Let’s talk GDP.


I have brought up the gross domestic product (GDP) of the United States and many other nations in prior posts. I sometimes employ the gross national product (GNP) instead of the GDP (footnote). And at times I will refer to the per capita GDP (footnote). Depending on which you choose, rankings change quite dramatically. For example the US and China vie for the number one spot in GDP and GNP. However, the United States is only 9th in per capita GDP and China is 70th (according to the World Bank). Seriously, Botswana has a higher per capita GDP than China! Qatar and Luxembourg top the list of per capita GDP nations and register levels nearly twice that of the USA (although the Central Intelligence Agency lists Liechtenstein as the per capita GDP leader and ranks the USA 13th.)

[Source: Gross Domestic Problems, by John Mauldin – I borrow liberally from Mr. Mauldin]

Having said that, I knew very little about the GDP. The measure was actually invented in the late 1930s when President Franklin Delano Roosevelt (FDR) needed some way to prove that his policies were working (so is it possible politics played a significant role in the formulation). And at 85 years old, it may well be time to retire the formula.

[From the Mauldin article] The only way for Roosevelt to show that his policies were working was to put government spending inside the GDP number. There was vicious fighting among economists over whether he should be allowed to do so. Many economists even argued that military spending should not be included in GDP because it didn’t produce anything.

The GDP formula is C + G + I + NX, where

C = Consumer spending
G = Government spending
I = Private investment
NX = Net exports.

Because the USA has for years run a trade deficit that deficit is subtracted from the remaining three components. Is it any wonder that President Trump wants to turn that around. [However, I must state that I favor free and unfettered trade and disagree with President Trump’s protectionist tendencies (see this excellent Daniel Mitchell piece and click on every link).]

Let’s take a quick example of how it is easy to distort the numbers. Take, for example, the simple task of cleaning your house. Mr. Mauldin explains: You consume some cleaning products, but your labor doesn’t count, no matter how long you scrub. But the labor does count toward GDP if you hire someone and pay that person to do the exact same work while you take a nap. The hired labor “produced” something of value, and you did not.

A stranger and more disquieting example is that a barrel of oil selling for $100 has the exact same effect on GDP as two barrels of oil selling at $50. Hmm.

The issue becomes much more dicey when one looks at the modern economy compared to the economy when the GDP calculation was invented. In the 40s and 50s America built a lot of cars, machines and roads. Those types of things are easy to add up when calculating the GDP.

Today we still do a lot of manufacturing (35% of GDP). However, we accomplish that with far fewer workers (only 9% of US workers are involved in manufacturing). We are producing more stuff than ever, but we are doing it with far fewer people. But unlike the 40s and 50s, today we produce large quantities of intangible goods: computer software, movies, music, etc. Productive capacity often exists inside some smart human’s brain. How do you measure that?

I’m not suggesting that I have a solution or even that a “solution” is required. However, that FDR, the über progressive, had it invented gives me pause, as does the fact that the formula has been static for 8 decades while the economy isn’t remotely the same as it was when the formula was first proposed.

Roy Filly

Footnote:

Gross Domestic Product = the total value of goods produced and services provided in a country during one year.

Gross National Product = the total value of goods produced and services provided by a country during one year, equal to the gross domestic product plus the net income from foreign investments.

Per capita GDP is a measure of the total output of a country that takes gross domestic product (GDP) and divides it by the number of people in the country. The per capita GDP is especially useful when comparing one country to another, because it shows the relative performance of the countries.

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About Roy Filly

Please read my first blog in which I describe myself and my goals.
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