...

  14. I just experienced some seriously crazy anticipatory broken widow GDP expansion while trying to buy batteries and water at Pathmark and Lowes.

    I saw people buying generators and it made me wonder if you maybe don't necessarily need super strict conditions for a net broken window expansion. I'm very poor and so the $20 I spent on batteries (I couldn't find water!)definitely is coming out of my weekly consumption allowance. I wonder if in a JK Galbraith kind of way there might not be such a direct effect on future consumption in a wealthy society of broken window spending today. I dunno.


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