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GDP: A BRIEF BUT AFFECTIONATE HISTORY

 
 

Diane Coyle

 
 

Princeton Univ. Press: Princeton, N.J., 2014, 159 pgs., index, end notes

 
 

Reviewer's Comment:

The book is much more than an academic treatise on GDP, although it is an excellent work on that subject. It is a clear summary of the history of the creation of the abstract concept of a GDP - a statistic designed to give government policy makers an idea of the total economic output of a country for comparative purposes. On this theoretic basis they could claim legitimacy for their ideologically based political actions. The author shows the fundamental faults and short comings of the methods used to create this GDP but accepts that this is the best we can do, at least currently. The story shows that creation of abstract concepts of this sort are directly the result of government bureaucrats and politicians desire to expand the power of governments to control the economic activities in their countries. She indicates that this desire was increased when governments sought to wage war (WWII) and intervene during the Great Depression. Not specifically mentioned, but inherent in this process, was the creation of a new category of academic bureaucrats, economists, who sought to enhance and expand their power as government advisors and officials. It was this new breed of 'secular priests' who needed all the alchemy and augury they could create. One must note also, that as powerful as they sought to be by claiming validity for their prognostications they remain advisors subject to the demands of their political bosses, which demands are for 'answers' that can be used as basis for legitimacy of political policies and programs. Thus, Dr. Coyle's academic, historical description of the origin and development of the concept of GDP and its growth throughout the academic economist industry results in a critique of the entire industry.

 
 

Introduction

- Dr. Coyle, as an author, begins by indicating why the subject of her book is important for readers. The statistic called GDP has become a critical political issue. Governments depend on it. Political careers succeed or fail due to it. In particular GDP has now been linked with the size of government and country debt by assessments of the ratio between them. If government budgets and total debts are deemed too large in comparison with the country's GDP serious problems may be predicted and critical demands on governments may be enforced. Since governments hate to reduce their budgets and don't see how to reduce their debts a solution to be considered is increasing the GDP number. Increasing the real size of a country's total economic output is not that easy. Instead, governments may focus of ways to manipulate the calculations that create this GDP number to increase it. This is entirely possible because the criteria for including or excluding any of the myriad components of economic activities were and are arbitrary.
The author cites "Benford's Law' about patterns in the digits in a statistic that indicate when the statistic has been fudged. She is explicit: "The point of the story of nefarious statistical manipulation is to highlight the importance of GDP in everyday politics and finance." But we read frequently these days about open measures beyond manipulation -such as governments publicly changing the composition of their GDP by adding entire categories of economic activity previously excluded.

So what is this GDP? She explains both what it is and why it is controversial. "GDP is the way we measure and compare how well or badly countries are doing." She continues: "GDP is a made-up entity. The concept dates back only to the 1940's". Further, she notes: 'Yet the primacy of GDP as the measure of economic success has been increasingly challenged, not so much by politicians or economists as by people who see it as the primary symbol of what's gone wrong with the capitalist market economy." By this, of course, she is referring to individuals who do oppose 'capitalism' itself and seek to abolish it. However, I believe that there are indeed politicians and economists who are firm supporters of free markets who question both the calculation of and the political use of GDP. Dr. Coyle writes, "But GDP is also, as this book will show too, an important measure of the freedom and human capability created by the capitalist market economy." And, "This book explains GDP and describes its history, sets out its limitations, and defends it still as a key indicator for economic policy." And. "How well the economy is going is always going to be an important part of everyday politics, and we're going to need a better measure of 'the economy' than today's GDP."

 
 

Chapter 1 - From the Eighteenth Century to the 1930s - War and Depression
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"Warfare is the mother of invention". A brilliant way to begin her discussion. The creation of the abstract concept of 'state' itself and its development since circa 1500 through various constitutional forms were also in response to changes in warfare as analyzed in Shield of Achilles. She notes, "GDP is one of the many inventions of World War II." Terrific. She follows with a clear description of efforts to estimate the power of 'states' on the basis of fundamental economic measures.

