The GDP Smokescreen

The Fall 2008 issue of Cornell Enterprise, a publication of Cornell University's Johnson Graduate School of Management, features a very interesting article on not only the shortcomings of Gross Domestic Product (GDP) as a measure of our national health, but some potential alternatives for gaining a clearer picture of where we actually stand as a country. Even more revealingly, it provides metrics that more accurately describe the relative strength of the United States at this point in its history, as well as in relation to other countries.

Gross Domestic Product first arose as a useful measurement during the Great Depression, a time prior to which no national metric for economic well-being was in use. Today, it is one of the most closely-observed and widely-quoted metrics around the world, and beyond its simple function to provide a tally of all cash-based, legitimate business activity, it has come to serve as a gauge of both overall prosperity and general happiness. Unfortunately, GDP has some serious limitations.

First, it isn't particularly accurate:

While the Gross Domestic Product is supposed to measure the total output of goods and services, it doesn't, and probably can't, says Karel Mertens, assistant professor of economics at Cornell.

For instance, GDP doesn't count the work of spouses who stay at home taking care of kids and cooking meals. But if the same family were to spend money on a nanny and carry-out from Burger King, the GDP would go up. Barter isn't counted either. If a mechanic changes the oil in his barber's car in return for a haircut, the GDP is static. If they pay each other, the GDP goes up.

Nor does the GDP count transactions in the murky black market, where stolen goods are marketed and consumers stock up on everything from bootleg DVDs to moonshine whiskey.

And second, a strong GDP figure is in no way an assurance of societal or even economic health:

Community activist Jonathan Rowe, who testified before the Senate Commerce Committee this year, defined the GDP as "a big statistical pot that includes all the money spent in a given period of time. If the pot is bigger than it was the previous quarter, then you cheer. The money could be going to cancer treatment or casinos, violent videos, or usurious credit card rates. . . . The money in the pot could betoken social and environmental breakdown — misery and distress of all kinds. It makes no difference. You don't ask. All you want to know is the total amount, which is the GDP."

While the U.S. now ranks 8th in the world in per capita GDP (down from second) - which is at least a top 10 showing but hardly a podium finish - other indicators of our national development are even more disturbing. The United Nations' Human Development Index (HDI), for instance, combines factors for life expectancy, education and literacy and purchasing power. The United States ranks fifteenth overall - behind Australia - and the individual components of HDI are even more alarming: the U.S. is 20th in education, trailing Slovenia; and 31st in life expectancy, just edging Cuba.

Similar alternative measures like the Institute for Innovation in Social Policy's Index of Social Health (ISH), which tracks sixteen indicators of societal strength, also reveal that, overall, America has actually lost ground in the decades since the 1970s:

Likewise, the Genuine Progress Indicator (GPI) includes per capita GDP, but also subsumes such factors as long-term environmental damage, crime, pollution, dependence on foreign assets and income distribution. Although GPI shows more uniform progress than ISH, when it is compared to per capita Gross Domestic Product, GDP's capacity for overstating national health is clearly revealed. While American GDP climbed sevenfold during the last half of the 20th century, in marked contrast, GPI increased significantly less than half as much, and most of that rise occurred prior to 1970.

Given the entrenched usage of Gross Domestic Product, it is unlikely that it will disappear as an important indicator of economic strength anytime soon. While it is unclear what modifications to GDP are most important - or even upon which agreement can be reached - when discussing the social health of the United States, metrics like HDI, ISH and GPI need to be considered.

"The GDP is a very crude, one-size-fits-all measure," says Stuart Hart, Samuel C. Johnson Chair in Sustainable Global Enterprise and professor of management. "It measures total economic activity regardless of the result of that activity. At the end of the day, if the GDP is your metric, then we're going to go over the cliff."

In fact, the U.S. has found itself dangling over the precipice despite a growing GDP. Consider recent events. On August 28, the Commerce Department announced the GDP had grown at a healthy 3.3 percent clip in spring and early summer, more than three times the anemic pace of the winter months. Hopeful investors pushed the Dow Jones Industrial Average up by more than 200 points by day's end.

Then the dominoes began to topple. Within a month, the government took control of mortgage giants Freddie Mac and Fannie Mae, Bank of America agreed to buy troubled Merrill Lynch, Lehman Brothers went under, the government bailed out insurance giant AIG, bank regulators seized Washington Mutual, and Congress agreed on a $700 billion bailout package for financial firms to try to stop the chaos. Meanwhile, the housing crisis and unemployment worsened.

"No one can question that the GDP has been growing," says Hart. "But what's the point?"

Be sure to keep that in mind the next time anyone tries to use GDP growth to sell you on the alleged strength of the economy during the first seven years of the Bush Administration.

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For more, here is a short clip from an interview with Professor Robert H. Frank, one of the country's foremost thinkers on the relationship between economics and society. (And an instructor I was lucky enough to have as both an undergraduate and a graduate student!)