Limitations with (just) measuring GDP Growth

Spinning off from the Happy thread as not sure its best place to debate economics: This post by myself which prompted replies from wiggin and GGT

GDP is one of the simplest measures of a countries economic health and one of the simplest economic formulae:
Y = C + I + G + (X - M)

Or in English:

GDP = Consumption + Investment + Government expenditure + (exports - imports)

However there are limitations both to the practicality of measuring this and to the overall importance of what it is measuring.

Firstly for Government expenditure all expenditure regardless of whether or not it is fully funded, efficient, needed or any other concern is counted. It is a measure of quality not quantity. Thus if a country runs a major deficit spending on vanity projects that it is not raising revenue for and achieve nothing significant (which we would all I hope consider a bad thing) that expenditure is counted on the positive side when counting GDP. Spending on education is measured the same regardless of the quality of education. A government can hire one person to dig a hole, another to fill it in and both people's salary are added to GDP.

Secondly the ability to accurately measure all components is limited. Private consumption does not all get tallied centrally by government accountants, especially in any sectors which involve "cash in hand" etc whereas government spending almost by definition is more accurately counted - you should hope! This means that figures are at best an estimate and can be incorrect.

Finally for now all that is measured is quantity not quality. You can get an iPhone 5 or Samsung Galaxy S4 or whatever else you want for basically the same cost today as an oldfashioned Nokia 3210 would cost a decade ago. Therefore that part of the measurement reveals no "growth" or improvement despite the fact that a modern touchscreen is world's apart from a Nokia 3210. Technological progress can be measured somewhat as we become more efficient we can consume and spend more but sometimes we consume the same but better and that's hard to reflect in the numbers.

GDP is an important measurement and tool but is by no means the be-all and end-all. I furthermore believe that it can be somewhat misleading as to the result of government interactions as they form such a key part of the measurement without counter-measures. If an economy is rebalancing away from unfunded and unsustainable government expenditure towards a sound balanced private/public footing then this is measured as a negative input into GDP despite being arguably a good thing.

1: A reduction in government expenditure, even if purely from efficiency savings (so the same outcomes actually occur) reduces GDP by reducing the G component.
2: If private Consumption/Investment is underestimated by being harder to measure or being in newer areas then even if that is rising as fast as government expenditure is falling it may incorrectly be said that GDP is falling when it is not.

I wanted to split this into two posts, the first a non-national general thought on the problems of measuring GDP alone and the second on the specific issues raised in the other thread about Britain.

Now in specific reply to the points raised in the other thread:

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Originally Posted by wiggin

Growth has been quite anemic and should be quite troubling to the UK's leaders. Obviously an early switch to austerity has some blame for this, and it might indeed have better results in the long term. But playing down the large and persistent output gap is probably not wise. Honestly the only major positive area is employment, and even that isn't fantastic (and productivity is markedly down).

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I don't disagree that GDP as measured has been anaemic for a while. However it is worth noting that the figures have been getting revised upwards recently. I have the feeling (no proof) that in coming years it is going to grow further and faster. Q1 of this year exceeded expectations, Q2 of this year is due to be announced on Thursday and I expect it will show growth above previous expectations too. The IMF recently increased its prediction for the UK while reducing across the board the rest of Europe, with us any nation in the Eurozone. During all this time of austerity private sector employment has grown faster than public sector has fallen which is why I feel that the GDP figures are a bit misleading as to the true health of the economy. It will be interesting to see what Thursday brings.

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Originally Posted by GGT

No offense, but you are either delusional or in denial. Maybe you got bit by the Olympic bug, and can't distinguish between current day reality and future optimism?

Based on numbers and statistics, the UK is still in recession, possibly a triple dip recession.

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Simply and categorically false. Recession has a technical definition and the UK left technical recession back in 2009. It was previously thought we had re-entered recession in 2012 (aka "Double Dip") and that we might re-enter it in 2013 ("Triple Dip") but the 2012 recession was revised away as never having happened and there has been growth this year so no dip now either. There was only one recession, which we've not fully recovered from, back in 2008/9.

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Your austerity measures haven't increased GDP, employment rates, currency values....or held inflation rates at steady levels.

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GDP growth has been fairly anaemic yes, its up on its base in 2009 but not by much and certainly not recovered to 2008 levels. But I always said pre-recession that such government spending was unsustainable. Austerity isn't supposed to increase GDP, its supposed to make the nation's economy sustainable.

