Tuesday, December 06, 2005

GDP/GPI Part Deuce-Wiki crticism of GDP

By way of Israeli
we visit the issues of GDP as an indicator of standard of living. I hope that I don't bore anyone with multiple repeating of points over these 3-4 posts on this issue.
The major disadvantage of using GDP as an indicator of standard of living is that it is not, strictly speaking, a measure of standard of living. GDP is intended to be a measure of particular types of economic activity within a country. Nothing about the definition of GDP suggests that it is necessarily a measure of standard of living. For instance, in an extreme example, a country that exported 100 per cent of its production would still have a high GDP, but a very poor standard of living.

The argument in favor of using GDP is not that it is a good indicator of standard of living, but rather that (all other things being equal) standard of living tends to increase when GDP per capita increases. This makes GDP a proxy for standard of living, rather than a direct measure of it.

First let me show the components of GDP:
GDP=C(private consumption)+G(government)+I(investment)+X(exports)-M(imports)

I see measures of standard of living more than nothing. The above formula shows investments by firms and consumption of goods and services and durable goods and houses and government investments in education and infrastructure and law enforcement and security of national interests.

But GDP is not meant to be an indicator of standard of living but to measure the relative strength of an economy. If GPI becomes a better indicator, that will have to be decided later.

And again back to the issue of a country that exports 100% of its GDP (barter and self-production for food assumed), just as if 100% of GDP goes toward investment, this would indicate a 100% savings rate. So while consumption is low during this time frame and standard of living would be implied to be low, future consumption would be greater than the present would have been. Without getting into all the formulas, this is because the currency of the country in question would rise in value as the central bank holds excess reserves of other currencies.

GDP doesn't take into account the black economy, where the money spent isn't registered, and the non-monetary economy, where no money comes into play at all, resulting in inaccurate or abnormally low GDP figures. For example, in countries with major business transactions occurring informally, portions of local economy are not easily registered. Bartering may be more prominent than the use of money, even extending to services (I helped you build your house ten years ago, so now you help me).

This just shows that we may be understating the level of GDP. While we look at the criticisms of GDP, we should keep track of the negative and positive effects on GDP. While it would be nearly impossible to count all underground economy, the federal government should look at incentives that make the underground economy over inflated One aspect that promotes the underground economy (my theory) is too high of a marginal tax rate. And whether money is involved or not does not make a difference, just as if I slip a few dollars to the neighbor boy to mow the lawn.

Having libertarian tendencies, I would like to see more of the "black market" included into the market. That is legalizing drugs and other vices. Instead of wasting vast amounts of resources trying to stop victimless crimes, it would be better to include it into the GDP and thusly tax and regulate as other industries that sells "sins".

Very often different calculations of GDP are confused among each other. For cross-border comparisons one should especially regard whether it is calculated by purchasing power parity method or current exchange rate method.

This is not really a criticism but more of a caution when comparing between more than one country. PPP takes into the fact that less developed countries have lower relative price levels than developed countries.

Quality of life is determined by many other things than physical goods (economic or not).
In 'poor' countries, it may just be that everything is cheap, except for a few western goodies. So one may have little money, but if everything is cheap that evens out nicely. Thus, the standard of living may be quite reasonable, it's just that there are, say, fewer TV-sets, meaning people have to share them (which may actually increase the quality of life in a social sense).

This is good way to view PPP. But if these facts were true then people in rich countries would not purchase the western goodies and that people would share TV-sets if it truly increased the quality of life. I know that I love to watch TV in my underwear while scratching my *****. If I had to share the TV, I don't believe I would have that pleasure. From an earlier post I showed how that reaching $13,000 PPP income per year would provide the highest total utility derived from money.

If many products are of low quality in terms of durability then people will have to (unnecessarily) buy them again and again, thus boosting GDP without increasing their satisfaction. (On the other hand, if products were very durable then that would hamper innovation because people would be less inclined to buy new products, giving producers less of an incentive to develop them.) Similarly, if many products are of low quality in terms of usability and people don't know beforehand which products are the best choice for them, then they will either have to make do with an inferior product or buy again and again until they find something more satisfying. Furthermore, if products have a short life-span in the market (e.g. because of fast innovation or fashion) then this process starts all over again when people need a replacement. Note that in a capitalist society these factors working together can easily cause a very high GDP combined with low customer satisfaction.

The original wiki entry seemed to be written by 2 people. The first part was written by an economist, and starting with this thread by a left wing radical. This passage is like the consumers are forced to buy inferior products and have no knowledge of the quality. Consumers do not have perfect knowledge but this creates opportunities for business to help consumers to make decisions. The rise of branding is one aspect that consumers can use to determine if a product is of quality.

In the USA, there are vast amounts of information for the consumer. Books, magazines and newspapers are one example as well as friends and relatives. We also have consumer protection laws and a legal system to protect the rights of consumers including class action lawsuits. Retailers also realize that to retain customers that they need to help customers on the service side of the problems.

GDP doesn't measure the sustainability of growth. A country may achieve a temporary high GDP by over-exploiting natural resources or by misallocating investment. Oil rich states can sustain high GDPs without industrializing, but this high level will not be sustainable past the point that the oil runs out. Economies experiencing a housing bubble or a low private saving rate tend to grow faster due to higher consumption, at the expense of reduced pensions in future.