The Early Days of National Accounting
The first effort Dr. Coyle describes took place in 1665 when a British scientist attempted to estimate the relative economic factors of England and Wales versus Holland during the Second Anglo-Dutch War. She notes that there were further attempts during the 18th century. The efforts were made because of a recognition of the importance of economic power as a basis for national political-military power. During that century England was almost constantly at war. Books on the history of money and banking show how important the creation of the Bank of England was in providing England with financial power to overcome France. Then, Dr. Coyle notes, Adam Smith separated the economy into 'productive' and 'unproductive' sides. And he counted creation of physical output but not services. The result for a nation's wealth was only its physical assets versus its debts. Smith's categories were accepted through the 19th century. With Alfred Marshall the distinction was dropped. She quotes Marshall, "Wealth consists of material wealth and personal or non-material wealth".

The Birth of Modern National Accounts
The author writes, "The definitions we use now date back to two seismic events in modern history, the Great Depression of the 1930's and World War II (1939-1945)". Further, "The experience of the Depression created this demand for statistics that might help the government figure out how to bring to an end the unprecedented economic slump." She mentions the role of Simon Kuznetess, who is frequently cited in the creation of GDP. However, she includes a point not always noted, "Kuznets, however, specifically saw his task as working out how to measure national economic welfare rather than just output."She then notes that now GDP definitely does not measure national welfare. The desired outcome was for a measure that would INCLUDE government expenditure, especially for war. But the subject was widely debated. They rested on decisions about what really constituted national economic expansion and what purpose measuring it would serve. The government wanted a measure it could use in developing fiscal policy and organizing national production for war. She provides a quotation, "By including all government purchases as part of national products, the GNP statistics established the role of national government in the economy as that of an ultimate consumer." Kuznets was not happy but he lost the arguments. Thus we see that GDP as a concept based on a specific set of statistics was designed from the start as a tool of expanded govenment intervention and manipulation of the entire national economy. An important change this supported was 'the switch to conceiving of government as adding to national income rather than subtracting from it." And by now this view of the role of government is so ingrained in the popular mind that it is difficult to argue against it. Another important economist the author cites is John Maynard Keynes. In Great Britain efforts to calculate national economic power proceeded along with the American efforts.

The Nature of the GDP
- While the effort to measure national income has a long history, there is no such thing in the real (physical) world as a GDP. It is an abstract concept and has become more and more complex.

What Is it? Definitions -
The author writes, "It is surprisingly hard to write down definitions of GDP that do not assume some prior knowledge." "The system for measuring GDP and its components has steadily become more and more complicated too." "GDP can be measured in three ways, in principle equivalent to one another." . "One can add up all the output of the economy, all the expenditures in the economy, or all the incomes." The author provides a table and graphical representation of 'circular flow'. The standard equation is GDP=C + I + G + (X-M) - that is consumer spending, plus investment spending plus government spending plus net exports minus imports. But what specifically in included in consumer spending or investment spending or government spending? And of course the reverse, what actual economic transactions are left out? Mark Skousen in his book - The Structure of Productrion - describes an even deeper problem with measurement of GDP -it only counts final expenditure and ignores the 'roundabout' economy that produces a finish product by many steps. One result is the statement one reads constantly that the consumer makes up 70% of the economy, but this ignores the multiple levels of producers who add value and participate in the market as well.

 
 

Chapter 2 - 1945 to 1975; The Golden Age

- The story of the development of GDP as a theory. Dr. Coyle begins with discussion of the devastated condition of Europe and the Marshall Plan. She writes "the growth of GDP is the single most important benchmark measure of how an economy is doing." And its growth showed that the Marshall Plan was working as Europe recovered. And this was a result of extensive government planning and control. She writes, "the foundations of prosperous modern consumer societies were being laid." This is why it can be called a 'Golden Age'. But now we read a critical comment. "It is one of the distasteful aspects of a disaster that the immediate consequence is a boom in GDP growth. GDP does not measure the nation's assets or balance sheet, only its flow of income, expenditure, and production from year to year. Wipe out a portion of the assets, whether through natural or man made disaster, and the activity or repairing and replacement will increase the growth of GDP."
And this is what happened after World War II. Terrific - just what I have claimed for years, The costs of repairing broken windows adds to GDP. Some commentators even pointed out after Sandy storm that the repairs and replacement of destroyed homes and infrastructure would add to GDP as if that was a great benefit. Meanwhile much work that does add to real wealth is not counted. But the worst aspect is that the concept of GDP was designed in the first place to enable government spending to be counted. Plus expenditures generated by credit-debt are included.

