Bringing GDP into the 21st Century
The government is changing the way it calculates Gross Domestic Product.
The government is changing the way it calculates Gross Domestic Product.
The Atlantic (“The Lady Gaga Fix: How the U.S. Is Rethinking GDP for the 21st Century“):
This week the government released yet another revision of first-quarter economic growth showing that the U.S. economy grew a tad less than initially reported ‑- 2.4 percent rather than 2.5 percent. This revision was hardly consequential, but over the summer the Bureau of Economic Analysis will unveil a new way to calculate the overall output of the United States. And that revision will be dramatic.
Over the past few decades, gross domestic product (GDP) has become the prima inter pares of economic statistics. It is not only a measure of national economic output, it is a proxy for “the economy.” The number exerts substantial influence on what we spend collectively and individually, not just in the United States but throughout the world. China has five-year plans with GDP targets, and the European Union has rigid – albeit loosely enforced – rules about how much debt a government can take on relative to its GDP. It is, in short, a big-deal number.
[…]
The BEA is the government agency responsible for compiling U.S. GDP figures, and it is always looking for better ways to measure. Every few years it tweaks its methodology. This time the tweaks will be more than incidental. In fact, not only will they add several hundred billion dollars — statistically, at least — of annual output, but they will also begin an overdue transition of these numbers away from the 20th century, when they were invented, and into the 21st, where we now live.
The change is relatively simple: The BEA will incorporate into GDP all the creative, innovative work that is the backbone of much of what the United States now produces. Research and development has long been recognized as a core economic asset, yet spending on it has not been included in national accounts. So, as the Wall Street Journal noted, a Lady Gaga concert and album are included in GDP, but the money spent writing the songs and recording the album are not. Factories buying new robots counted; Pfizer’s expenditures on inventing drugs were not.
As the BEA explains, it will now count “creative work undertaken on a systematic basis to increase the stock of knowledge, and use of this stock of knowledge for the purpose of discovering or developing new products, including improved versions or qualities of existing products, or discovering or developing new or more efficient processes of production.” That is a formal way of saying, “This stuff is a really big deal, and an increasingly important part of the modern economy.”
The BEA estimates that in 2007, for example, adding in business R&D would have added 2 percent to U.S. GDP, or about $300 billion. Adding in the various inputs into creative endeavors such as movies, television and music will mean an additional $70 billion. A few other categories bring the total addition to over $400 billion. That is larger than the GDP of more than 160 countries.
This move makes sense. GDP always undercounted creative activity; it matters more now that it’s a more fundamental part of the economy. Alas, the move is not without controversy.
The announcement has already received some attention, much of it negative. One website used the headline “U.S. GDP: America is About to Look Richer – But Don’t Be Fooled.” Criticism ranged from the accusation that the Obama administration is juicing the numbers to burnish its record to the belief that the new calculus only widens the gulf between those doing well and those struggling in today’s economy. And because the revision significantly expands the statistical size of the economy, some fear it will be used as a spur to both austerity and complacency about the structural challenges we face.
The A in BEA stands for “Analysis.” It’s their job to collect the best data they can to analyze. But, yes, the change will have the impact of making it seem as if the economy suddenly grew—but only if one compares the old news reports and the new ones. The BEA will standardize all the data, of course, for its own purposes:
It’s true that simply restating overall output does not make anyone richer. People will have what they had before the numbers reflected it, and will continue not to have it if they didn’t. The BEA will, in fact, restate all GDP going back to 1929 under the new methodology, which means that while the overall size of the American economy may increase, the historical ebbs and flows will remain roughly the same.
The government periodically makes major changes in the way it calculates economic data. Under President Reagan, we started counting government employees, including military personnel, in the employment figures. Since those people are by definition employed, it made the unemployment numbers go down. Under President Clinton, we started counting money in the completely fictional Social Security Trust Fund as part of the general treasury, making the deficit go down. Both those changes made rational sense. Both were criticized as political. And, of course, they were! These numbers are both analytically useful for professional economists and fodder for political food fights.
Zachary Karabell, the author of the Atlantic piece, thinks too much significance is paid to GDP in particular:
[H]ow we measure and what we measure shape our collective sense of how we are doing. The limitations of GDP will not disappear with this revision, but at least the numbers will better reflect the nature of today’s economy. When GDP was created in the middle of the 20th century, manufacturing and output of goods was much more central. Our indicators today are very good at measuring mid-20th century industrial nation-states. They are less good at capturing the realities of 21st century economies fueled by ideas and services. This revision is the start of reframing our national numbers to reflect the economy we have rather than the one we had.
