How to measure the strength of the economy, redux

Last month, I argued the point (admittedly at rather more length than necessary) that GDP does not measure what we’re interested in. I’m currently reading Tim Harford’s fascinating book The Undercover Economist [amazon.com, amazon.co.uk] — which, by the way I highly recommend — and I was pleased to discover that he agrees with me.

UE reissue Bpb.indd

Here’s what he says on page 122, right at the end of the chapter on negative and positive externalities:

A pollution tax might well make a number like GDP smaller. But who cares? Certainly not economists. We know that GDP measures lots of things that are harmful (sales of weapons, shoddy building work with subsequent expensive repairs, expenditures on commuting) and misses lots of things that are important, such as looking after your children or going for a walk in the mountains.

Most economics has very little to do with GDP. Economics is about who gets what and why. Clean air and smooth-flowing traffic are part of the “economy” in this sense. […] There is much more to life than what gets measured in accounts. Even economists know that.

From this, I draw two conclusions.

First, it’s comforting to me that I came to the same conclusion as actual economists.

And second, it’s disturbing that politicians (many of whom are economists by training if not by aptitude) largely don’t seem to get it.

13 responses to “How to measure the strength of the economy, redux

  1. Oh, I think that most politicians do “get” it. But they also get that it’s a subtle, complex and interlinked issue that cannot be reduced to the simple soundbites that our modern 24-hour media monster desires it to be. In much the same way that everything is, really. And by accepting the monster rather than tackling it, the vicious circle is maintained.
    In other words, I guess I’m arguing that the problem is actually with the way information is presented in simplistic, bite-sized form, making it out that there is a single, correct answer to every question that is easily understood, not necessarily with the issues themselves.
    And whilst I respect the many reporters and journalists out there who are attempting to go deeper (and yes, Harford is definitely one of them), they seem to be overwhelmed by the rest.

  2. Once you’ve finished that, try his second book, which is about macro-economics.

  3. Well, David, I hope you’re right. But all I ever hear from Osborne in particular is that we tell how awesome the Conservative government is (including the recent Conservative-dominated coalition) because GDP is rising. He certainly gives every impression of believing that maximising GDP is the purpose of a government.

  4. I have to agree with David. People — economists and politicians — do not talk about GDP because it is a very good measure, but because it is the best measure we know of for a broad set of economic activity, and most people’s means of making a living is reflected somewhere in GDP (payments made to them, by them, or both).

    To that extent, while Harford might view things like weapon sales as harmful, those market transactions mean that salespeople and factory workers are able to feed their children. That is why they are part of GDP, and why such a measure is useful. That Harford is more interested in taking a cheap policy shot than explaining when GDP is useful disrecommends his book to me — it seems more like a signal of mood affiliation than productive commentary or explanation.

    Is it surprising that the Chancellor of the Exchequer puts weight on the most commonly used measure of the economy? I see that one of his most recent tweets was about the UK employment rate hitting a record high; is that also an unhealthy fixation? What should he talk about, or try to measure, instead?

  5. Michael P postulates:

    People […] talk about GDP […] because it is the best measure we know of for a broad set of economic activity.

    I am arguing, and Harford is agreeing, that it’s a very bad measure. And if we’re right, then continuing to talk about it is a very bad thing, because we will always optimise our behaviour to maximise the quantity that we’re trained to care about. (Example: examination results for school-teachers, publication in high-IF venues for researchers.)

    The first step to increasing the things we care about is measuring the things we care about.

    To that extent, while Harford might view things like weapon sales as harmful, those market transactions mean that salespeople and factory workers are able to feed their children. That is why they are part of GDP.

    No. The only reason those things, or any things, are part of GDP, is this: they are easy to measure. Everyone can agree on how much revenue is generated by a bomb factory. Getting people to agree of the social benefit (or cost) of the factory is much harder. So we keep measuring the thing that is easy to measure, and — bingo! — we have a society that keeps doing the thing we measure.

    Where do you get “cheap policy shot” from?

  6. You argue that GDP is a very bad measure. If Harford agrees, he did not say so in the excerpt you quoted — at strongest, his point there is that we should not optimize solely for GDP.

    You seem to think that there is some better metric that will cover all the things we should care about. There isn’t. The economic calculation problem says that a centralized decision-maker cannot know how to optimize all economic activity, much less optimize them using a single number.

    Any first-world government regularly measures thousands or millions of statistics, each one designed to provide insight about a particular issue or sector in the nation or the world. GDP is a useful proxy for market activity across an entire country, and it is one of the most commonly used economic metrics because most people do not share your view that measuring or increasing this is “very bad”.

    The “cheap policy shot” was that weapon sales are per se harmful, which is about as well-supported and well-settled as right-wing claims that same-sex marriage is per se harmful. Maybe Harford lives in a world where good people never acquire weapons, but most of us do not.

  7. To elaborate on some of the problems and limitations of other measures that we might want to optimize for, consider the poverty rate. Many people would like to see more emphasis on reducing the poverty rate than on increasing GDP. (I don’t think you necessarily have to prefer one over the other, but to the extent that you do, I am torn between them because of the poverty measurement problems I am about to outline.)

