Irish Liberty Forum

GDP: A Meaningless Statistic

with 2 comments

Look inside any economics textbook and it will present you with a formula. It may look something like this:

GDP = Y = C + I + G + X – M

Gross Domestic Output = Consumption + Investment + Government Spending + Exports – Imports

However this metric, when used as an indicator of a country’s ‘well-being’ is essentially flawed. Let’s see why:

C (Consumption)

This is the aggeregate of all private spending in the economy. Everything from food to clothes to pianos to computers. However the figure soesn’t include the various supply-constraining measures that the government imposes it. The Common Agricultural Policy for example has the effect of raising food prices for everybody. This will show up as an increase in consumption spending, when in fact the poorest people suffer the most from it. Any government licensing fees also limit supply, and hence artificially push up consumption.

Also calculated within ‘consumption’ is the money spent on combatting government violence. Lawyers and accountants are two professions that come to mind. Governments always make the legal system and the tax code more complicated, thereby increasing demand for the services of lawyers and accounants. This expenditure does not add any wealth to a nation, it merely keeps the money flowing from person to person.

That’s what consumption calculates. But what doesn’t it calculate? Well, all services rendered for free or as barter transactions do not show up in GDP. If I paint your fence and you mow my lawn, we both receive a benefit but it does not add to GDP.

Finally, Black Market activities are not included in consumption data. Money traded for illicit goods like guns and drugs, and illicit services like prostitution and gypsy cab rides, does not add to the GDP figure. 

I (Investment)

This is a fairly good indicator in GDP. However in the GDP formula, ‘investment’ refers to ‘gross investment’, rather than ‘net investment’. It does not calculate the effects of depreciation of the capital stock. In reality we should be using ‘net investment’ as our indicator and hence ‘net domestic product’ (NDP) as the gauge of a nation’s prosperity.

G (Government Spending)

Government spending is the aggregate sum of all spending on goods and services by the government. It does not include transfer payments, which are just transactions where money is taken from one individual and given to another.

The assumption that all government expenditure is good for the economy is ludicrous. Many occupations funded by the government would not survive in the free market. Governments are ripe targets for rent seeking activity, whereby powerful interest groups lobby the government for more money without increasing their productivity in return. Government jobs are seen as cushy, insulated and uncompetitive. 

Lastly, as governments collect their money involuntarily, there are always problems when it comes to the greater economy. If the government gets its money from taxes, it disincentivises work and investment. If it gets its money from the printing press, it causes inflation. If it raises its money from creating debt, it distorts the interest rate.

(X – M) (Exports minus Imports)
This is also known as the ‘trade balance’. The best critique of this measure is, for me, Milton Friedman’s. In Free to Choose, Friedman wrote:

“Another fallacy seldom contradicted is that exports are good, imports bad. The truth is very different. We cannot eat, wear, or enjoy the goods we send abroad. We eat bananas from Central America, wear Italian shoes, drive German automobiles, and enjoy programs we see on our Japanese TV sets. Our gain from foreign trade is what we import. Exports are the price we pay to get imports. As Adam Smith saw so clearly, the citizens of a nation benefit from getting as large a volume of imports as possible in return for its exports or, equivalently, from exporting as little as possible to pay for its imports…

…In your private household, you would surely prefer to pay less for more rather than the other way around, yet that would be termed an “unfavorable balance of payments” in foreign trade.” (Source)
GDP is a broken measure. The only reason it stays in use as an indicator is because every nation on earth uses the same broken indicator.


Written by 20000miles

November 9, 2008 at 10:25 pm

Posted in Uncategorized

2 Responses

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  1. […] I think one of the biggest downfalls is that every dolar is weighted the same, so money that’s wasted is counted just as heavily as money spent to improve "productivity and economic health". $1MM worth of missles that are burried in the dessert effect GDP equally as $1MM worth of food or vaccinations. Also, (although this wasn’t specifically addressed in your questions) GDP doesn’t speak to the distribution of wealth or economic stability, so coutries like Saudi Arabia can have a really high GDP, but not a really great standard of living. GDP: A Meaningless Statistic Irish Liberty Forum […]

    Gross Domestic Product

    November 23, 2008 at 12:02 am

  2. […] that GDP is an adequate measure of anything (GDP: A Meaningless Statistic Irish Liberty Forum), but yeah, if you want you could really measure sectors’ percentages against Gross National […]

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