Everything You Always Wanted to Know about GDP (but were afraid

to ask)CLAS Mini-College Presentation

24 May 2010

Professor Joshua L. Rosenbloom

Economic Measurement Issues

Some types of measurement seem simple—e.g., length

But others entail summarizing multiple dimensions

This is usually the case in economics

How, for example, do we summarize the activities of an entire economy?

Economists have developed a range of indicatorsGDPCPI

GDP is used as the conventional measure of economic growth

From the New York Times, 26 March 2010

“No measurement without theory”

Every measurement answers a particular question

The question arises in the context of a theory

To understand the measurement we must Understand the theoryKnow what question the measurement answers

Today’s take home lessons

GDP and other economic statistics are grounded in economic theory that provides a rationale for their construction

It is possible for reasonable people to disagree about the choices that underlie the construction of these statistics

Understand what choices are embodied in official GDP statistics and why they matter

Agenda

Brief history of income measurement

Formal definition of GDP

Adjusting for the cost-of-living (real GDP)

Interpretive issues

A brief quiz

QuestionsHow big was U.S. GDP in

2009?

What was U.S. GDP per capita in 2009?

How big was China’s GDP in 2009?

What was China’s GDP per capita in 2009

Answers $14.26 Trillion

$46,400

$8.79 Trillion (Purchasing Power Parity)

Or $4.81 Trillion (Official Exchange Rate)

$6,600 (PPP)

Source: CIA World Fact Book https://www.cia.gov/library/publications/the-world-factbook/index.html

Measuring the National Economy

GDP seeks to answer the question: “How Big is the Economy?”

Efforts to answer this question began at least as early as 1665 with Sir William Petty in EnglandHe adopted a broad definition seeking to to measure

the “Annual Value of the Labour of the People” and the “Annual Proceed of the Stock or Wealth of the Nation.”

Others adopted a narrower definition In France Quesnay (1764) believed only agriculture

produced a net product

Modern Era of Measurement

There was no continuous, real-time measurement of GDP before the 1930s

Several American efforts in the 19th century Seaman in 1952 King 1915 National Industrial Conference Board began to produce annual

estimates in 1920 About the same time the National Bureau of Economic

Research produced retrospective estimates for 1909-19 The first government effort was produced by the FTC in 1926

In 1932 the Senate Called on the Secretary of Commerce to produce estimates for 1929-1932 and then to continue these going forward Intellectual leadership was provided by Simon Kuznets

Modern Definition of GDP

GDP is defined as the market value of all final goods and services produced within a country during a specified period of time

Note that GDP is a Monetary quantity – it is measured in dollarsFlow -- dollars spent per unit of time

Key features of GDP: market prices

Market prices reflect the opportunity cost of purchasing an item

Money spent on one item is not available for other things

So market prices tell us the relative value that all consumers place on different products

Key Features of GDP: Final Goods and Services

Final goods and services are those used by their ultimate consumers

Distinct from intermediate goods purchased by one producer from another

This avoids double counting

A Simple Example

Intermediate Product

Income Sales

Farmer, wheat $0 $1 $1

Miller, flour $1 $2 $3

Baker, bread $3 $4 $7

Total $4 $7 $11

Key Features of GDP: Within a Country

GDP focuses on the location of production

GNP measures income of American citizens wherever located

Key Features of GDP: Gross Product

Gross vs. NetRefers to treatment of capital depreciationNet product subtracts an estimate of investment

needed to maintain the capital stockGross product reflects focus on total available

production It is not the best measure of sustainable

consumption

Three Routes to GDP

Intermediate Product

Income(= Value Added)

Sales

Farmer, wheat

$0 $1 $1

Miller, flour

$1 $2 $3

Baker, bread

$3 $4 $7

Total $4 $7 $11

We defined GDP as a measure of goods and services produced, but… Production = Income Production =

Expenditures

So Production = Income = Expenditures We can measure the

same concept in three different ways

System of National Accounts provides these different perspectives

Real GDP

Because GDP is measured in $ it depends on bothPhysical productionPrices

To isolate changes in the physical quantity produced economists us real GDPTo do so we use a constant set of pricesBut the choice of what prices can have a big effect

Calculating Real GDP

Date Computers Everything Else

Price Quantity

Price Quantity

1980 $100

10 $9 1000

2000 $10 100 $9 2000

Prices of

Year Real GDP

2010 1980 $10x10+$9x1,000 = $9,100

2010 $10x100+$$9x2,000 = $19,000

1980 1980 $100x10+ $9x1,000 = $10,000

2010 $100x100+ $9x2,000=$28,000

How much did GDP grow?

