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Growth pain

28 Feb 2014 By Edward Hadas

Gross domestic product is both a useful measure and a terrible one. Diane Coyle explains why in “GDP: A Brief but Affectionate History.” Despite some cogent arguments in support of its use, readers may struggle to share the British economist’s fondness.

Coyle’s basic argument is that this crude indicator, which measures the sum of the value of goods and services purchased in a nation, is better than any available alternative. There is something to that. It also passes the most basic test of viability. GDP usually rises as residents of a country become wealthier and normally falls when they become poorer.

For countries moving out of poverty, GDP generally shifts in much the same direction and at roughly the same pace as other indicators of wellbeing or what economists call welfare, for example health, education or environmental quality. That makes GDP a convenient single indicator for progress. But, as the philosopher and Nobel prize-winning economist Amartya Sen has pointed out, the distribution of wealth matters. For instance, an almost-exclusive policy focus on national GDP growth has done remarkably little to help the Indian poor.

The book’s arrangement as a history of the development and use of GDP brings some interesting observations. GDP, as Coyle puts it, is an abstract idea not a reality that was waiting to be measured. No one seems to have wanted to try to sum up an economy in a single cash value before the 1930s, when the Great Depression and then the costs of massive war spurred interest. The worship of GDP growth, which is now almost universally taken for granted, starts even later.

However, Coyle’s chronological approach scatters her discussion of the many flaws of GDP. She notes that GDP fails to take into account the distribution of consumption. She points out that it ignores investment, environmental damage and almost all activities that are not paid for in cash. She mentions that increases in bad things like crime add to GDP and that international GDP comparisons rely on questionable assumptions.

There is more. Adjustments for inflation and changes in the variety and quality of contributing factors are arbitrary. Estimates concerning the economic value of semi-legal and illegal activities are little more than guesses. The high value attributed to financial services seems to be exaggerated.

It is easy to conclude that the apparent precision of GDP, and even more so of GDP growth rates, is spurious. GDP may be less cumbersome and no less useful than any available alternative, but its crudeness sharply limits its usefulness.

Coyle understands the problem, warning readers “not to confuse GDP with social welfare.” She argues that current reported GDP growth rates underestimate improvements in welfare from increased economic sophistication. But the opposite case is also plausible. More GDP may do little for wellbeing at high levels of prosperity, since a rich economy may produce pretty much all the wellbeing it can.

Taken to its logical conclusion, Coyle’s analysis suggests there is little reason to calculate GDP, at least in developed economies. If wellbeing is the main goal of a society’s economic activity, and one accepts the argument that shifts in GDP do not capture changes, the metric is more misleading than helpful.

For many economists, GDP has the virtue of familiarity. Coyle ends her short book with the assertion that GDP is “a bright light shining through the mist.” Her arguments point to a much more critical judgment.


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