Saturday, December 17, 2005

"What's wrong with the GDP?"/GPI (Genuine Progress Indicator) Part 3


By the way of Israeli.
This will be some repeating of the points we covered in GPI One and GPI Part Deuce, but we will finally look at GPI indicator.
GDP TREATS CRIME, DIVORCE AND NATURAL DISASTERS AS ECONOMIC GAIN

Since the GDP records every monetary transaction as positive, the costs of social decay and natural disasters are tallied as economic advance. Crime adds billions of dollars to the GDP due to the need for locks and other security measures, increased police protection, property damage, and medical costs. Divorce adds billions of dollars more through lawyer's fees, the need to establish second households and so forth. Hurricane Andrew was a disaster for Southern Florida. But the GDP recorded it as a boon to the economy of well over $15 billion...
The GDP also adds the cost of prisons, social work, drug abuse and psychological counseling that arise from the neglect of the non-market realm.

This again goes back the broken window posit that even though resources are diverted to these problems which increases in local level of GDP growth, but it diverts resources that could have better allocated to more productive uses. Crime, prisons, drug abuse and all counseling take potential productive members of society out of the work force even if just for temporary times. So while GDP may increase in the short run by lowering savings and increasing consumption, it limits the potential for long term growth.

GDP IGNORES THE NON-MARKET ECONOMY OF HOUSEHOLD AND COMMUNITY
The crucial functions of childcare, elder care, other home-based tasks, and volunteer work in the community go completely unreckoned in the GDP because no money changes hands. As the non-market economy declines, and its functions shift to the monetized service sector, the GDP portrays this process as economic advance.

This underestimates the GDP level. But the problem with measuring such non monetary transactions would be how to calculate the value to society. Would the benefits be calculated as the replacement to have someone with those skills do the task, or the wage scale of the person doing such work? For example in "Desperate Housewife's" TV show, the wife was staying home and taking care of the children, but the roles changed when the husband lost his job. Since the wife earned more income than the husband would the value be just what someone to replace them in the various tasks or the opportunity costs and thusly different between the husband and wife.

GDP TREATS THE DEPLETION OF NATURAL CAPITAL AS INCOME
The GDP violates basic accounting principles and common sense by treating the depletion of natural capital as income, rather than as the depreciation of an asset. The Bush Administration made this point in the 1992 report of the Council on Environmental Quality. "Accounting systems used to estimate GDP" the report said, "do not reflect depletion or degradation of the natural resources used to produce goods and services." As a result, the more the nation depletes its natural resources, the more the GDP goes up.

Let me break this down into non-renewable natural capital and renewable. As far as renewable resources, there is several harvesting techniques that will still maintain the resource base. One technique is to harvest so that the base produces the most volume on a yearly basis, but most environmentalists do not like this. Well defined property rights are important to maintain the capital for the long term.

The GDP does not record depletion of the resource base and it also does not count the amount of the resource base. Not to get too far ahead, the GPI also does not count the amount of natural capital. So we could say that GDP and GPI underestimates the levels of both measures. It is also true that it does count as a negative when 6 million acres burn nationwide in forest fires or over 4 million in Alaska alone. Another thing to consider is that if we do not use the resources resposibly that are provided to us, then how do we increase the well being of its citizens?

And this goes along with non-renewable resources also that not using the resource benefits no one. Some environmentalist say that we should save all resources for later generations, but of course it is selective on what resources to not exploit. No one says not to mine gold, silver, platinum, etc. If we do not use the resources now, what is to say that future generations will need it anyway. In the future what we save may be meaningless in the future. Now the question becomes what is the resource depletion that makes the most sense. One way an economist would answer this is that the value of resources in today's dollars if extracted at the maximum non damaging extraction would be compared to the future price adjusted for the expected interest rate. More clearly the question would be if you had the potential to extract $1 million now or in one year it would be valued at $1.05 million but the interest rate was 4%. Thus it would be better to extract the resource in the future, but if the interest rate was 6% it would be better to extract the resource now and put it into the going rate of interest.

