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GDP is an
economic planners’ concept, and is the yardstick by which their success
or failure is judged. As the definition used by Wikipedia puts it: “GDP
refers to the market value of all final goods and services produced in a
country in a given period”. Only refers. This article questions the
validity of GDP as a meaningful statistic, and finds it to be valueless and
even worse, misleading, with profound implications for mainstream Keynesian
economics.
If you really want to know how
an economy is growing, you must take every item of manufactured product and
every service sold, and estimate the change in their
individual quantities and qualities over time. You should only include
products and services freely exchanged for value,
otherwise there is no sound transactional basis for their existence. You must
somehow capture technological improvements in each product, and changes to
benefits in each service. It amounts to an impossible task, given its
complexity and the degree of subjectivity involved: this is why it is far
simpler to use money values instead for central planning purposes. And
therein lies the trap, which is readily exposed by considering the application
of money GDP in a sound money environment.
If a nation has completely sound
money, there is no expansion or contraction in its quantity, or of bank
credit. Let us also assume that there are no net cross-border flows. This
being the case, GDP in Year 1 obviously will be exactly the same as in Year
n, irrespective of the actual economic activities in those years. This makes
it obvious that GDP is a measurement of total money deployed in an economy,
and not of the goods and services themselves, which are free to vary within
the confines of the money total. The only money variances that can occur are
from changes in cash levels (hoarding and liquidity) and exclusion of
activities from the statistics (black markets). It is the nature of sound
money that these errors will be very small, reflecting public and business
confidence in the medium of exchange. And with sound money, there is no
statistical error to consider since there is no change in its quantity.
History has shown that in a
sound-money economy, the prices of goods fall over time, reflecting increased
production efficiencies and technological advancements. So, in real terms,
this impossible-to-measure annual economic growth probably works out at a few
per cent annually, and the purchasing power of money can be said to have
risen to reflect that improvement. And it is the certainty of this return on
savings from the gradual increase in their purchasing power that helps keep
nominal interest rates low.
In practice, economic
performance is always a combination of private and public sector activities.
As any thinking economist with experience in the commercial world should
know, the difference between the two is that the private sector, left to its
own free choices, uses the available resources of consumption and savings to
maximum efficiency because waste is abhorred; while the public sector, which
deploys economic resources primarily for social and bureaucratic purposes is
considerably less efficient in its use of them. There is no way of measuring
the loss of economic resource from its redeployment to the public sector, and
it will be greater or lesser across different government functions. In all
instances of government-provided goods and services, there is no independent
pricing mechanism to establish their true value. To the loss of economic
resources from government transactions must be added the loss of the economic
production that the private sector would otherwise have enjoyed if its
economic resources had not been redeployed to finance government spending.
These two losses together can be considerable.
We can begin to see the
differences emerging between the changes that can occur in an economy despite
a fixed monetary value for total market transactions. Furthermore the cost of
government in a sound money environment becomes immediately obvious to the
public, because the government cannot use the hidden tax of inflation as a
source of revenue, or as an economic management tool. In a sound money
environment, when a government borrows to finance its spending, it drives up
interest rates against both itself and against the productive private sector,
because it is unable to increase money in circulation to compensate. Because
all government intervention is immediately noticed for what it costs, democracy
in a sound money economy can be expected to elect small efficient
governments. Consequently, the drag on an economy from government spending
and intervention should be minimised in a sound
money environment.
Now let us consider the
conditions we have today, whereby governments manage the quantity of money at
will, and banks are licensed by the authorities to vary credit supply. Our
task is to identify the factors that enable nominal GDP, as reported by
statisticians, to grow over time. The information that makes up GDP is based
on domestic product, so trade imbalances are already compensated for, and
capital transactions are not included.
The first factor is the addition
into the economy of fiat money itself. This additional money and bank credit
must be reversed out, because it is solely extra money and does not represent
an increase in the market value of goods and services, which became clear
when we considered the sound money example. Secondly, government spending is
also an additional statistical distortion, because it is included as if it
were a normal productive activity, but again we know from our sound-money
example that it is actually a net economic cost; so here again, an increase
in government spending artificially increases GDP above its true worth and
should also be removed. And finally, the change in the general price level
which accompanies monetary and credit expansion further boosts nominal GDP,
rather than the other way round as is commonly supposed: this is a misleading
impression caused by the use of a GDP deflator to compensate for price
inflation.
Accordingly, the increase in GDP
in a fiat currency over a period of time is the simple monetary result of
these three distortions. If they are removed from official GDP figures, there
should be no growth in an adjusted GDP statistic at all. The chart below,
which is of US GDP from 1960 to 2010 showing the relevant adjustments,
supports this conclusion.
