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OP-ED: Does GDP tell the truth?

  • Published at 08:28 am August 23rd, 2020
A faulty guide BIGSTOCK

The structure of how the number is calculated makes it a poor guide

The Centre for Policy Dialogue tells us that the estimations of Bangladesh’s GDP do not properly reflect the impacts of the coronavirus and so should not be used for policy formulation purposes. CPD is of course correct even while everyone is doing their best.

GDP is never an accurate measure of the economy, and most especially when significant change is underway. This means that GDP is never a good guide to detailed policy formulation -- that is, this is not something specific to our current troubled times.

Gross Domestic Product is an attempt to measure the size of the economy. There are a number of problems with the attempt though, most of which are well known to economists, some of which are only recalled if an economist is really pressed to do so. Among the better known is that it only measures market economic activity -- things that are done with the intermediation of money -- and so it ignores entirely all those things done within households.

Child-care, cooking, cleaning, laundry and so on, much of what is called “women’s work,” is ignored. We could call GDP excessively masculinist for this reason alone.

It also doesn’t include the damage from, say, pollution or disaster, but does include the attempts to clean up or rebuild. This is a significant bias. Further, GDP doesn’t measure whether people are gaining more of what they desire, nor what they should be getting -- only that more is produced or consumed. And it also entirely ignores the distribution of that production and consumption -- equality or inequality.

It’s thus not that good a guide for policy reasons. At least, we should not be only using GDP as our only guide to policy.

However, things get worse. Britain has had the worst economic collapse among the rich nations as a result of coronavirus. At least, as recorded by the GDP it has, but this is entirely to do with the way in which the Office for National Statistics (ONS) has decided to measure that effect.

They’ve tried to do it right even as everyone else hasn’t. So, we have better UK numbers but we cannot compare them to everyone else’s, which is a bit of a problem as comparison is one of the first things we do do.

The problem revolves around the idea that we only measure market-based economic activity. Much of what the government does doesn’t happen in such a market. Government health care, or education, for example. There are no market prices at the point of consumption -- this is the very point of having government provision of these things -- and so we cannot measure their contribution to the economy at those market prices that don’t exist.

So, to be able to do our sums, we perform a little logical trick. We say that we will count government activity at the cost of doing it, not the value created by doing it. This is just the way GDP calculation works.

This has some bizarre results. One of which is that if we raise the pay of every bureaucrat, then the country is recorded as being richer. We measure the value of the bureaucracy, in GDP, at being how much the bureaucracy costs us. Raise that cost and we’ve raised GDP, even as not a single more chitty gets stamped, not a single more licence gains approval.

That’s a relatively trivial point of course. But the implication of it is something the ONS has got right. During coronavirus, the schools and the health care system -- that part of it not directly devoted to fighting Covid-19 -- have closed down in Britain as in many other places. But everyone in those systems is still receiving their full pay. The system still costs us the same amount, so the GDP is the same, even as we’re getting much less education and health care.

What the ONS has done right is point this out and include it in their figures. We’re getting about 30% less health care, perhaps even less education. Our economy is thus even smaller than the normal GDP calculation puts it.

The other way of putting this is that everyone else in the world is ignoring this truth. Proper GDP, the way we should be calculating it, is very different from actual GDP as people are recording it. Here, our example is specific to these difficult times.

But this does mean that if we know we’re recording the numbers wrongly then we cannot use the numbers as a detailed guide to economic policy. That would just be to get us into the GIGO loop, garbage in, garbage out from our decision-making process.

CPD is quite right, GDP is not, currently, a good guide to policy formulation. But it’s much worse than they think: the very structure of how we calculate the numbers means that it never was that good a guide.

Tim Worstall is a Senior Fellow at the Adam Smith Institute in London.

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