GDP INCREASES WITH POLLUTING ACTIVITIES AND THEN AGAIN WITH CLEAN-UPS
Superfund clean-up of toxic sites is slated to cost hundreds of billions of dollars over the next thirty years, which gets added to the GDP. Since the GDP first added the economic activity that generated that waste, it creates the illusion that pollution is a double benefit for the economy. This is how the Exxon Valdez oil spill led to an increase in the GDP.

But again these resources are diverted to more useful endeavors. The money that Exxon pays (that they should) out could have been better used for reinvestment and further enhancing the capital base. Can anyone say that a country that experiences many natural or man made disasters have long term growth?

GDP TAKES NO ACCOUNT OF INCOME DISTRIBUTION
By ignoring the distribution of income, the GDP hides the fact that a rising tide does not lift all boats. From 1973 to 1993, while GDP rose by over 50 percent, wages suffered a decline of almost 14 percent. Meanwhile, during the 1980s alone, the top 5 percent of households increased their real income by almost 20 percent. Yet the GDP presents this enormous gain at the top as a bounty to all.

This site does not give the raw data to confirm or see how GDP rose by 50 percent when wages (whose wages) declined by 14% and still have the top 5% real income increase by 20%. In a free economic society, who is to decide when someone makes too much? While yes inequal distribution of income may be of concern, what is too much concentration and is it possible to be too egalitarian? When all people are equal then why stive for excellence? Why compete if the worst you will be is equal to all others? Thus what level of equality is best and what scale is used?

I feel that a better gauge is mobility of individuals into other income brackets. If you look at some of our most wealthy individuals you will see that most did not come from wealthy families but made it on their own. I guess the best example is Bill Gates went from humble begginings to being the richest man in the world.

GDP IGNORES THE DRAWBACKS OF LIVING ON FOREIGN ASSETS
In recent years, consumers and government alike have increased their spending by borrowing from abroad. This raises the GDP temporarily, but the need to repay this debt becomes a growing burden on our national economy. To the extent that Americans borrow for consumption rather than for capital investment, they are living beyond their means and incurring a debt that eventually must be repaid. This downside of borrowing from abroad is completely ignored in the GDP.

One aspect that I think people forget is that for every dollar of debt is a dollar of assets of someone else. Thus consumer debt could be considered either corporate assets or consumer assets (money balances). A large percentage of consumers have home mortgages but is this bad to have a chance to make present consumption with future earnings?
I have been strugling to come up with an easy answer to this besides the market will eventually solve this dilemna. No government/organization wants to suddenly and without warning to change the location of their large investments and holdings. Because in the short term, no one is there to purchase all your holdings and as soon as the prices of what you hold starts to fall others in the market will start to increase purchases. Even if China wanted to dump (sell in a fire sale) their holdings in the US, the prices would drop and China would loose lots of money. Secondly other
Asian countries, or other parts of the world do not have to follow China's lead when the prices drop. If you have enough power to influence prices, then you want price stability.
A very good report is Global Current Account Imbalances: Hard Landing or Soft Landing. While I would love to cover this whole article, let me just say that in one way I was wrong. I had heard all the gnashing of teeth about the Current Account deficit at the 6% of GDP or 600 million. But with an economy of over 11 trillion this is a trivial amount. We could pay it off in 6 months at 1% per month. But the true number is U.S. indebtedness to non-residents which is about 25% of GDP accumulated as of 2003 or in other words 250% of exports. (While this is substantial it is not as much as the Federal Debt so foreigners are paying some of the debt they are not paying for all.) This last figure would mean we would take 2 1/2 years of zero imports to pay this back.

Sorry but again it looks as if it would be better to create another post to discuss the benefits of GPI as an index next time.

Links of note:
Browse International Employment Data from the BLS
Civilian Participation Rate
Trinity College
(PDF)GPI of USA 1950-1999

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