GDP rules the world, but should it?

Editor’s Note: If ever there were an acronym synonymous with economics, it would be GDP. The political and economic might of countries around the world is hung on their Gross Domestic Product. In the United States, the Bureau of Economic Analysis calculates the monthly number that is supposed to represent growth (with advance estimates for the first quarter due out Wednesday). It’s a statistic politicians use to tout their leadership and attack others’ tenure.

But while the GDP neatly sums up production and output into one number, the reality of what it includes and excludes is actually quite messy, says Zachary Karabell, author of “The Leading Indicators.” As we heard last month, Karabell is no fan of the statistics that move markets and animate political firefights, particularly the Bureau of Labor Statistics’ monthly unemployment figures, which, Karabell explained in a separate post on this page, actually began as a Progressive Era reform to assess the plight of the working class.

Karabell is equally unhappy about what factors into the GDP – what he sees as a 1950s statistic – that is ill suited for 2014, when national output is a poor indicator of the wealth of average Americans. Karabell appears in our Making Sen$e segment on the GDP and alternative ways of measuring economic health (watch below). Paul Solman’s extended conversation with Karabell about the GDP, including its origins and the threat to long-term growth of relying on such a short-term number, follows.

Simone Pathe, Making Sen$e Editor

Paul Solman: Every month, there’s a huge amount of attention paid to the Gross Domestic Product. What does it measure and how reliable is the number?

Zachary Karabell: GDP has become the king of all statistics. It’s kept by every country in the world. In fact, it has to be kept by every country in the world, at least according to the UN’s system. And if you’re a country that wants a loan from the World Bank, you actually have to measure GDP in order to be eligible, to be able to show that it helped. So GDP has become the proxy of national pecking order, much more than military might, which would have been the proxy for most of human history — how many men did you have in arms, how much land, how much farming output did you have. Now it’s just GDP as a number, and governments rise and fall on their ability to say, “I enhanced GDP,” or the populous’ ability to say, “no you didn’t, GDP went down under your watch.”

So, if you’re going to think of a number that has kind of determined the world we’re living in, more than any other, clearly it is GDP. What’s fascinating is how quickly this number has come to assume such a place of prominence, given how recently it was even invented. GDP didn’t replace Gross National Product (GNP), until the 1990s, and GNP wasn’t really used until the late 1930s, and really not until the 1940s. So these numbers are remarkably recent. We existed for most of human history, and Americans existed for most of American history, without reference to something called national output, or GDP.

Paul Solman: And what is it measuring, exactly?

Zachary Karabell: GDP is extremely good at measuring how much stuff we make, and how much stuff we consume, full stop. It’s an extremely good number to measure output, and in that sense, it’s a good number for 1950s economies, when you had more closed systems, high trade barriers, local manufacturing, particularly for the United States, where most of the stuff the U.S. consumed in 1950 was made in America.

Paul Solman: Right, and the rest of the world had nothing because the rest of the world basically couldn’t make anything after World War II.

Zarchary Karabell: Exactly, and in fact, as you say, most of the rest of the world is consuming American stuff. By some calculations, 50 percent of global stuff was made in the United States.

Even with the loans we gave to the rest of the world under the Marshall Plan so they could build factories; they rebuilt their industry based on our money.

Paul Solman: We gave them the money to buy stuff from us, too.

Zachary Karabell: To build their roads and factories, exactly. So in that sense, it’s a good 1950s number. The question is, is it a good 2014 number? And obviously my leading conclusion on that one is that, no, it is not a good number.

The limitations of GDP have been known for a while. Robert Kennedy made a very famous speech in 1968 where he essentially said GDP measures everything except that which is worth measuring because it doesn’t measure interpersonal relationships. It also measures market transactions very narrowly defined, so even when GDP was invented in the 1930s by luminaries like Simon Kuznets, who’s one of the grandfathers of this number, and John Maynard Keynes, they very purposely left out domestic work. Not that domestic work isn’t one of the foundations of a healthy economy, but because it has no market price, washing the dishes, cleaning the clothes, making dinner… Even taking care of the kids did not then have a market price. Today actually, if you were an economist, you’d say what is the payment of a nanny or day care, and you then would assign a market price to domestic work. But at the time they said, okay, we cannot create a market price, so we’re just going to leave that out of GDP.

Paul Solman: And we still leave it out?

Zachary Karabell: And we still leave it out of GDP. The other thing GDP does, is it privileges output irrespective of the nature of that output. So if you buy an LED bulb today, to replace your old incandescent, you will have maybe spent more on that bulb because they’re more expensive, but you won’t replace it for four, five or six years, whatever the number is – and that will then show up as a negative on GDP. Why? Because you’re buying fewer light bulbs, and therefore fewer bulbs are being made.

