The
extraordinary tale of a false statistic
An American economist and
econometrician, Simon Kuznets, was awarded a Nobel Prize
in 1971 for “his
empirically founded interpretation of economic growth
which has led to new and deepened insight into the
economic and social structure and process of
development”. It was Kuznets who is credited with the
invention of Gross Domestic Product, which he worked on
in the late 1930s.
Before his work on GDP there was no statistical
measurement of the size of an economy. The problem was
to reduce the diverse production of goods and services
to a single measurement, so that apples and pears could
be lumped in with motor cars and trucks. GDP is the
value of all goods and services in an economy measured
in the currency of the country, in this case US dollars
because Kuznets worked for the US Government. Allowance
was also to be made for government provisions of goods
and services, many of which were provided to end-users
for free. The solution was to include these at cost.
GDP might be useful when quantifying the size of one
economy compared with another, and it allows us to
construct a table showing their relative importance to
each other. But GDP was taken further in its use by
Keynesian economists to become an important, and now the
most important statistic, for assessing the
effectiveness of macro-economic policy. And because it
does not differentiate between the value of
consumer-driven GDP and government-driven GDP, it has
been easy for politicians and their economic advisers to
slip into the habit of assuming they have similar
economic values. This allows a politician to spend money
and know that that spending contributes to “economic
growth” as reported in the GDP statistic, to the same
degree as does an increase in private sector output.
This lack of value-judgement in the GDP number is
analogous to valuing a company on its balance sheet
alone. The balance sheet might say the company has
productive assets at a figure in the books, but no
serious investor is going to take the accounting
information as read: he will go and look at the trucks,
the factories, and the equipment therein and then form a
judgement on their condition and value to the
enterprise. The numbers in the balance sheet are no more
than an accounting identity of the factors of
production. In the same way, a GDP figure will be
comprised of the output of some businesses that are
dynamic, inventive and have a commanding global product.
There will be other businesses that rely on government
subsidies to remain in business: the value of their
product is less perhaps valuable to the economy, except
in the eyes of the politicians who have authorised the
subsidy. In that case, it cannot be said that the
product of these subsidised businesses are wanted by the
consumer in the quantity produced or at a profitable
price. There are also those businesses whose output is
dependent on government contracts; contracts that may or
not add true value to an economy. And then there is the
cost of government services, which are forced upon
people whether they want them or not, which diverts
through taxes financial resources that would otherwise
be applied to products and services that people actually
do want.
This much the Austrian School of economists agree with.
Von Mises himself wrote that “the attempt to determine
in money the wealth of a nation or the whole of mankind
is as childish as the mystic efforts to solve the
riddles of the Universe by worrying about the dimensions
of the pyramids of Cheops”.[i]
But we can advance criticism one step further to
demolish any pretence the GDP statistic has to represent
the values of production, and therefore be a valid
measure of economic output.
To do so, we need to consider an economy with sound
money, with no change in the quantity of money and bank
credit, and a balance in trade and cross-border capital
flows. If, on the last day of the previous year, GDP is
one billion monetary units, what will it be on the last
day of the current year? It has to be the same one
billion units. Production activity can change, the ratio
between consumption and savings can change, the ratio of
private sector to public sector in the economy can
change, but if there is no change in the quantity of
money, GDP must be the same. The adjustment is on
prices, so a rise in overall production leads to lower
prices, and lower production to higher prices.
Having established that in a sound money regime there
can be no change in GDP, it becomes clear that in a fiat
money regime, GDP will change only to reflect monetary
inflation, independently of production activity. In this
case the stock of money is simply being increased, and
the effect on the prices of final goods is a secondary
consideration, just as it is in the sound-money example.
But there is a further difference between the two
conditions. In the sound money example, prices can be
expected to fall over time, making the application of
savings to business investment an attractive proposition
for savers. Not only does the saver get a modest
interest return, but the purchasing power of his capital
increases over the years. For this reason surplus
capital tends to be productively invested as savings
rather than speculated with, positive returns being
certain, except for individual entrepreneurial risk.
In a fiat money regime, this relationship between savers
and productive investment is interfered with by the
consumption of capital that results from inflation, and
by the destabilising effect of credit-driven
boom-and-bust cycles. As savers become aware of the loss
of their capital they seek other ways to protect it. And
because they, or financial intermediaries acting on
their behalf, increasingly seek to protect their savings
from inflation, money-savings shift away from productive
investment. Instead they are reapplied to more
speculative activitites, such as gambling in stock
markets and other asset classes thought to benefit from
monetary inflation.
The long-run effects are demonstrated in the contrast
between economies primarily driven by savings and those
driven by consumption. In the post-war years, Germany
and Japan developed a strong savings culture that
flourished under successive governments, which pursued
an anti-inflation bias in monetary policy. The
consequence was interest rate stability at levels that
were more influenced by supply and demand for savings
than by the central banks’ monetary expansion. The
benefits enjoyed by these savings-driven economies are
in accordance with the Capital Theory developed by
adherents to the Austrian School of economists.
Stability in the cost of money and other factors of
production allowed intermediate manufacturing processes
to thrive, and both Germany and Japan developed into
economic power-houses as a result.[ii]
The position of consumption-driven economies has been
entirely different. In the post-war years the
governments of the US and UK (taken as an example) have
relied on monetary expansion as the driver of economic
growth as they followed Keynesian and Monetarist
macro-economic policies. Inevitably, the ethos whereby
savings are applied to industrial investment has
suffered considerable and increasing disruption. The
decline in the savings ethos in both these Anglo-Saxon
economies has been driven by monetary inflation and the
unstable economic conditions for productive investment
that results from monetary expansion. Again, this is
easily deduced from Capital Theory. The consequence is
that manufacturing, with unstable costs of both money
and the other factors of production declined, leaving
these economies increasingly dependent on consumption.
The growing pool of speculative capital
Attempts to manage the GDP statistic through injections
of fiat money have not only distorted the relationship
between genuine savings and productive investment, they
have also led to a growing accumulation of speculative
capital, as mentioned above. For this reason, monetary
expansion does not automatically feed into GDP. To the
extent that this leakage occurs, monetary expansion has
to be pursued more aggressively to bolster this number.
And here a self-defeating mechanism becomes evident. The
more monetary inflation is injected into the economy,
the more capital owned by the private sector is
consumed, and therefore the more monetary expansion
favours financial speculation over productive
investment. Further injections of fiat money are simply
ceasing to bolster the GDP statistic.
Not that this will stop economic policy from continuing
to try to grow the GDP accounting identity: Keynesianism
and Monetarism is based in large measure on the delusion
that the GDP statistic is actually economic growth and
not just growth in the money in the economy. The only
way this process will cease is when all confidence is
lost in the purchasing-power of fiat money. Only then,
in the post mortem, might the mistake of confusing an
accounting identity for the real thing become clear to
the economic establishment and the wider population at
large.
7 October 2011
Alasdair Macleod
[i]
Human Action as quoted in an article by Dr
Frank Shostak published by BrookesNews.com 3
Sept 2007.