Dr. Coyle then includes a table showing GDP growth rates between 1950-1973 compared to between 1973-1998 to indicate that the higher growth rate for the earlier period was boosted by Marshall spending. Dr. Coyle notes that "There is no simple explanation for the thirty-year success story." She mentions several that she questions. But she writes: "Perhaps as important was the steadily improving availability of consumer goods, and the virtuous circle of consumer spending, increased output of consumer goods, increased employment, and higher incomes." What she does not mention is that this 'mass consumerism' was (and is) based on expanding credit-debt - in other words this immediate spending is funded by built in decreases in future spending. She does note (favorably) how recent is this 'mass consumerism'.
In her next section she discusses the use of GDP" as a tool for comparison between the economic conditions in different countries. She credits the UN with establishing ideas and rules to make GDP calculations comparable. One has to question the validity of creating GDP figures retroactively into the past, given the questionable nature of historical data. She does raise important issues (questions) about the impact of exchange rates on such GDP data. Also there is the problem of how much economic activity in a given country actually involves official markets. She describes the concept of 'purchasing power parity" ( PPP ) as a solution. The Economist Magazine has a simpler method based on its McDonald Big Mac cost comparisons. And she notes that PPP is controversial. She describes some of the arguments in detail. Of course all this effort in data collection and statistics is to make comparisons between countries appear valid. And such comparisons then are the 'bread and butter' of politicians. They are used to support ideological theories created to legitimize political policies and actions. She notes that the early theories had weak at best real data bases even though they were manipulated by elaborate math and algebra.
Her final comment is key. "Economists were confident that they knew how to use government spending and taxation to manage GDP, using the mechanics of the circular flow developed in the national accounts. But the Golden Age was not to last."

 
 

Chapter 3 - The Legacy of the 1970's: A Crisis of Capitalism

- Dr. Coyle describes the situation clearly. "After the postwar boom, Western capitalism started to falter, and its troubles were various. There were four distinct challenges to conventional economic thinking by the 1970's, challenges that corresponded to disturbing developments in the global economy.." She identifies the first 'problem' with the trend for declining GDP" growth accompanied by increasing inflation. - The so-called 'stagflation'. "Conventional economic management tools seemed to make matters worse rather than better." Indeed so - read Keynesian for 'conventional'. She claims the second problem was the 'Cold War' itself. And she thinks that MAD was 'correct'. (digression here) Then her third challenge is the emerging environmental movement. And I agree with her. And her fourth challenge was the failure of the newly 'developing nations' to achieve the economic success that the establishment economists claimed for their nostrums. She correctly fingers the policy programs that substituted 'welfare for growth'. In terms of the book's purpose she writes: 'This, too, has proven a lasting challenge to the dominance of GDP". She continues that the four challenges to conventional economic thought resulted in 'the most profound crisis of capitalism since the Great Depression and until our own Great Financial Crisis".
Without coming right out to say it, she asserts that the entire superstructure of economic theory built around focus on GDP was responsible for the mismanagement that created this mess. Or at least I can infer that conclusion from her evidence. She then describes the era of 'Stagflation' in relation to data on GDP changes. And she notes, "There was, in a way, too much growth. The tools of demand management proved too tempting and were used to boost the economy whenever there was a business cycle downturn. But lower interest rates and extra government spending (or tax cuts ) were generally used to try to limit downturns and keep the level of employment high." In other words the establishment economic theories were used to support political policy by preventing the normal period of deflation that is created by a period of inflation. The economy had been floated on a cloud of credit-debt and when that began to contract it could no longer support the irrationally expanded production.
Here she fingers the central problem. "The definition of GDP was constructed around Keynes's model of how the economy works." But politicians, responding to public demands, refused to allow the normal results of a market economy responding to deflation. She describes some of the actual battles between unions and employers - governments. But then, unfortunately, she claims the "Philips curve' is valid. She continues: "The dismal economic experience of the 1970's paved the way for both a revolution in thinking about the economy and a political revolution, too. In economic theory, there was a loss of faith in the simple Keynesian demand management tool of adjusting the government's budget deficit. Instead, the new consensus was that the government should concentrate on creating a good environment for business."
She writes much more, but concludes, "for the first time in a generation economists were not confident they had the answers". Well, lets limit that to the dominant establishment Keynesian economists. Austrian School economists following Ludwig von Mises and Frederick Hayek had since the 1920's proposed theories about the real workings of economies. They were more than ever confident that they had the answers politicians had suppressed. Dr. Coyle continues with a section on Communism and one on Environmentalism and one on developing nations in which she relates these to ideas about GDP.

