by Eric Zencey
Tue Aug 11th, 2009 at 04:02:53 AM EST
GDP is a deeply foolish measure of how the economy is doing, and if we're ever going to have an ecologically sustainable economy, we need to dump it and devise another measurement of economic well-being.
That's the gist of an op-ed I have in the New York Times today: G.D.P. R.I.P.
The published piece is long, but the original was longer; it gave a little more detail. I've posted the original here.
If there's a silver lining to our current economic downturn, it's this: It brings with it a spasm of what economist Joseph Schumpeter called "creative destruction," the process by which outmoded economic structures fail and new, more suitable structures replace them. Downturns have often given a last, fatality-inducing nudge to dying industries and technologies. Very few buggy manufacturers made it through the Great Depression. We see the same dynamic at work today: in the auto industry SUV builders are in collapse while makers of smaller, more fuel-efficient cars muddle through, and in the energy industry firms developing renewable energy sources (photovoltaics, windmills) are gaining market share on the old fossil-fuel energy companies.
Creative destruction can apply to economic concepts, as well. And this downturn offers us an excellent opportunity to get rid of one economic concept that has long outlived its usefulness: Gross Domestic Product. GDP is a deeply foolish measure of how the economy is doing and it ought to join buggy whips and domestic coal furnaces on the dust-heap of history.
Read on... Front-paged with a slight edit by afew
GDP is one way to measure National Income--the sum total of all economic activity in the country. The first official attempt at this sort of reckoning of national accounts was done by order of Congress in 1934, during the Depression. The task fell to the Department of Commerce's Bureau of Economic Analysis, under the direction of economist Simon Kuznets, who led a team that gave an approximation of what was then the main number wanted: Gross National Product, or GNP. (In 1991 the Bureau switched to GDP to reflect a changed economic reality: as trade increased, and as foreign companies built factories here, it became apparent that the basic national income accounts ought to measure what gets made in the US, no matter who makes it or where it goes after it's made.)
Since then GDP has become our single most commonly cited economic indicator, the basic number that we take as a measure of how we're doing economically from year to year and quarter to quarter. But it is a miserable failure at representing our economic reality.
Its shortcomings are well known to economists, who have offered cautions and criticism from the moment we began measuring national income accounts. In his first report of GNP to Congress, Kuznets listed the many things that GNP didn't include, and warned that "the welfare of a nation can...scarcely be inferred from a measure of national income." More recently Federal Reserve Chairman Ben Bernanke said, in the understated language of the economics textbook he co-wrote in 2004, that "Real GDP is at best an imperfect measure of economic well-being."
As a measure of well-being, GDP is at best imperfect (let's be honest: fatally flawed) for several reasons. One, it doesn't include a great deal of production that has economic value. Neither volunteer work nor unpaid domestic services--housework, child rearing, home improvement--make it into the accounts, and our general level of economic well-being benefits mightily from both. Nor does GDP include the huge economic benefit that we get directly, outside of any market, from nature. A mundane example: If you let the sun dry your clothes, the service is free, and doesn't show up in GDP; if you throw your laundry in the dryer, you burn fossil fuel, increase your carbon footprint, make the economy more unsustainable--and give GDP a bit of a bump.
In general the replacement of natural capital services (like drying clothes, or the propagation of fish, or flood control and water purification) with built capital services (like those from a clothes dryer, or an industrial fish farm, or from levees, dams and treatment plants) is a bad trade: built capital is costly, doesn't maintain and repair itself, and in many cases provides an inferior, less certain service. But in GDP, every instance of replacement of a natural capital service with a built capital service shows up as a good thing, an increase in national economic activity. Is it any wonder that we now face a global crisis in the form of a pressing scarcity of natural capital services of all kinds?
This points to the larger, deeper flaw in using a measurement of National Income Accounts as an indicator of economic well-being. In summing all economic activity in the economy, GDP makes no distinction between items that are costs and items that are benefits. If you get into a fender-bender and have your car fixed, GDP goes up. A similarly counterintuitive result comes from other kinds of defensive and remedial spending: health care, pollution abatement, flood control, and costs associated with population growth and increasing urbanization--crime prevention, highway construction, water treatment, school expansion. Expenditures on all of these increase GDP, although mostly what we aim to buy with them isn't an improved standard of living but the restoration or protection of the quality of life we already had.
The amounts involved are not nickel and dime stuff. Hurricane Katrina produced something like $82 billion in damages in New Orleans, and as the destruction there is remedied, GDP goes up. Some of the remedial expenditure on the Gulf Coast does represent a positive addition to economic well-being, as old appliances and carpets and cars are replaced by new, presumably improved, ones. But much of the expense leaves the community no better off (and indeed much worse off) than before.
New Orleans used to be protected from storm surges by fifty miles of sponge-like bayou between it and the Gulf Coast. When those bayous were lost to development--channelized to move oil rigs, mostly-- GDP went up, even as the development destroyed the city's natural defenses (along with the Gulf Coast shrimp fishery), imposing real economic loss and the since-realized risk of an $82 billion storm-recovery cost on the economy. The bayous were a form of natural capital, and loss of their flood-protection services was a cost that never entered into any ledger--not GDP, not anywhere. Economic decision making simply didn't account for these costs. Wise decisions depend on accurately assessing the costs and benefits of different courses of action. If we don't count ecosystem services as a benefit in our basic measure of well-being, their loss can't be counted as a cost--and economic decision-making can't help but be irrational, giving us undesireable and perversely un-economic outcomes.