If a coal factory pollutes a river, by virtue of some sort of industrial accident, the clean-up of that is a positive of GDP because you have to spend money to make the water clean; you have to spend money to fix the plant. The health care costs, if there are some, associated with that are a positive for GDP because if someone goes to a hospital, money is spent to treat them.

So GDP is totally neutral about the constructive or destructive effects of output; it just treats all output as a plus, and therefore, it rewards a political system that boots output and consumption irrespective of its long-term viability. This is not an argument against output as something we should aspire to, as an economy that can make things productively, but we need to understand what this number measures and what it does not.

Paul Solman: And it does not measure mental health and happiness. There have been alternative measures proposed, though, right?

Zachary Karabell: There have been, and there have been a lot of people who have tried to create happiness indices, one of which was created by one of the smallest counties in the world, Bhutan. That is more of a Buddhist tradition; they came up with the gross national happiness index, which resonated with people, particularly after the1970s, since we’re not measuring quality of life, we’re just measuring stuff. The problem is that with any index or one synthetic number that purports to describe lived reality with an average, you have to make choices about what to include and exclude.

So the gross national happiness index may include “do you feel good,” “do you feel fulfilled,” “is the work you’re doing meaningful,” “do you feel your society is adding to the constructive output of your family’s,” but it would then have to not include other things because any index that includes everything essentially has no value.

We have a desire, an understandable desire, to understand us and the world, and numbers are a convenient peg to hang our understanding on. But simple numbers, for lots of us living in a complicated set of systems, are always going to be wrong, even if they’re wrong for different reasons.

Paul Solman: But if GDP is moving, relative to itself, in one direction or another, doesn’t that tell us something significant?

Zachary Karabell: So if GDP is going up, it tells us that our output is going up, or it tells us that our government spending is going up, or it tells us that our consumption is going up. It tells us nothing about employment. There is certainly a belief among economists that it should tell us something about employment. At various points in the 20th century, there was a connection between employment and output, but today, factories can make a lot of stuff without generating a lot of employment. GDP can go up and up and up, and be very productive, without it leading to a lot of hiring and a lot of income.

Paul Solman: And it’s not just factories. You’re talking Twitter, Google, Facebook — huge revenues with very few employees.

Zachary Karabell: Very few employees, and many of the companies that we laud today are high on output of ideas and high generators of revenue, but extremely minimal employers of actual people who get incomes.

GDP going up also does not lead to incomes going up. Now, it will lead, statistically, to per capita income going up, because per capita income is just GDP divided by people. So yes, if GDP goes up, then everybody’s income has gone up. But as we know, we don’t live in an average income; we don’t all get a check from the government with our share of GDP, and one of the points that’s been made a lot about today’s economy is that the way in which GDP rewards are distributed is by no means equal. And in fact, many people benefit much more from the rise of output than many other people. Labor does not benefit, it would seem, at all from the increase in output. In the past 30 years, a very few number of companies, and a very few number of individuals have benefitted immeasurably from the rise of output, and you don’t have to be a critic of our particular system to be aware of that statistical reality.

Paul Solman: So is this a big problem?

Zachary Karabell: The degree to which government derives legitimacy based on GDP doing well is a problem because there are multiple ways governments have learned to make GDP look pretty good. You can spend more money, you can give tax breaks, you can boost consumption, it’s all very short term. It’s easy to boost consumption in an election year, and politicians have been doing that in the United States, and every country in the world, as long as we can remember. That kind of boosting of consumption, making GDP look good, allows leaders, even dictators, to say to the electorate, “Look, we’re growing, we’re stronger.”

It says nothing about how that’s being distributed, and it says nothing about the long-term viability because a lot of consumption is by its very nature ephemeral. If I give you a $100, Paul, and you have a really nice dinner with your wife and see a movie, you’ve had a good night and are going to be pretty thankful that you got that hundred, but in terms of the long-term viability of our economic system, it’s gone. If you invested that $100 in a bond, in a company, in your child’s education, or in building a high-speed railway, there’s a better chance that that hundred will have long-term constructive effects and multiply itself many times over. If it’s dinner and a movie, it’s not multiplying.

Paul Solman: And that would also hold true of a lot of employment in this country, right? There’s the old Sam Bowles argument about guard labor – that we hire lots of security guards, who could otherwise be in more productive roles.

Zachary Karabell: These things [hiring lots of people as guards, for example] are optically good, but structurally bad in that we’re not going to create the kind of society that has long-term viability. Tethering our long-term health to whether or not GDP looks good or bad on the short term looks to me like a recipe for not only diminishing returns, but less and less prosperity over the long term.

Paul Solman spoke with Zachary Karabell last month about his book “The Leading Indicators.”

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