1980 2010 Index (1980=100)

Nominal GDP $10,000 $19,000 190

Real GDP (2010 $)

$9,100 $19,000 209

Real GDP (1980 $)

$10,000 $28,000 280

The Conventional View of Economic Activity in WW II

But the Definition of GDP Matters

Kuznets, National Product in WartimeNational accounts are based on definite assumptions

about the “purpose, value, and scope of economic activity.”

War magnifies these conceptual difficulties by “raising questions concerning the ends economic activity is made to pursue…” and the “distinctions between intermediate and final products.”

“War and peace type products…cannot be added into a national product total until differences in the valuation due to differences in the institutional mechanisms that determine their respective market prices are corrected for.”

Kuznets’ revised wartime GDP

Higgs’ revision of Kuznets

Which is the correct picture?

There is no one correct answer

It depends on the question we want to answer

The official series captures wartime mobilization of resourcesClearly the economy was capable of marshalling

substantial resources

But not all of these were devoted to final goods and services that directly raised welfare

These are illustrative of broader conceptual issues that have been raised by critics of GDP

Allen Field House – March 18, 1968

Kennedy’s Critique of GDP

Too much and for too long, we seemed to have surrendered personal excellence and community values in the mere accumulation of material things. Our Gross National Product, now, is over $800 billion dollars a year, but that Gross National Product - if we judge the United States of America by that –

that Gross National Product counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage. It counts special locks for our doors and the jails for the people who break them. It counts the destruction of the redwood and the loss of our natural wonder in chaotic sprawl. It counts napalm and counts nuclear warheads and armored cars for the police to fight the riots in our cities. It counts Whitman's rifle and Speck's knife, and the television programs which glorify violence in order to sell toys to our children.

Yet the gross national product does not allow for the health of our children, the quality of their education or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our wit nor our courage, neither our wisdom nor our learning, neither our compassion nor our devotion to our country, it measures everything in short, except that which makes life worthwhile. And it can tell us everything about America except why we are proud that we are Americans.

These themes have been echoed by others

Not everything included in GDP appears to enhance well-beingLocks for our doors, jails, etc.

There is no deduction for environmental damage or resource depletionPollution, the destruction of the redwood

It fails to count things not traded in marketsThe beauty of our poetry, the strength of our

marriages

The Genuine Progress Indicator

Produced by Redefining Progress

Begins with the official GDP data

Makes a series of adjustmentsDeducts expenditures judged unproductiveDeducts estimates of the cost of pollution and

resource depletionDeducts for reductions in leisure timeAdds an estimate of unpaid family and household

workAdjusts for negative effects of inequality

GPI and GDP per capita, 1950-2004

GDP and GPI are answers to different questions

GDP asks how much is produced? It accepts the value of those goods and services to the

individuals who purchased them It doesn’t attempt to account for environmental

consequences Nor does it attempt for the most part to value non-

marketed goods

The GPI asks how does this production relate to welfare? It is one possible answer But because it inserts judgments based on non-economic

considerations it is possible to question many of these

There is no one right answer

Conclusions

There is no measurement without theory

GDP is founded on microeconomic theoryThis theory justifies the use of market pricesAnd the focus on goods and services exchanged in

markets

But it also accepts the limits that this theory imposes It cannot adequately incorporate non-market

transactionsMost importantly our transactions with the natural

environment

There is a need for better measures of sustainable production

Further Reading

U.S., Dept. of Commerce, Bureau of Economic Analysis. Measuring the Economy: A Primer on GDP and the National Income and Product Accounts (Sept. 2007) http://www.bea.gov/national/pdf/nipa_primer.pdf

Carson, Carol S. “The History of the United States National Income and Product Accounts: The Development of an Analytical Tool” Journal of Income and Wealth (1975), 153-181

Krueger, Alan B. Measuring the Subjective Well-Being of Nations: National Accounts of Time Use and Well-Being (University of Chicago Press, 2009

Stiglitz, Joseph E., Amartya Sen, Jean-Paul Fitoussi, “Report by the Commission on the Measurement of Economic Performance and Social Progress” http://www.stiglitz-sen-fitoussi.fr/en/index.htm

Redefining Progress, The Genuine Progress Indicator http://www.rprogress.org/sustainability_indicators/genuine_progress_indicator.htm