The basic problem is that GDP measures gross economic activity, not our level of economic welfare. If you kept your checkbook the way GDP measures the national accounts, you'd record all the money deposited into your account, make entries for each and every check you write--and then add all the numbers together. The resulting bottom line might tell you something useful about the total cashflow of your household, but it's not going to tell you whether you're better off this month than last, or indeed, whether you're solvent or going broke.
And going broke is a real possibility for a civilization that counts the drawdown of natural capital--the degradation of its ecosystems--as income, as GDP does. This mistake is exactly what led to the downfall of both Carlo Ponzi and Bernie Madoff : they treated capital inflow as income, paying previous investors out of capital entrusted to them by newcomers. Our economy is pyramided in the same way, with the consumption of natural capital being treated and spent as income. Our chief measure of economic well-being can't register the loss.
Because GDP is a flawed measure of economic well-being, it's foolish to pursue policies whose primary purpose is to raise it. Doing so is an instance of the fallacy of misplaced concreteness--mistaking the map for the terrain, or treating an instrument reading as though it were the reality that it supposedly represents. When you're feeling a little chilly in your living room, you don't hold a match to a thermometer and then conclude that the room has gotten warmer. But that's what we do when we seek to improve economic well-being by goosing up GDP.
Several alternatives to GDP as a measure of economic welfare have been proposed and have achieved varying degrees of acceptance in Europe, Canada, and other developed nations. In 2007 The Organization for Economic Cooperation and Development, along with the European Union Commission, the EU Parliament, the Club of Rome, and the World Wildlife Federation, brought together hundreds of European policy planners and interested parties for a conference titled Beyond GDP, in which alternatives were assessed and plans were laid for implementation of a change. The problem is to avoid subjectivity in assessing the dollar value of goods and services that have never had a dollar price. What exactly was the value of the services provided by those bayous in Louisiana? $82 billion? But what about the value of the shrimp fishery that was lost with them? What about the insurance value of the protection the bayous offered against another $82 billion dollar loss? What about the security and sense of continuity of life enjoyed by the thousands of people who lived and made their livelihoods in relation to those bayous before they disappeared?
It's admittedly difficult to set a dollar price on such intangible goods or services--but this is no reason to set that price at zero, as GDP currently does.
Some of the measurements that have been proposed as alternatives to GDP are rigorous and objective, steering clear of the problems of subjective evaluation that are inherent in putting price tags on non-market satisfactions and goods. Knowing the difficulties with GDP,the Bureau of Economic Analysis has been compiling and reporting Satellite Accounts that provide a needed correction to it. One satellite account tracks the nation's expenditure on Research and Development--part of the cost of doing business, which ought to be deducted from income accounts; but GDP counts it as a positive contribution. And for a time in the 1990s, the Bureau of Economic Analysis experimented with constructing a Satellite Account to measure ecosystem losses. The work is difficult and technical, and some would say it can't help but involve subjective evaluations that are essentially political, not economic, in nature. But as natural capital services worldwide disappear, it gets easier and easier to assign a non-subjective valuation to them--and value them we must if we are to keep them at all. Civilizations that lose ecosystem services don't survive.
Common sense tells us that if we want an accurate accounting of national economic welfare, we need to separate costs from benefits and to account for losses in natural capital.
Given the fundamental problems with GDP as a leading economic indicator, and our habit of taking it as a measurement of economic welfare, we should drop the use of it completely. We could keep the actual number, but re-name it to make clearer what it represents; let's call it Gross Domestic Transactions. Few people would mistake a measurement of gross transactions for a measurement of general welfare. And the renaming would create room for acceptance of a new measurement, one that more accurately signals changes in the level of economic well-being we enjoy.
Models for this new measurement include the UN-developed Human Development Index; the Index of Sustainable Economic Welfare proposed by economist Herman Daly and theologian John Cobb in 1989; and a derivative of that measure called the Genuine Progress Indicator developed in 1995. Each corrects national income data by including non-market contributions to individual well-being and deducting some obvious costs from benefits. The latter two have the additional virtue of treating the draw-down of natural capital as a cost.
All three have proponents and detractors; none ventures as far into measuring intangibles as does the Kingdom of Bhutan's recently instituted index of Gross National Happiness.
Perhaps the wisest course would be to convene a Blue-Ribbon panel of economists and other relevant experts to join the Bureau of Economic Analysis in creating a new measure--call it Net Economic Welfare--that corrects the basic Gross Domestic Transactions account by adding non-market goods and subtracting relevant costs. This work would be a continuation of what the BEA is already doing with Satellite Accounts. It would also require the BEA to re-institute a Satellite Account for environmental costs, so that drawdown of natural capital can be treated as an expense to be deducted from national income.
With GDP in decline, there is no better opportunity to make this change than now. This economic downturn may signal the beginning of the end of the old order--the petroleum-based, "nature be damned," more-is-always-better economy that flourished when oil was cheap and plentiful. Each quarter, GDP figures are eagerly awaited to see if the downturn is over. As we climb up out of the hole that we've fallen into, what we need is not simply a measurement of how much money passes through our hands, but an indicator that will tell us if we are really and truly gaining ground in the perennial struggle to improve the material conditions of our lives.