    What is the poverty rate? It is usually defined as the number of households that have an annual income less than “the poverty line”. How is that determined? Here in the US, as I understand it, it is a function of the number of adults and children in the household, and the average market cost of some standardized “basket” of goods. (Maybe it should treat disabled adults or children differently, but how much so?) It does not consider local cost of living, mostly because it is too hard to objectively decide whether a household could reasonably relocate to a cheaper place. But the poverty line still assumes that adults and children can essentially be averaged to have some annual marginal cost of living.

    How is the basket of goods chosen? At least here in the US, it is chosen by government economists using an, apparently intentionally, opaque process — they do not explain why they do (or, in the much more common case, do not) rebalance the basket as the relative prices of things like beef and chicken change. In practice, people will decide to eat more chicken or tofu when beef prices go up.

    Should a household’s annual income, as compared to “the poverty line” for that household, include government transfers? Again in the US, it does not. That makes it useful for measuring something about market activity, but because government transfers to a household go up sharply as the household’s annual income goes down, excluding those transfers excludes the government’s contribution to the household’s well-being. That makes it a very poor measure of how much the government specifically helps the poor.

    No matter how we answer the questions above, we should measure the poverty rate, and we should try to reduce it. But like any other aggregate measurement, we need to understand the strengths and weaknesses of the measure, and we need to consider those when deciding to optimize for this measure over some other measure.

  8. The first step to increasing the things we care about is measuring the things we care about.

    Very true, and one of the problems is that nobody has proposed an alternative measure which was sufficiently compelling that support has coalesced around it as an improvement (note, there are many alternatives which have been proposed).

    Also, as an interesting theoretical question, when considering a replacement for GDP, how important is ease of calculation? Obviously data collection has increased to the point at which there are options for calculations which are far more detailed than GDP. But, if you get too complicated you lose a couple of features which may be important: First the ability to do historic and cross-national comparisons easily. Secondly, if it gets too complicated you run the risk of losing the consensus agreement that the officially published figures represent the correct calculation. Finally, of course, the more complexity you introduce the more room you create for argument about whether some proposed measure (call if GDP+) is actually the best or if we should be using GDP++ instead.

    Look, I agree with you, it would be good to have a replacement measure for GDP, people have been saying that for decades, and it’s disappointing that there isn’t more attention paid to the issue. But I don’t think it’s going to be easy, and those issues give some reason why no politician will switch without an alternative which is clearly superior, has a significant institutional base of established users, and isn’t associated with a specific political party or position (having just typed that I suspect the last of those might be the most difficult hurdle).

    Also, to Michael’s question:

    Here in the US, as I understand it, it is a function of the number of adults and children in the household, and the average market cost of some standardized “basket” of goods.

    I think it’s even worse than that. I think it was originally based on a “basket” of goods in the 60s, and then inflation adjusted from there. I don’t know that there’s been a new attempt to great a representative “basket” of goods for the 21st Century and derive a new poverty threshold.

  9. If George Osborne harps on how GDP is going up, that could (as Mike suggests) indicate that he doesn’t understand that GDP is a crude measure and increasing GDP isn’t necessarily a good thing. Or it could (as Michal suggests) indicate that he knows GDP is a kinda reasonable measure and about as good an indication as we have of overall economic productivity. But I suggest (regretting that my name isn’t Mikhail or Michaela or something of the kind) a third explanation: he looks around for something that’s (1) increasing and (2) generally regarded as a good thing; he finds GDP; so *of course* he harps on how GDP is going up. Why on earth should it make any difference whether (in reality, or in his opinion) GDP is actually a good measure of anything or not?

  10. Er, of course “Michal” in the foregoing is a typo for “Michael”. Sorry, Michael!

  11. No worries!

    I would say that it is important for politicians to make at least reasonably honest statements to the citizens of their country because the appearance of deception or incompetence undermines their positions. There are a lot of more good-of-the-nation and similar moral arguments for why they should, but if Osborne (to continue with the example) does not think that GDP is a reasonable proxy for what he is trying to improve, or does not think improving that underlying thing is good for the country, or does not think his preferred policies are really helping improve that, he should change what he is doing and/or saying.

    For example, if GDP is going up for some reason that he doesn’t understand or (worse for him and his party) can’t influence or even opposes, the opposition is likely to point that out — and if they make a better case, I would hope that sways some minds. Maybe it will not. In US politics, there is a lot of epistemic closure all around; it is easy for me to see it when people take positions I disagree with, but if I try (which is not always easy to do, or even to remember to do) I can often spot the same flaw in people making arguments I agree with.

  12. For the avoidance of doubt, I also think that if Osborne is attempting to maximize GDP but GDP is a bad measure of national wellbeing then he *should* change what he is doing. I just don’t think the fact that he’s boasting about GDP going up is much evidence either for what he’s actually trying to do or for what he thinks is important.

  13. Pingback: Why I’m jealous of my eldest son | The Reinvigorated Programmer

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