The common error of confusing growth with progress goes largely
unnoticed, though it permeates all macroeconomic analysis. There is no better
example of this mistake than the fallacies behind the interpretation of Gross
Domestic Product. GDP is the market value of all final goods and services in
a given year. As such, it is only an accounting identity reflecting the
quantity of money in the economy.
Econometricians constructing GDP have devised a sterile statistic that
should not be used to set economic policy. It leads to the common error of
assuming any increase in GDP is desirable. Statistics like GDP tell a story
of an economy based on historical prices but devoid of any qualitative value;
and progress, the improvement in the human condition, is what really matters.
Transactions reflecting both wealth creation and also economically
destructive state spending are included in GDP without differentiation. Far
from the government component of GDP being singled out from the total, it is
often welcomed as contributing to economic growth. Macroeconomists, with an
eye on the statistical impact of cuts in government spending, discourage
governments from making them. The lack of distinction between wealth-creation
and wealth-destruction is fundamental to their belief that state intervention
is beneficial.
More light can be shed on this issue with an example. Imagine an economy
with a fixed quantity of money and credit; further assume foreign trade is in
balance, and that the population is stable. Products will succeed, stagnate
or fail. People will get pay rises, pay cuts or be encouraged by reality to
move from the least successful businesses into more successful businesses.
The businesses of yesteryear fade and those of tomorrow evolve. Winners will
redeploy resources released from the failures. Annual GDP, the sum total of
all production paid for by everyone's earnings and profits, will therefore be
unaltered from the previous year: it is a zero sum, assuming that as a whole
people's money preferences relative to goods do not change. Without the
injection of extra money, people are always forced to choose between items:
they cannot add to the purchasing power of their income through extra credit
created out of thin air, creating demand that otherwise would not exist.
Progress is, therefore, marked by improved products and lower prices,
because as the volume and quality of production increases the total money
value of them must remain the same. This is true for both final products and
for investment in the higher orders of production. But importantly, GDP
growth is nil.
Now we must consider what happens in the case of unsound money; that is to
say money and credit that can be expanded by the will of the state and the
banks it licences. Over a period of time, this new money is absorbed into the
economy, reflected in new transactions that otherwise would not have
occurred. The value of transactions attributable to the expansion of money
and credit is likely to be a multiple of the new money introduced, as it
passes from the original beneficiaries to later receivers.
If we assume this is a single expansion of the quantity of money these new
transactions will only be a temporary feature. The prices of goods bought
with the new money rise to compensate with a time lag. Having initially
expanded, real GDP would then contract as the temporal lag between stimulus
and price effect is fully unwound. With all transactions fully accounted for
real GDP ends up unchanged, always assuming there has been no change in
consumer preferences between money and goods.
The dubious benefit of stimulating demand by increasing the quantity of
money and credit has been only temporary. Changes in GDP described above
reflect not economic progress, but the absorption of the extra quantity of
money and credit deployed. If the matter stopped there, the damage to a
properly functioning economy would be limited, but monetary inflation also
triggers a transfer of wealth from the majority of people to a small rich
minority. This happens because price increases spread from where the new
money is first deployed (typically through the banks and financial markets),
leaving the majority of people to face higher prices with no offsetting
monetary benefit. There is, therefore, a secondary impact: the apparent
benefit of increasing the quantity of money is followed by a fall in demand
for goods and services because of the wealth-transfer effect, the opposite of
the intended result. The economy as a whole ends up worse off than if no
monetary stimulus had occurred. This is why extreme monetary inflation is
always accompanied by economic collapse.
In the foregoing example, the effect of a single injection of additional
money and credit was considered, but once this policy is embarked upon it is
almost always continued at a compounding pace. Macroeconomists note only the
initial benefits, and when they fade, as described above, they clamour for
more. The result over time is that weak-money policies lead to the continual
currency debasement with which we are familiar today, together with the
build-up of debt, which is the counterpart of expanding bank credit. As the
currency buys less, more is required to achieve the same initial effect.
That changes in money and credit do not equate accurately to changes in
GDP in practice is partly due to econometricians selecting which activities
to include in GDP. They interpose an artificial distinction between
categories of spending with the intention of isolating spending on new goods
and services deemed to be consumption. This is an error, because these
economists are forced into making a subjective judgement that is bound to be
at odds with reality. In practice, a consumer can only be described in the
broadest terms.
Consumers may spend money on buying assets such as housing, art or stocks
and shares: there is no difference between spending on these and on anything
else, because they all have a valid purpose in the mind of the consumer. In
addition, there are unrecorded transactions on the black market or not
recorded from small businesses, as well as transactions in second-hand goods
which are specifically excluded on the grounds that the purpose of GDP is to
record new production only. Therefore, much economic activity is excluded
from the GDP calculation with the complication that money will flow between
the econometrician's version of GDP to the wider transaction universe,
undermining all the macroeconomists' attempts to link an increase in prices
to an increase in the quantities of money and credit.
In conclusion, GDP has nothing to do with economic progress. It is a
flawed statistic that imperfectly summarises the money-value of selected
transactions over a given period. The fact it is usually positive is a
reflection of the temporal difference between monetary inflation and the lagging
effect on prices, and has nothing to do with economic progress.
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