According to GDP, the Great Recession has been over since June 2009. Really? Perhaps we need a better way of measuring economic growth! by Bill Gee
(centrist)
Tuesday, February 1, 2011
How we can measure economic growth in society has been a subject of debate that leaves many highly respected economists getting into heated discussions that eventually lead to an "agreement to disagree". Since June 2009, the Great Recession has been over. Really, it has. That is because the definition of a Recession is a "general slowdown of economic growth." We define economic growth as a period of increased productivity as measured by Gross Domestic Product (GDP). From December 2007 to June 2009, we had experienced such a slowdown in economic growth. Since June 2009, GDP has been going up. So why are we still not happy?
The answer lies in how we measure GDP, and why it remains to be one of the poorer measures of economic progress. For those of you who need a quick refresher on GDP, I will keep it brief.
This is the simple definition of GDP using the "expenditure approach":
GDP = C + Inv + G + (eX - i)
That is, Private Consumption, plus Investments, plus Government spending, plus the net of all Exports and Imports).
Problems with Private Consumption
This only measures Finished Goods purchased by consumers. It counts purchases of durable goods (washers, cars, etc.), nondurable goods (pizza, gasoline, etc.) and services (rent, haircuts, etc.). What it does not count is new housing, and raw materials purchases. In other words, this measurement will count the new car you purchased and the gasoline you put into the car, but it will not count the expenditures involved in creating the vehicle, nor does it count the purchase of the oil that was eventually refined into your gasoline.
Problems with Investment
Investment includes the purchase of new manufacturing equipment, and new software, but it does not count "transfer investments". Therefore, purchases of company stock, or pulling a factory out of "mothball" does not count. Buying a house counts here as a "consumer investment", but if you purchase a previously owned house it does not count.
Problems with Government Spending
What are included are government purchases on "final goods", which includes the salaries of government employees. What it does not count are transfer payments from Social Security or Unemployment. Therefore, the expenditures in "shovel ready" projects likely inflated GDP more than it would have done so on its own.
Problems with Net Imports/Exports
Exports increase GDP. An Export is any good or service that is produced in this country for consumption in another country. Imports decrease GDP. An import is any good or service that is produced in another country for consumption here. The problem with this measurement is the difficulty when dealing with a global economy. When a product is designed in the USA, has its principle components manufactured in China, and has its final assembly and packaging in California, is the good an import or an export?
What we end up with in the final calculation is an aggregate number that may or may not be a reflection of the standard of living of its participants.
The Economics of Utility
Utility is the measurement of "relative satisfaction", which was first postulated by Jeremy Bentham (1748-1832) and John Stuart Mill (1806-1876). The basic premise is that we can maximize economic happiness by maximizing everyone's relative satisfaction in the things they consume. In other words, by increasing our satisfaction, we promote economic growth.
The problem with the concept of utility is that it is very difficult to quantify. A single taco for a person who has not eaten in two days is likely to have a much higher level of utility for a person who just finished a Thanksgiving dinner. Conversely, a brand-new TV may have a higher level of utility for a person earning less than $40K per year as a person earning more than $150K per year.
At least in the above examples, we can possibly use GDP to estimate the level of Utility in society. After all, if we find that more brand new TV's are being purchased, then we can assume that TV's provide a high degree of utility for society. Where using GDP breaks down is when our satisfaction is not correlated to a specific purchase of a new finished good.
If I grow my own vegetables and fruit, ride a bicycle to work, and spend my evenings playing cards on the porch of the house I purchased on the secondary market, my contribution to GDP would be minimal at best, but my overall utility may be extremely high.
Our Obsession with "New"
By measuring economic growth and by correlation, utility, using GDP, we have created a consumer culture that is obsessed with "stuff". We cannot see ourselves as having any satisfaction in our lives unless we are buying something "new". The news media measures economic success by how many things consumers are buying, which then makes those of us who are working hard to pay off our debts and saving our money feel as though we are not doing our part to provide jobs and economic growth to our neighbors.
Therefore, if we simply look at the numbers, the Great Recession has been over since June 2009. After all, GDP has been slowly sputtering back to positive numbers, consumers spent well during the Holidays, and those of us fortunate to have regular jobs are finding more money in our pockets due to lower taxes. By doing our Patriotic duty and spending that money, we are told this will translate into more jobs for our neighbors. If we accumulate more "stuff", our economy will continue to grow.
A New Paradigm
What happens when we measure economic growth by using individual utility as the primary source of measurement? We begin by listing ten things in our lives that give us the most satisfaction, and we rate them on a scale of one through ten, with one meaning, "I do not have this in my life" and ten meaning "I do this thing every day". Some of these things will likely involve making purchases of new things, but some will not. For example, if eating new and interesting foods is high on your list, then going out to a nice restaurant would involve spending money. If spending time with your kids is high on your list, then playing a game at home would do.
A score of 100 means that you have complete satisfaction in all ten of the measurements in your life, while a score below 50 means that perhaps you need to readjust your priorities or alter your spending habits. It does not matter if something on your list changes because what we are looking for is aggregate utility, and changes in utility priorities is normal.
We can then measure overall satisfaction by aggregating these lists across a population, and we can then compare these aggregate numbers from period to period. As utility levels go up, we should find some correlation with economic growth, and if utility levels go down, we should find some correlation with economic contraction as it relates to the concept of Circular Flow.
By leaving GDP out of the picture, we can start concentrating on economic growth that is more centered on building a better quality of life rather than simply buying more "stuff", which only leaves us feeling overburdened and unhappy.
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Posted By: Walt
Date: February 3, 2011 11:38:17 AM
Rather than measuring growth, I suggest that we measure universal prosperity. Any measure of economic growth will be heavily biased in favor of Wall Street and against Main Street. Prosperity, on the other hand, is a more democratic measurement, because instead of measuring the aggregate which a small number of wealthy industrial concerns can dominate, prosperity would have to be measured by counting up the number of people who consider themselves prosperous. It's not the kind of measurement that ivory-tower economists like, but it's certainly a kind of measurement that Joe American would like.
Let me clarify that the test should be: "Do you feel that you and your family are prosperous?" This reduces the kind of subjective weight that aggregates usually skews such measurements such that if the rich are doing well, then the country is judged to be doing well. That kind of measurement needs to be avoided at all costs.
