By George Markides
In 2008 the French President Nicolas Sarkozy, dissatisfied with the state of statistical reporting on the economy, asked Nobel Laureate Joseph Stiglitz to head a commission called “The Commission on the Measurement of Economic Performance and Social Progress” (CMEPSP). The commission was tasked with identifying the limitations of using Gross Domestic Product (GDP) as the indicator of economic performance and social activity.
GDP was first introduced in the 1930s in the USA by economist Simon Kuznets at the behest of then president Franklin Roosevelt.
The USA was deep in recession (the Great Depression) and the president had to rely on snippets of information that did not represent economic activity as a whole. Roosevelt wanted to jump start the economy by increasing public spending and he needed a holistic standard for economic output to justify his actions.
Kuznets was very particular in selecting what data he was going to include in his calculations. He tended to focus only on activities he believed contributed to society’s wellbeing and rejected activities that did not. “Why count things such as armaments, when war clearly detracts from human welfare,” he argued.
Crucially, he did not include financial activities that he considered dangerous (since this was the Great Depression) or government spending, which in essence was tax money and therefore money produced from somewhere else.
Kuznets’ calculations showed that economic output in the US fell by 50 per cent between 1929 and 1932, providing Roosevelt with more than enough justification to launch his New Deal series of programmes that pulled the US out of recession.
Kuznets’ rationale in calculating economic output (as the sum of activities that contribute to society’s wellbeing) has been cast aside in modern GDP calculations. Government expenditure is included and makes up 60 per cent of total GDP.
In the run-up towards its economic collapse in 2010, Greece had overhauled its statistical service (ELSTAT) after pressure from Eurostat, the EU’s statistical office. The revision showed that Greece was including in its GDP reporting items such as black market activities, drug trafficking, and prostitution, exaggerating the country’s GDP. Ironically, the UK’s national statistics office has recently taken the decision to include in its GDP calculation the economic contribution of prostitution and drugs. As a result, the UK’s GDP magically increased by five per cent.
The problem here is twofold. First, countries can (and do) include activities (such as the case of Greece) that have no relation to Kuznets’ original concept of the total economic output as being the sum of all activities that contribute to society’s wellbeing.
Second, and more importantly, GDP calculations do not capture the value added of services. Statisticians can measure the value added of Daimler Benz assembling a Mercedes C-class although complex production lines and component inputs from all over the world render the value added in the assembly line obscure and difficult to accurately capture. Conversely, statisticians can’t put a price on immaterial items such as nursing, education, or the exotic derivatives product that Lehman Brothers bought from Washington Mutual and which led to their downfall.
Then we return back to the original problem faced by Kuznets. What do we measure? There is no country in the world that measures the economic contribution of stay at home individuals looking after others. What is the economic contribution of an individual who stays at home cooking, cleaning the house, doing laundry, or looking after elderly people? The Financial Times asked a fascinating question: What if by law a country demands all stay at home individuals to do their daily chores not for their own households but for their neighbour’s for a fee? Under this scenario there is no value added for anyone as the same amount of work will be done carried by the same people. However, since that amount of work now has a price tag or a monetary value, it has to be included in the GDP. Under present circumstances, stay at home individuals do contribute to the country’s wellbeing yet their contribution is not quantified.
Conversely, the financial sector does not contribute to society’s wellbeing and nowhere is this more evident than in the Eurozone.
Looking at the stock exchange in Spain, the IBEX 35 index closed on Friday July 4 at 10.459 points, levels it has not seen since May 2011.
On a year to date basis the IBEX has added 44.7 per cent in value and yet Spain is still plagued by crippling unemployment and high indebtedness.
However, the financial sector’s output is measured by statisticians the world over. The financial crisis of 2008 showed that statisticians did not fully understand what they were dealing with. The US financial sector officially accounts for eight per cent of the country’s GDP, however, the impact of the crisis forced the FED and the US government to dish out more than $4 trillion to contain the fallout of the crisis or 20 per cent of the total economic output. Kuznets in his original deliberations did not take into account the financial sector when he measured the economic output of the US. Had modern societies followed his example, there might not have been a crisis to begin with, as nobody would care about the financial sector because its economic contribution would not be captured to begin with.
In their 2008 report,CMEPSP made a number of recommendations that relate to Kuznets’ original measurements. One of their key messages was that “the time is ripe for our measurement system to shift emphasis from measuring economic production to measuring people’s wellbeing.” The report defined wellbeing as a measurement of these dimensions: material living standards (income, consumption, wealth); health; education; personal activities including work; political voice and governance; social connections and relationships; environment (present and future conditions); and insecurity, of an economic as well as a physical nature.
Under these dimensions, the authors argue, many countries considered better off (solely by looking at their GDP) will fare poorly compared to others.
George Markides, BSc and MBA, is an economics researcher