01 Mar 2010

Inventories Don’t Kill Growth–People Kill Growth

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[UPDATE below.]

This is an esoteric piece, but is actually one of my personal favorites. I was struggling with this notion of an “inventory bump” in GDP growth for a while, and I resolved the issues (at least to my own satisfaction) in this article. So if you have always been vaguely uncomfortable with people attributing percentages of GDP growth to inventory adjustments, this one’s for you. From the conclusion:

The textbook GDP equation is not false; it is a tautology and so of course it is true. Nonetheless, it is a destructive framework for thinking about macroeconomic events. Abuse of the equation leads economists and pundits to blame savings and praise reckless consumption, to hate imports and love exports, and (in principle) to attribute a doubling in the flow of goods coming out of factories to a nonchange in the level of a nonexistent stock of inventory.

The part I’ve just underlined is the contribution of the article; I came up with an easy numerical illustration showing that the standard GDP logic leads to that absurd possibility.

UPDATE: David R. Henderson has a good piece on “GDP fetishism” at EconLib today. Something isn’t quite clicking for me in his example of the government paying $10 billion to workers who dig holes and then fill them up. David argues that if the workers get paid $10/hour for work that they would only have been willing to do for at least $6, then only $4 billion of “well-being” has been created on net, once we take into account the loss of leisure. But isn’t this too an overstatement, since the workers only value the wages because of the actual goods and services they will be able to buy (and hence redistribute away from everyone else)? Maybe David is capturing that in his categories of price inflation or future tax hikes. Anyway, it’s a good article.

4 Responses to “Inventories Don’t Kill Growth–People Kill Growth”

  1. Edward says:

    As always, I really enjoyed the article.
    I guess if we really wanted to boost GDP we could burn all our houses down and rebuild them.

  2. Alasdar Macleod says:

    Now that you have sorted that one out, perhaps you could comment on the validity of including government consumption in the GDP numbers!

  3. David Stinson says:

    The thing I don't get is that, if the absolute GDP figures used to calculate %GDP growth are both post-inventory-change-adjustment, why it even makes sense to talk about the contribution of inventory adjustment to GDP percentage change (given that it is specifically excluded from the both the GDP figure at time t and at time t+1). It's really misleading isn't it?

  4. Bob Murphy says:

    David,

    Welcome to my world. It would be more accurate if they said, "If we don't do an inventory adjustment, then GDP only grew by…"

    Except, that wouldn't allow you to say that an inventory going from 0% to 0% contributed 100% of the GDP growth.