As for the rest you're again wrong. Our employment rates are up and have been steadily increasing for about 2 years (basically the whole time austerity has been happening). Each quarter in that time public employment has fallen and private employment has increased by more than the fall in public. Overall the net is up, but private alone is up by far more than the net (which is good as the public jobs that are going away were never sustainable). Currency values and inflation have held within reasonable ranges.

Didn't I argue with you about 10 years ago that I didn't think GDP was the end all be all?

I too think including government as a major variable is problematic. After all, why not include loan origination as a component of GDP?

Perhaps a growth calculation should include a component that summarizes real income growth across the population? Then again, they do some calculations to deal with inflation so maybe that's not really necessary.

Jeebus, I need to sleep.

You can fool GDP numbers for a while, but in the long run it's not a terrible statistic. Economies in the long run exhibit trend growth rates which are largely independent of transient stimulus or recessions, mostly driven by population growth and technological advancements (in turn increasing productivity). Everything deviating from trend growth has a reason - either slack in the economy from cyclical factors (as many economies, including the UK, are currently experiencing) or large amounts of deficit spending or some other explanation (like a bubble). Most of the time you rapidly get back to trend growth because the fundamentals can't be monkeyed with for too long.

In the case of government spending, deficit spending too much for too long has effects on other aspects of the economy, so it can't support GDP numbers for long. First, it crowds out private investment and consumption (and can also have an effect on trade). Second, a poor fiscal position can have dire effects on the competitiveness and productivity of an economy, resulting in lower trend growth rates even if government spending is helping support numbers a bit. Conversely, a strong fiscal position can have the reverse effect in the medium term, though care should be taken that spending is not curtailed to the point that it negatively effects other components of GDP (e.g. by hurting infrastructure quality which improves productivity or by cutting R&D spending which increases the pace of technological progress).

This isn't to say that your underlying thesis is incorrect - GDP is hardly the only statistic that matters - but it is more robust in the long run than people commonly think.

Re: the UK numbers in particular, I can't comment intelligently on whether GDP numbers are likely to be revised up in the near future. It's certainly possible, but even with revisions the UK's GDP will still be sporting a very large output gap compared to trend growth (especially compared to other large, rich economies), which is troubling. There aren't that many idle hands, thankfully, but those hands are far less productive than they should be. There's lots of potential reasons given for the UK's relatively poor performance (small business lending? austerity? eurozone messes?) but it definitely isn't some statistical fluke.

So how d'you guys feel about these changes to GDP-calculations:

http://www.businessweek.com/articles...ic-creation#p1

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Originally Posted by wiggin

You can fool GDP numbers for a while, but in the long run it's not a terrible statistic.

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It is terrible for short run analytics. Can you name a member of the House or Senate that votes long term on economics?

Can you name a member of the House or Senate that votes primarily on GDP at all?

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Originally Posted by wiggin

Can you name a member of the House or Senate that votes primarily on GDP at all?

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No, but I suspect that staff uses it as much as they use U3 in advising their boss which way to go. Both are long term indicators being used to find solutions for short term problems. Niether work which is why we find ourselves in a mess of superproductivity with lagging participation...long term unemployment and decline in labor force participation.

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Originally Posted by Aimless

So how d'you guys feel about these changes to GDP-calculations:

http://www.businessweek.com/articles...ic-creation#p1

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I'd agree that using current GDP measurements hasn't kept up with innovations and intangible values, and some kind of change is needed.

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Intangibles include brand-building, worker training, and the development of advanced organizational practices like total quality management, which meet the definition of an investment because they create assets that will produce revenue a year or more in the future, says Hulten. Those, however, will continue to be treated by the government as expenses. Brent Moulton, the BEA’s associate director for national economic accounts, says their investment nature can’t yet be measured accurately enough to use as official data.

That underscores the limits of trying to come up with a single statistical measure of the nation’s economic activity.

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But that last sentence is right. Macro-economics is one thing, but using a single statistic to measure annual "activity" and revenue is no way to run a railroad. It doesn't mean much on its own, and shouldn't be cited as the VIP of numbers. Defining investment as an expense is problematic, too. But that's what happens when theory meets math, and public policy cedes to accountants. :(