Under a free markets the sustainability is factored into the prices of a commodity. We do not worry about running out of any raw material besides oil. Why is this? We don't confine the extraction of gold, silver, uranium, nitrogen, phosphorous, etc.

It is nearly impossible for an oil exporting country to industrialize because of the Dutch disease. A few things contribute to this problem. First internally, the industry that is growing and earning the most money (oil) bids away resources from the other sectors and thus raising the costs for the industries. And since it bids away capital it also raises the interest rates. This leads to not as many projects that were profitable are no longer profitable at a higher interest rate. Externally, as more oil is exported and not a corresponding import amount of volume will increase the value of domestic currency. This will result in tradable goods becoming more expensive for foreign countries and the domestic market not being able to compete with cheap foreign tradables. So there really is no simple solution. This actually would work better under some social engineering. Hopefully the gains from oil are used to develop intellectual property and the development of human intelligence.

The next sentence on housing bubble and savings rate is completely wrong. Higher consumtion does not grow an economy. It may over-inflate it for a while but will not grow the economy. Investments and productivity gains are what causes an economy (GDP) to grow. Thus low savings rates whether caused by a housing bubble or any other bubble (wealth effect) only moves spending from those that lend to those that are spending, because for every dollar of debt is a dollar of assets for someone else. So yes some people are tapping into the equity and having low savings rates that reduce what is put into their retirement funds. This is a reason that I feel that many people will get a rude awakening when they are ready to retire. But no one forced them to overspend their assets of income.

GDP counts work that produces no net change. For instance, a hurricane destroying thousands of homes would not be counted by GDP, but the rebuilding of those homes would be. A good recent example would be the aftermath of 2005 Katrina hurricane, which is poised to become the most expensive hurricane in history. GDP would capture the rebuilding activity and suggest a rising living standard, but we're only working toward restoring what was lost for the most part. Therefore, GDP growth would over-estimate the increase in the standard of living. See Negative externalities.

This refers to the broken window phenomena. That if the window was not broke out, then that money would have been spent on something else. First I would say the replacement would be better (safer, newer) than the original though not the full value. Secondly there is some negative feedback that hurts the GDP in the longer run. First Katrina created a large number of unemployed though did not affect the rate nationwide. Secondly the resources were not put in the most efficient location, instead of being able to be used for further growth and development we are using resources to replace existing assets. While yes the hurricane overestimates the true value of GDP, but it also will have negative feedback to the GDP. There are also some other factors if people work more by taking time off to volunteer to help rebuild (Habitat for Humanity), which would not be counted in GDP. "See negative externalities" just show that not an economist wrote this and the author did not explain why thinks this is an externality.

As a measure of actual sale prices, GDP does not capture the economic surplus between the price paid and subjective value received.

Consumer surplus underestimates GDP by the amount consumers were willing to pay above the going price of goods and services as shown in the triangle ABK below and above link.


the annual growth of real GDP is adjusted by using the "GDP deflator", which tends to underestimate the objective differences in the quality of manufactured output over time. (The deflator is explicitly based on subjective experience when measuring such things as the consumer benefit received from computer-power improvements since the early 1980s). Therefore the GDP figure may underestimate the degree to which improving technology and quality-level are increasing the real standard of living.

All I can say is yes it underestimates GDP. Recently the left talked about the fact that the Model T had more MPG than the present current fleet of Ford vehicles. But let me just ask you. Which vehicle would you choose and you could not sell it and had to use it?

Some economists such as Herman Daly consider GDP to be a poor measure even of material well being, especially in developed countries. They argue that GDP only measures production and consumption, not however the level of utility people gain from producing and consuming. This idea is expressed in the theory of uneconomic growth, which states that GDP growth above a certain "economic limit" actually decreases material well being. An extreme example of this is a major war. Historically, GDP growth was often boosted in wartime while material living standards fell considerably.

Yes, from the study of Democratic Peace and Happiness shows that marginal utility decreases its growth after $13000 PPP. But wealth never becomes a negative marginal utility and thus well being is still rising and there is no "economic limit". If all else fails just give your money away like Bill Gates!

This is one aspect I can agree with Marx, that providing as meaningful as possible to as many citizens as possible. The USA is actually places a lot of emphasis on full employment while the EU does not. Sorry but can we say, "French Riots".

The phrase on major war has no place in this paragraph but is an example of the Hurricane effects. The weapons of war are "used up" and produce no benefit to society including low levels of investment. There tends to be an increase in research for the war and may help consumers later on, but many resources that could have been used for expanding GDP are expelled in lost lives and raw materials.

GDP {ALSO}does not take inequality into account.

Yes but there are other measures for this and do want everyone to have equal results? Another question on equality is what is the chance of upward mobility? Just because there is inequality, does this mean it is bad and is it because of choices made?

Well this is enough for now. Next time I will discuss GPI and what it measures (I hope). I may add some more to this thread also.


Links of note:
The e-commerce investment gap: Europe-USA eight year comparisons
Measuring Real Investment
Financial Bubbles-Clinton
Investment dearth, not savings glut
Thailand, Ghana and the Military “Coup Trap”

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