 
 

Chapter 4 - 1995 to 2005: - The New Paradigm

- This chapter contains much worthwhile food for thought. In this chapter the author describes shifts in thinking by establishment economists as a result of their previous failures. She summarizes: "This menu of policy choices was mirrored by the development of a new consensus in economics, which also downplayed the scope for activist fiscal policy and instead emphasized the role of the central bank in providing monetary stability." She focuses on the disputes over economic concepts between Keynesians and monetarists. (meaning the Chicago school principally). In this the concept of 'economic growth' is related to the concept of GDP as a measure of this 'growth'. (I object to this term 'growth' since economies expand rather than grow). Anyway she cites the availability of more refined data. Her chapter title refers to the then increasing use of the terms "new Economy' or New Paradigm' based on the expectation that computers and IT in general was creating a new economy. She rightly notes that: "From today's side of the financial crisis, the New Economy hype looks almost delusional." Great insight.
She moves on to describe the difficulty in using GDP estimates when the economy is shifting more and more from manufacturing countable items into services many of which do not even enter into usual financial accounts. Plus there is the problem of adjusting for changes in quality rather that changes in quantity. What does 'productivity' even mean? She notes that GDP does not capture 'innovation' well. She writes: "The lesson to draw from this discussion is that GDP is not, and was never intended to be, a measure of welfare." Wonderful - by 'welfare' she means not government welfare subsidies but the broader concept of the 'quality of life' of the population at large. But I believe Dr. Coyle ignores the increase in influence of Hayek and Austrian school economic theory.

 
 

Chapter 5 - Our Times: The Great Crash

-Dr. Coyle begins with this: "There are three elements to classic Greek tragedy: arrogance, foolishness, and destruction: hubris, ate, and nemesis." She continues: "The arrogance was the triumphalism about the prevailing model of economic growth." Unfortunately, she does not address the real causes of the collapse of the mortgage market and the subsequent expanding influence that had. She sticks to the establishment story that it was all caused by 'greed', in the private financial industry. But, in keeping with her subject, she focuses on 'two fundamental issues the crisis raises about measuring economic output.' The first is the growing role of the financial sector itself. In this she is very right and her view deserves wide appreciation. In part this includes how and why the financial sector's activities are measured and included IN the GDP number. I have long objected to the huge percent attributed to the financial sector in not only GDP but in the various weights of stock market indices. The establishment considers that the financial sector contributes greatly to the economy, while I think it is mostly a parasite that sucks wealth from real producers. Dr. Coyle's lengthy discussion makes the whole book worthwhile.

There is much more in this chapter. A most telling comment is: "GDP is a constructed statistic that can rise without limit." She then launches a lengthy discussion of whether GDP and other economic statistics are valid measures of 'happiness'. But 'happiness' is not an economic concept and cannot be measured by ANY economic data. But she is only the messenger on this issue, reporting what establishment economists are thinking.

 
 

Chapter 6 - The Future: Twenty-first Century GDP

- This chapter is a summary with some ideas about the future of GDP as a means for measuring a country's economic condition. She writes: "This book has described the origins and evolution of GDP, the measure of economic performance used all the time in the media and in the world of economic policy. And in this she has achieved her goal very well. He conclusion is that despite the many problems she has identified GDP is still the best tool we have. But she also concludes with this remark; "At present, we are in a statistical fog, without the information needed about either the negative aspects of growth when it is unsustainable and depletes the natural and other assets available for the future, or the positive aspects, when it delivers innovations and creativity."

 
 

References

 
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Lawrence H. White - The Clash of Economic Ideas: The Great Policy Debates and Experiments of the Last Hundred Years Dr. White describes the origin and purpose for the creation of the theoretical concept of GPD.

 
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Frederic Mishkin - The Economics of Money, Banking, and Financial Markets Ninth Edition

 
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