The "GDP Fraud"

If GDP is telling us that the US economy is steadily improving, how come so many folks on Main Street feel so bad? Don’t they read the papers? Don’t they know the GDP is improving?

The short answer to these questions is that the GDP calculation is a fraud…or perhaps it’s a fraud wrapped in a deception.

To understand why the GDP numbers could be so good when the economy all around looks so bad, it is necessary to understand a few pertinent details of the GDP calculation. It is necessary to see just what meat and meat by-products go into this economic sausage. For one thing, GDP includes government spending…but does not SUBTRACT any of the borrowing the government does to fund its spending. And obviously, government spending is in no way a reflection of private sector economic activity.

Therefore, as Frank Shostak, an adjunct scholar of the Mises Institute, observes, “The GDP framework gives the impression that it is not the activities of individuals that produce goods and services, but something else outside these activities called the ‘economy.’ However, at no stage does the so-called ‘economy’ have a life of its own, independent of individuals. The so-called economy is a metaphor – it doesn’t exist.”

Convention tells us that the GDP framework is, more or less, a tool used to measure the size and health of this “metaphor”…ahem, the “economy.” Most often, we hear it expressed as a rate of growth – either positive or negative. And it is this widely followed number that determines when economic expansions end and recessions begin (two consecutive quarters of “negative growth.”). But GDP as a measurement is really just hogwash. It can no more calculate the health of an economy than it can tell you the time or give you a back massage.

Let us consider briefly the computation of the GDP measure. There are three main ways to calculate GDP:

1) The expenditure method

2) The income method and

3) The value-added method.

Theoretically, all three methods should produce the same result although, in practice, this almost never happens. For instance, when there is a large surge in public spending, as we have seen recently with the torrent of stimulus packages from governments around the world, the GDP “growth” registers most prominently in the expenditure method.

Roughly speaking, this method calculates the “size” of an economy by totaling its expenditures, minus imports. It is also the most common method employed to determine GDP. The equation looks like this:

GDP = private consumption + gross investment + government spending + (exports − imports).

To understand just how misleading the expenditure method can be, let us consider briefly the case of the Australian economy. It is widely accepted that the Aussies, under the deft stewardship of Prime Minister Kevin Rudd, had avoided entering a technical recession during the crisis from which we are now said to be “recovering.” It’s a nice story…except that it is a lie or, at best, a “one-third truth.”

Australia DID unquestionably fall into recession. It’s just a matter of definitions.

Like their American counterparts, Australian politicians pushed through a series of emergency stimulus packages, now credited with having helped the country avoid recession. Dr. Steven Kates, who lectures on economics at RMIT University in Melbourne, provided a rare dose of clarity in a recent article, published in The Australian. Dr. Kates concludes that by both the income and value-added measures, Australia comfortably satisfied the criteria for a technical recession.

“The income series… indicates a pretty minimal year all round,” Dr. Kates explains. “Both the September and December 2008 quarters showed an actual fall in the level of output, the very definition of a technical recession. Over the year, the level of GDP has fallen 0.4 per cent, by no means as bad as elsewhere, but more in keeping with the general experience across the economy.

“The third measure shows the changes in GDP according to the production-based data,” Kates continues. “Here, too, [in the value added, or, production series] we have the ingredients for a technical recession, with an actual reduction in the level of output in both December 2008 and March 2009. Across the year, GDP has fallen by 0.7 per cent.

“While the stimulus package appears to have been able to distort one of the three sets of national accounting measures we use,” Dr. Kates concluded, “beneath it all the Australian economy, in keeping with the rest of the developed world, has gone through a recessionary phase from which it is only now beginning to emerge.”

Therefore, the only way the Australian government could claim that it had “avoided” a recession was by utilizing the expenditure method, or by averaging all three measures of GDP together. Here we see that unprecedented government stimulus spending propped up the expenditure metric, much like a steroid injection might help prop up a cheating athlete. Not only is stimulus spending an unsustainable and deceptive scam, measuring it as a “+” under the expenditure GDP calculation separates further the reality individuals experience from the fantasy their governments serve up to them.

As the Australian example shows, this methodology simply ignores the fact that government spending is not true production at all because it is debt financed. Government spending, therefore, should really only be government spending, LESS government borrowing.

You see how misleading this measurement can be, especially when huge sums of debt-financed stimulus must be taken into account. Sound familiar?

Murray Rothbard, the legendary Austrian economist, elaborated further when he proposed his alternative measures: Gross Private Product (GPP) and Private Product Remaining (PPR).

Rothbard defines the former as “gross national product less income originating in government and government enterprises.” PPR is GPP less the higher of government expenditures and tax revenues plus interest received. Rothbard argues that because government output is “financed coercively” (i.e., by taxation), it is unclear what – if any – market value may be ascribed to the end product. Simply put, both measures place government “production” where it belongs: in the “opportunity cost” pile.

If free market participants did not deem it worth their while to buy something in the first place, why should it be considered a net positive when the government uses their money (or China’s) to buy it on their behalf? This case may be brought against the “cash for clunkers” program, the $8,000 credit for homebuyers and impending “cash for anything” programs currently finding their way through the special-interest-greased halls of Congress as we write. Indeed, the entire bailout and stimulus programs fall squarely into the opportunity cost pile. But that’s not how those trillions are calculated using conventional GDP metrics.

Measure it how you will, dear reader; true economic progress is forged not in the crucibles of debt or coercion, but from the honest toil of individuals seeking to better their own lot, unhindered from the government’s long, strangulating reach. No nation can spend its way out of recession…no matter what the official GDP numbers may imply.

Regards,

Joel Bowman,

for The Daily Reckoning