The new framework will not stop the needless and often harmful fetishizing of these numbers. GDP is such a simple round number that it is catnip to commentators and politicians. It will still be used, incorrectly, as a proxy for our economic lives, and it will still frame our spending decisions more than it should. Whether GDP is up 2 percent or down 2 percent affects most people minimally (down a lot, quickly, is a different story). The wealth created by R&D that was statistically less visible until now benefited its owners even those the figures didn’t reflect that, and faster GDP growth today doesn’t help a welder when the next factory will use a robot. How wealth is used, who benefits from it and whether it is being deployed for sustainable future growth, that is consequential. GDP figures, even restated, don’t tell us that.
That’s not surprising, in that they’re not supposed to.
Yeah, I wrote a couple of posts about this revision more than a month ago when the revision was first announced. As much as anything else it’s a full employment plan for economists. The number of things that will need to be recalculated and revised is truly vast.
Also, if GDP has actually been growing at a faster rate than we thought, then Okun’s Law is good and truly broken. That’s not good news.
Someone criticized Reinhart And Rogoff yesterday, for using “debt” figures that were not really calculated the same, country to country. Like GDP the available number is is a huge simplification.
The key thing to understand is that when you do reduce a complex economy to a single number, the resulting number is only useful with respect to itself, as a time series. And then all you are doing is looking at how your simplification changes.
That narrow meaning of GDP is not very useful in politics though, and so essentially every use in politics will be wrong. This includes using GDP as a proxy for “growth” (at least close), or “progress” (not so much), or “happiness” (not even).
Really the last meaning is the thing to acknowledge. The implication is that more GDP means more happiness, and that the other party hasn’t done enough to make you happy, “as you can see in black and white.”
Exactly, but if GDP was used as it should be, it would basically never appear in a political essay.
tl;dr – if your concern is the welfare of your citizens, there are much better numbers to use.
Simon Kuznets, the economist who developed the first comprehensive set of measures of national income, stated in his first report to the US Congress in 1934:
@john personna: Yeah, it’s pretty obvious even from a cursory look at the measures that go into the GDP index. From a political science standpoint, it’s been so widely used simply because it’s so easily available for almost every country going back a very long time. So, it makes a very handy proxy for the strength of a national economy that’s “close enough” for a lot of things being investigated. And GDP/capita is considered “close enough” for a lot of other things. But among those things, for example, isn’t average prosperity; unfortunately, it’s often used for that.
@James Joyner:
Leave aside whether we should be interested in “average prosperity”. That can be accomplished by increasing the the prosperity of a single individual.
The problem is that nobody really knows how to create more general prosperity. We have a pretty good idea of how to increase GDP (it can be done by borrowing and spending, for one thing).
We also have some pretty good ideas about increasing aggregate demand to meet potential production. The hope of both increasing GDP and increasing aggregate demand is that doing so will increase prosperity.
That’s where my first comment about Okun’s Law, a rule of thumb relating increases in GDP to increases in employment, comes in. What if there is no relationship between GDP and employment? For one thing, it would mean that a lot of the policy, not just of the last five years but of the last 40 years, would be shown to have been wrong.
IMO we need to be focusing more closely on creating employment, something more likely to improve your prosperity measure, than increasing GDP or average income would be. Nothing that anybody is proposing right now is likely to do much to increase employment.
@Dave Schuler:
To be fair to Okun, shouldn’t we continue to apply his Law with the GDP as then understood?
He made no guarantee about different numbers defined later.
(I think we should be interested in average welfare of our citizens, and the old pyramid example shows that more GDP doesn’t necessarily buy that. In that thought experiment you draft all the unemployed and put them to hard manual labor building a stone pyramid. You pay them deficit dollars, greatly raising GDP. Is the country better off? Not really. Of course if you can find more productive and more pleasant activities for the unemployed than dragging stones …)
If the truth be know, this is Enron style accounting seeping into the GDP world. There is almost no way to attach reliable values to most of this “R&D” work, so the numbers will be interpolated, extrapolated and put together with scotch tape and paper clips, subject to political manipulation and crony interventions. If artistic investments pay off their value is reasonably reflected in downstream in expenditures that are already tracked and included in GDP. This change is being made as political payoff to arts organizations and their donors who will now claim that everything they do is for the economic good whether it produces value or not. It is a big step backwards in terms of going forward with numbers that are real and meaningful.
Eh. GDP is currently kind of a “dumb” (but useful) number and will continue to be so.
Great but not that important. Middle class and poor folks have been ignored for 5 years by Bernanke and Pres Obama. Wall Street, large corporations and the rich have done wonderfully for last 5 years thank you very much. It is time for Pres Obama and Bernanke to focus on most Americans. It is time they show they care about most Americans and want them to succeed and don’t focus as much in the next 18 months on the rich but more on us, working class and poor folks. So far Pres Obama’s financial policies have not benefitted most Americans even with GOP obstructions. As for minority populations..their support for Pres Obama have not been reciprocated by the President.