The chart reflects the removal
of the three distortions we have identified that make up nominal GDP (the red
line) in individual steps to arrive at a sound money equivalent (the black
line). Nominal GDP grew from $526.4bn in 1960 to $14,849bn in 2010. The fully
compensated figure fell marginally from $439.7bn in 1960 to $436.3bn in 2010,
So our theoretical proposition,
that all the growth in GDP is entirely due to the growth in government
spending, domestic monetary and credit inflation, and the falling purchasing
power of the currency, is confirmed by the adjusted statistics. However, the
compensated figures do have some volatility, though this is small compared to
the adjustments made. The variables not taken into account, that might have
some effect, are changes in levels of money-hoarding, changes in the level of
black-market activity, and changes in the composition and methodology of
calculating the consumer price index. Over the period there have been
improvements in data collection and there is the changing relationship
between M2 and other monetary factors, such as money in the shadow banking
system, which are bound to affect any estimates. But taking these variations
into account the relative constancy of the fully adjusted number over the
last forty years is impressive. Our conclusion therefore stands as valid on
this evidence.
So it turns out that GDP, this
emperor among central planners' statistics, has no clothes. It is just a
meaningless money quantity. It started as an invention of a US economist and
Nobel laureate, Simon Kuznets, who was working for the National Bureau of Economic
Research in the 1930s, and GDP was first applied in 1942 to complement
estimates of national income and to facilitate war-time planning. Any caveats
he might have put on its application have been ignored. The result was as if
Congress had asked him to come up with a new statistic that would justify the
future growth of government, making sure the losses to the economy were concealedi. And the fundamental basis of this statistic
does not seem to have been seriously questioned since: after all, the ground-breaking
work of a Nobel laureate, and all the statistical methodology of the best
brains government can employ is regarded as authoritative.
Therefore the majority of
published material on economics over the last seventy years is itself based
on complete bunkum. Modern statistics are selected to support bad economic
theories that seek to justify government intervention rather than the truth;
and the further theories derived from the fundamental building-blocks of
modern economics are themselves built on sand. According to the GDP statistic
government spending does boost the economy, which is why Keynesians are
convinced that government intervention is beneficial. But economists of the
Austrian school know that government spending is detrimental to the economy.
It is reliance on false statistics, such as GDP, that go a long way to
explaining how the two camps can radically differ in their opinions. So
familiar are we to the concept that GDP actually reflects economic activity
that it is hard to accept that it is no more than a meaningless money number,
but that is precisely what it is.
We shall now briefly look at the
implications of this conclusion.
There are the obvious ones. For
example, the more monetary inflation there is, the better GDP statistics will
appear: this is an incitement for central banks to continue to expand money
supply and encourage the growth of bank credit. No wonder we have ended up
with a progression of higher and higher debt, the counterpart of bank credit,
to the point where the debt bubble has finally become unstable. Secondly, the
more government taxes and spends in an economy, the more it artificially
inflates the GDP numbers: this gives socialism its veneer of success. No
wonder government is encouraged to grow itself at the expense of the private
sector, when this growth has statistical benefits, even though it is
economically destructive. And finally, the more a government can manipulate
CPI calculations to keep them artificially low, the more GDP appears to grow,
reflecting actual changes in price levels: this is precisely what the US
government has been doing in recent years, as recalculated inflation
statistics from Shadowstats.com clearly demonstrate.
Governments use all these
tricks, and have been successfully fooling themselves in the process since
the GDP concept was invented and developed at their behest. So long as GDP is
growing, we have tolerated the increasing burden of government and its
management of our affairs. And the public now firmly believes from GDP
statistics that increases in government spending, management and control over
the economy are the road to salvation from the uncertainties of economic
life.
Less obviously, at least to
governments, we are now at the end of this social fallacy, with all the signs
that the central planners have led us into a dead-end. Government debts in
nearly all developed nations have now spiralled out
of control, with even greater welfare costs in the pipeline. Governments are
now no longer just fooling themselves with false statistics; they are
fighting for their own economic survival, ensnared in a debt trap.
The fight will be lost, because
governments are victims of their own statistical propaganda, wrongly
believing that anything can be fixed with enough intervention, and not understanding
why their flawed schemes are falling apart. Instead they blame the private
sector for the economic ills that are actually the consequence of their own
interventions. Their gut reaction is to inflate the components of GDP
identified in this article even further: banks must lend more, governments
must spend more, and the recent growth in the CPI must be ignored because a
little inflation is good for GDP growth.
While these quack remedies are
pursued in the vain hope that modern economies will recover given enough
time, they are killing the prospects for any lasting recovery. The right
balance of consumption and savings is needed, which can only be decided in
the free market, and not by economic planners. Instead of permitting this to
happen, accelerating levels of money and credit creation will take place,
destroying savings entirely. And monetary inflation is no longer just puffing
up GDP; it is being used to buy time to defer government bankruptcy and the
unwinding of the associated malinvestments in the
private sector.
For further proof that the GDP
statistic is as far removed from actual measures of economic performance as
stellar objects are from each other, consider this: if GDP had been
calculated in the early 1920s, Germany would have been shown to be enjoying
an unprecedented post-war boom, when the reality was hyper-inflation. And if
you still cannot accept the proposition that GDP has no statistical value,
come up with a convincing argument how the total money-value of all goods and
services can actually change in a sound money environment.
Alasdair
McLeod
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