25 Nov 2013

## A Note on GDP Calculations

David R. Henderson has an interesting post on the problems with using GDP as a criterion of economic goodness. Now let me be clear (as Obama would say): I fully agree with the general theme of his post, especially the examples of cheap or even free things offered on the Internet and hence not showing up in conventional GDP measures.

However, I think there is a slight problem in the specific example David uses to motivate the discussion:

Picture this: The U.S. government finally sells the Postal Service. As with other functions moved from the government to the private sector, the privatized post office does what the government did for about half the cost. So, with prices correspondingly lower, people spend roughly half as much as before on mail–which frees them to spend the difference on other desirable things. Because the Postal Service costs over \$40 billion a year, the saving is \$20 billion. By any reasonable measure, the average person in the U.S. is better off. In fact, the per capita increase in well-being is approximately \$20 billion divided by 260 million citizens, or about \$80 apiece.
But how does this change show up in gross domestic product? It doesn’t. The government’s contribution to GDP is measured not by how much value it creates but by how much it costs. So the \$40 billion spent by the Postal Service counted as a \$40 billion contribution to GDP. Cutting that in half through privatization may shift \$20 billion from public to private hands but still adds up–under the conventions of national income accounting–to the same \$40 billion. So the net effect on GDP of a \$20 billion increase in economic well-being is precisely \$0.00.

I don’t think that’s the whole story. Someone who wanted to defend the orthodox approach would say:

This critique conflates nominal with real GDP. When the BEA announces growth estimates, it refers to real GDP; that’s what we’re trying to promote.

Suppose an economy initially has total expenditures on final goods and services of \$1 trillion, and the CPI is 100. Then a bunch of the firms have eureka moments and figure out how to massively cut their prices, without reducing their output. Their customers then (we suppose) take the savings and increase their spending elsewhere, so that total expenditures is still exactly \$1 trillion. But the CPI has fallen by 50%, meaning real GDP has doubled.

Again, I’m not saying that GDP is a great way to gauge economic output, especially since government expenditures are counted as “output” on equal footing with private investment. All I’m saying is that one of David’s particular examples might overstate how bad a criterion it is.

#### 10 Responses to “A Note on GDP Calculations”

1. valueprax says:

Bob,

I don’t know if this is captured in your point or tangential but I would think another problem here is not just “what should get counted, and how should it get counted, in GDP?” but also, “What does it mean to have \$X increase in economic well-being?”

It seems like an improper use of money prices to add them up and expect the aggregate to mean something when people don’t value on that aggregate basis.

Sorry if I am jumping the shark for you on this thread.

2. Matt M (Dude Where's My Freedom) says:

“But the CPI has fallen by 50%”

Oh yeah right. As if our central bank overlords would ever allow such a thing to happen… I understand you’re making a theoretical objection here but come on, a Krugman-inspired alien invasion is more likely to occur than this.

3. Major_Freedom says:

Murphy, I am not sure Henderson’s post can be critiqued in that way. I don’t think he is conflating the real with the nominal. I see no change in total output in his example. Thus, it looks as though he is saying that given an aggregate amount of “stuff” is produced, it is better if individuals spend money on themselves than if the government spends it for them. The shift in nominal spending is itself the gain in Henderson’s post (it seems to me).

I do agree with you that he’s not telling the whole story. In my opinion, what he is not saying is that total output can GROW on the basis of a net fall of \$20 billion in postal spending and a freed up \$20 billion in private spending. This of course occurs if any of the freed up \$20 billion is saved and invested in the private sector. Then total output can rise, and thus real GDP will rise. If Henderson mentions that more private sector spending in general means more investment spending in particular, then the gain is represented by whatever amount of money from the \$20 billion is saved and invested. For the difference might be \$40 billion aggregate spending consisting solely of consumption before, versus, say, \$40 billion aggregate spending of which \$30 billion is investment spending and only \$10 is consumption spending. This shift in the ratio between total spending and investment spending will increase output.

4. Matt Tanous says:

“When the BEA announces growth estimates, it refers to real GDP; that’s what we’re trying to promote.”

Except “aggregate demand”, per Scott Sumner, is the same thing as NOMINAL GDP. Which is PRECISELY what he is trying to promote, and (again, per Scott Sumner) “[NGDP targeting is] not what Keynesians have been doing, it’s what their theory tells them they should have been doing.”

5. Tel says:

The problem is that no one knows real GDP. What we do is take nominal GDP and apply some adjustment that supposedly allows for inflation, then it gets called “real”. Anyone who happens to spend money on something different to the official basket of goods ends up with a different result. For example the price of assets is completely ignored.

As you say, there’s a bunch of other problems, separating voluntary spending from involuntary, broken windows, etc.

• Rick Hull says:

Optimizing for that which we can measure, searching for the keys under the lamppost, etc.

6. NicTheNZer says:

I have a failure to understand Bob,

You claim that \$20 billion are saved in your example because, “the privatized post office does what the government did for about half the cost”, ok so conjecture but anyway. Are not the postal workers who lost half their income worse off? By exactly the same amount that the postal service customers are better off?

If that nets to zero, that would hardly be surprising.

On the other hand your “\$20 billion increase in economic well-being” appears to have a pretty negative effect on postal workers incomes. Of course I must insist you apply half your usual rate while clearing up this confusion.

7. Gamble says:

One glaring problem with GDP is it measures production that the majority of Americans do not benefit from and this production may even cost them.

” I am proud to announce this farm is booming. We produced 4.5% more this year when compared to last. The main quarters will be enlarged by 25 %, ensuring hours and hours of work to be done. The grassy area will be enlarged and beautified. You will certainly benefit from the terrific views. Security has been improved and the jail area has been brought up to snuff. Thank you and enjoy your stay at the Hamilton Plantation.”

Somebody remind me, how much has my personal wealth increased this year, forget about GDP.

• Ken B says:

You got to spend time with all of us, and that’s a treasure beyond reckoning.

• Gamble says:

Yeah thanks.