Economics

GDP Economics: Fat or Muscle?

David J. Hebert

Recently, Italy “discovered” it was no longer in a recession. Why? The nation started counting GDP figures differently.

Adding illegal revenue from hookers, narcotics and black market cigarettes and alcohol to the eurozone's third-biggest economy boosted gross domestic product figures.

GDP rose slightly from a 0.1 percent decline for the first quarter to a flat reading, the national institute of statistics said.

Italian officials are, of course, celebrating. In politics, perceptions are more important than reality. But such celebration is troubling for several reasons, which have less to do with headlines or black markets and more to do with fat.

One of F.A. Hayek’s lasting insights was that aggregate variables mask an economy’s underlying structure. For example, a country’s GDP can be calculated by summing the total amount of consumption, investment, government spending, and net exports in a given year. The higher this number, the better an economy is supposed to be doing. But adding these figures together and looking only at their sum can be wildly misleading.

One way to illustrate why is through the following example: I am currently six foot one and weigh 217 pounds. As it turns out, Adrian Peterson, a running back for the NFL’s Minnesota Vikings, is the same height and weight. Looking at only these two variables, Peterson and I are identical. Obviously, this isn’t true.

Likewise, cross-country GDP comparisons are difficult to make. If two nations grow at the same rate, for example, but one nation “invests” in useless boondoggles while the other grows sustainable businesses, we wouldn’t want to claim that both countries have equally healthy economies.

But what about comparisons of a country’s year-to-year GDP? Is this valuable information? Well, yes and no.

If we know that more stuff is being produced this year than last year, we can infer that more activity is happening. However, this doesn’t mean that government should subsidize production in order to increase activity. In that case, all they’re accomplishing is increasing the number of things that are being done at the expense of other things that could have been done.

What economists should be looking for are increases in economically productive activity from year to year. For example, digging a hole and then filling it back in does increase the measure of activity, but it’s not adding any value to society. Digging a hole in your backyard and filling it with water is also activity, but it’s productive because you now have a swimming pool, which you value enough to employ people to create.

It’s no mystery that Italy is seeing a higher GDP as a result of its change in measurement and that as a result it’s avoided a recession on paper. That is, it’s counting more activities as “productive” than it was previously. It is wrong to conclude, though, that more production is actually happening in Italy. These activities were happening before; they just weren’t being counted in any official statistics.

There are many problems with using GDP as a measure for an economy’s health. Changing what counts toward GDP only introduces yet another confounding factor. When I step on the scale, I can get some basic idea of how healthy I am. But when I take my shoes off and step on the scale again, I didn’t magically become healthier. I just changed what’s counting toward my weight. It would be wrong for me to conclude that I can skip the gym today as a result of this recorded weight loss. Similarly, citizens of Italy should not be celebrating their increased GDP. They still face the same problems as before and must still address them.

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