From independence, freedom and truth

Economy

Still believing in GDP?

Fernando del Pino Calvo Sotelo

November 28, 2012

When the Greek philosopher Plato wrote the “Allegory of the Cave” 2,400 years ago, he was surely thinking about Keynesian economists (that is to say, nearly all economists): a group of men, chained to their convictions, confusing reality with the shadows that the light of real life projects on the wall of their own cave. In this real world, behind these men’s backs, life goes on totally unconcerned by their ignorance and pretensions of knowledge. If they were obliged to look straight at the light of reality, “will they not have a pain in their eyes which will make them turn away”, and go back to the shadows “which they will conceive to be clearer” than the reality being shown to them?

In the very same fashion, economists (with very few exceptions) prefer their world of perfect theories and mathematically predictable and quantifiable behaviors to the complexity of real life where the individual acts guided by the liberty he is allowed to have and not by linear models. And when these economists are exposed to such reality, they become “pained and irritated”, according to Plato. Poor fellas.

Economics has always envied Physics, a science in which, given some assumptions, we can predict and get an exact result. Uncomfortable with the realm of ideas and the deep concept of uncertainty, economists would rather work with mathematical formulae and the determinism and security brought about by Newton’s discipline. As a consequence, they soon copied Physics’ models and developed formulae often based on utopian hypotheses which, on paper, ended up being aesthetically nice even if they had little to do with reality. Economists became obsessed with measuring and forgot about thinking.

Today I want to write about one of those formulae, the Gross Domestic Product. GDP is interpreted as supposedly measuring the increase in a country’s wealth over a period of time. GDP is calculated by adding consumption and investment to net exports and part of Government expenditures. So, what is my criticism?

First, the mere pretension of calculating such a complex issue as the increase in a whole country’s wealth seems delusional to me. The outcome must be a wild bet, but it is nevertheless calculated with the exactitude of one decimal point and funnily enough, taken seriously by everybody. Secondly, GDP is what economists like to call a flow variable, such as a Profit & Loss account. However, it does not consider whether this “growth” has been financed by debt or not, nor does it take into consideration the accumulated amount of debt. There is no “stock” variable, that is, a Balance Sheet, where this relevant item would appear. That is why the obsession with GDP made it possible for the largest debt bubble in History to go literally unnoticed beneath the radar of economists, central bankers and other policymakers alike, blind to anything but that supreme measure of economic success called GDP. That is why, even today, they get “pained and irritated”, flabbergasted by the malfunctioning of their formulae; that is why they still don’t understand anything of what has happened.

Thirdly, GDP calculations consider politicians’ squandering as something positive. In fact, according to GDP, the most extravagant spending wasted by the most open-handed politician has the same value, euro per euro, that the most profitable capital expenditure invested by the most efficient and astute businessman. According to GDP, the more the government squanders, the better: we grow more. If pavements are broken on purpose and then rebuilt, we grow and, therefore, end up richer; if we build some pyramids in the middle of the desert or pay for high-speed trains that run with no passengers inside, we become richer; if we build a four lane bridge to a rocky desert islet in North Africa, we end up richer; is we dig a hole and then cover it up again, we are richer; if a natural disaster destroys a city, great! We have to rebuild it. Wars are good for the economy, and the more official cars, private planes and other perks we buy for politicians’ use, the more we grow and the richer we, the people, become. It’s easy to understand why GDP is so popular within the ruling classes! Of course, all this crashes head-on with common sense and tends to obviate that behind every government’s expense there is a tax, and behind every tax there is a financial resource taken away by coercion from the private sector, which otherwise would have put that money to much more efficient use and would have created real wealth. As the always insightful Charles Gave of GaveKal puts it, what should matter in economics is not quantity of production, but value creation.

GDP is really an excuse to enlarge this amorphous and ugly giant called the State. In the end, we are talking about a Keynesian invention which justifies a permanent increase in interventionism and government spending. In other words, taking GDP as the chief economic goal invariably results in an increase in politicians’ power and a decrease in liberty and economic progress for us citizens.

Sir John Cowperthwaite, the architect of Hong-Kong’s amazing economic success, whom I wrote about in a previous article, always rejected the compilation or publication of official statistics. Weird as it might seem today, for many years that colony didn’t publish either its GDP or CPI, which didn’t prevent its citizens going from poverty to wealth in just one generation. On the contrary, Sir John always argued that official stats were extremely dangerous because as soon as they got published, they created an irresistible temptation for politicians to meddle with them in order to “fix” them. There was yet another danger that Sir John didn’t mention, perhaps because he lived in an age when gentlemen were still the rule in public service. This second danger was that, when the socialists of all parties ran out of interventionist ammo yet failed to achieve that omnipotence of the god they arrogantly pretended to be, they would feel like cooking, massaging, manipulating the numbers. I will come back to this on another occasion.

We must tear down the myth that maximizing GDP should be the main goal of economic and political action. It is an erroneous measure that tends to increase, year after year, the suffocating weight of the State, which in Europe is quickly approaching its untold totalitarian paradigm. Nobody seems to know what it really measures, and more often than not it loses touch with reality. For instance, since 2008 Spanish GDP has fallen a cumulative 5%. However, during that same period of time, both industrial production and retail sales have fallen by 30%, the unemployment rate has gone from 8% to 26%, home prices have collapsed an official 25% and a real 40%, public debt has increased from 36% to maybe 90% of GDP, the financial system is broke…and GDP has fallen a tiny 5%?

There is an alternative formula which has proved to be an adequate objective of economic policy. It has been empirically tested with great success and is consistent with human nature and common sense. It is not a mathematical formula, but a logical one. I leave it here for my friends in politics and economics, with my apologies because of its simplicity, of course: Economic Growth = Private Property + Rule of Law + Low Taxes + Free Competition + Minimum Interventionism + Free Enterprise and Trade – Government Size.

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