The GDP Indicator
It is the wrong tool for taking the economy's pulse
GDP Growth is actually just the national rotation to the Great Nursing Home.
GDP growth such that we have it is driven primarily by old folks buying healthcare stuff (variously, on the taxpayer’s dime)
Recently, I was walking and I ran into a neighbor I had not seen in several months. Knowing that his adult children live nearby, I asked, “Are you going to see the grandkids?”
“Nope. Gotta pick up a prescription. Going to the pharmacy and going to doctors. That’s all we do these days.”
As Sternstein points out, all of these Boomer purchases of medical services get counted in GDP. It gives new meaning to the term “healthy economy.”
Outsourcing vs. Production
What is GDP supposed to measure? I think of it as a measure of economic activity, meaning goods and services bought in the market.
If I pay you to mow my lawn, your labor counts in GDP. If I mow my own lawn, my labor does not count in GDP. That might seem wrong, but I believe it is exactly right. I think of economic activity as specialization and trade. We exploit comparative advantage and the division of labor. The more we outsource, the better off we are.
You can say that when I mow my own lawn that should count as production. But I don’t want GDP to measure production. I want it to measure economic activity, which is the exchange of goods and services in the market.
People who think in terms of production complain that housework belongs in GDP. But I say that if a woman (or a man) engages in housework, that is economic malfunctioning. She should be able to outsource housework to machinery and/or someone she employs.
From a long-term perspective, looking at the economy as a whole, production and outsourcing are the same thing. The only way you can have a modern economy is with a lot of specialization and trade. If you had to limit yourself to consuming only what you produce for yourself, you would be in a primitive state.
Another way we use GDP is as an indicator of consumer well-being. Again, that might be true from a long-term perspective. But a lot of stuff counts as GDP that does not contribute to well-being, and there is a lot of stuff that contributes to well-being that does not count as GDP. I repeat: GDP is just a measure of economic activity.
Reliable at low frequencies only
I differ from most economists in that I never look at GDP as a way of taking the economy’s pulse. For example, journalists will say that a recession is two consecutive quarters of declining GDP.
I think that changes in GDP over a few quarters, and even over one or two years, are mostly noise. The economy is always experiencing changes in its patterns of specialization and trade. Only over long periods are those changes meaningful.
An important concept in economic statistics is frequency. High-frequency data is data observed at short intervals. For example, initial claims for unemployment insurance, an indicator of the state of the labor market, are reported weekly, which is relatively high frequency. GDP is reported quarterly, which is a lower frequency.
I view changes in GDP as meaningful only at very low frequency, much lower than quarterly. A change in GDP over a five year period means something. Comparing the level of GDP in the United States to that of France means something.
Economists follow many ratios involving GDP. There is the ratio of GDP to total hours of paid work, which is productivity. There is the ratio of GDP to population, which is an indicator of consumer well-being. There is the ratio of government debt to GDP, which indicates fiscal sustainability or lack thereof. There is the ratio of labor income to GDP, which indicates the share of income earned by human capital as opposed to physical capital. There is the ratio of stock market value to GDP, which indicates how optimistic investors are about the ability of large corporations to capture the value of economic activity.
All of these ratios are best studied at low-frequency intervals. On a year-to-year basis, you should not use GDP to measure what is happening to consumer well-being. Recall Sternstein’s point that increased health care spending on the taxpayer’s dime counts as GDP. But the correlation of that with well-being is not clear. In fact, many studies show little or no link between more health care spending and better health.
The most widespread abuse of high-frequency data is the claim to assess trends in productivity. In my opinion, we barely have enough signal in the productivity ratio to be able to make a claim about the difference in productivity now relative to 5 or 10 years ago (the first differential, if you are conversant with calculus) . But economists will claim to interpret changes in the productivity growth rate (the second differential) over even shorter intervals. Ignore those claims.
How is the economy doing?
If I don’t like using high-frequency GDP data to assess the economy, what do I use? My answer is idiosyncratic, depending on what seems interesting.
Right now, what is most interesting to me is the divergence between the sectors generating wealth and the sectors generating hiring. The big tech companies drove last year’s increase in the stock market, but they are laying people off. Health care and government are doing a lot of the hiring, but they are not profit-making, or even profit-seeking. That does not seem to me like an increase in patterns of sustainable specialization and trade.
The pandemic revealed that in recent years we overbuilt downtown offices. Now, thanks to industrial policy, we are building a lot of infrastructure for the Green Revolution, and I worry that this revolution will not unfold as planned. Building downtown offices and factories to nowhere is not good for PSST, either.
I am bullish about the impact of AI five to ten years out, but with a lot of broken patterns of specialization and trade along the way.
I still see the government as a supplier of paper wealth, via deficits, not backed by any real output. If this does not generate a resurgence of inflation, it won’t be for lack of trying.
The bottom line: I expect that over the next few years inflation and unemployment both to rise above recent levels, by one or two percentage points but possibly by much more than that.
substacks referenced above:
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Why should anyone care about the level of economic activity as such? What everyone wants is an improvement in, or if wealthy the maintenance of, their living standard, which I define as their ability to get what they want, whatever that may be. That is a function of a person’s financial resources (income plus savings) and the cost of whatever is in their market basket. A dollar decline in their cost of living is actually better than a dollar increase in their income because the latter gets taxed, the former doesn’t.
When GDP's predecessor GNP was first being developed in the 1930s, the government was very small relative to the private sector. If it were still that way, economic activity, which is what GDP measures as you say, would be closely correlated with living standards. As governments have become much larger relative to the private sector in recent decades, GDP increasingly measures activity producing what politicians and government administrators want, which mostly is not what people want for themselves. The government buys stuff from the private sector, so an increasing amount of private sector activity serves government demand, not private demand.
Keep in mind that when people work or earn the profits from their business, whatever their jobs or businesses, they use that money to buy consumer-oriented output such as food, clothing, shelter, energy, travel, healthcare, etc. Before the government got so big nearly everyone was producing exactly that output. Now, tens of millions of people working in the government and private sector are getting paid but not producing what they and others want for themselves.
IOW, more government spending increases the demand for consumer-oriented output, but not the supply. That pressures their prices up and reduces living standards because people, especially those already on tight budgets, are forced to buy less.
This is why there is such a disparity between economists, who look at GDP and think the economy is doing fine, and big chunks of the public who are unhappy because they are very aware of all the things they used to buy regularly but can no longer afford to do so, despite working as hard as ever.
For more, please check out my recently published book and substack.
“The more we outsource, the better off we are.”
So, we should pay others to have kids and enjoy years of leisure provided by the services of those paid for children?