• Victor C. Bolles

G!@$&   D*%#@%&!   P@*?%#!

While watching Squawk Box on CNBC the other day, host Joe Kernan, prior to a discussion of China Trade Policy, asked his guest, Derek Scissors of the American Enterprise Institute, what he thought of the second estimate of the first quarter Gross Domestic Product (GDP) that had been reported earlier in the show. Joe, like most people including the president and most of Congress, is fixated on the quarterly growth rate of GDP.

Dr. Scissors’ response surprised Joe. Dr. Scissors said that GDP didn’t matter; that it was a 1930’s statistic and that he focuses on other metrics such as household income and labor force participation. I was intrigued. Some of you might know from reading my book, Principled Policy (2016), that I am no fan of GDP. But Dr. Scissors is even more outspoken on the defects of GDP as a tool to measure economic performance.

First of all let me say that our fascination with GDP has more to do with behavioral economics than real economics (or maybe behavioral economics is real economics). US (and global) economic performance is just too complex to be distilled down to a single number (to which we add a decimal point in order to give the illusion of even greater accuracy).

So I queried Dr. Scissors about his ideas regarding GDP (most of his articles at AEI are about China and India) and he sent me links to two interesting articles he wrote (see links below). As Dr. Scissors points out, GDP was created to measure industrial production in the 1930s but industrial production represents a declining portion of our economic activity and GDP does not do a good job on these other elements. He notes that if you build a house it will add to GDP. But if you tear it down the next year the demolition will also add to GDP. But when the cost of a microchip declines even though its speed and power increase enormously GDP declines. As technology advances, GDP falls further and further out of sync. This is one of the reasons uncompetitive medical services are becoming an ever larger part of GDP while competitive cutting edge technologies drop in price (and relevance to GDP).

The problem with this reliance on GDP is that it results in some very poor policy choices. Keynes showed government policy makers that deficit spending financed by public debt could create GDP and our lawmakers have been doing exactly that ever since. Of course, Keynes intended deficit spending to be countercyclical. He recommended deficit spending to offset the economic impact of recessions because those impacts cause real hardships for the people enduring the recession. Also, cutting government spending to offset reduced tax collection during a recession would just worsen the impact of the recession by firing government workers and reducing essential benefits in an effort to reduce costs. But Keynes realized that the GDP that was created by the deficits (and as pointed out by Milton Friedman) is only borrowed from the future. Keynes felt that once the economy recovered from the recession, increased tax revenues should be used to reduce the debt incurred during the recession. Our politicians have forgotten about that part. Deficit spending during economic growth is pro-cyclical but counterproductive.

And because imports are subtracted from GDP, our excessive focus on GDP leads many people to think that imports and trade deficits are bad. The Trump administration views the trade deficit as the lifeblood of our economy being sucked up vampire foreign countries. In reality we are buying foreign products at favorable prices where those countries have a competitive advantage and we give them what? Paper. Fiat paper money. Most countries with trade deficits discover their currency devaluing because nobody wants to hold their currency. The devaluing currency changes the terms of trade and (hypothetically - which means before politicians get involved) trade rebalances. But in the United States our currency doesn’t devalue because foreigners invest their dollars back into our economy because (guess what) we also have a competitive advantage - our financial system.

Dr. Scissors believes that combined household wealth is a better measure of how the economy is doing than GDP. But household wealth also has some drawbacks as a measure of performance. Policies that gin up GDP also goose household wealth. Low interest rates designed to spur GDP also inflate asset prices and assets prices (real estate and securities) make up a substantial portion of household wealth. And the Treasury bonds held by American households (directly or indirectly) make up a portion of that wealth. And when that debt must be repaid it is the taxes of those households that will be used to retire the debt (remember what I said earlier about Milton Friedman). And while the public debt held by American households is relatively small compared to the almost 100 trillion dollars of household wealth we must consider the seventy trillion dollars of future Social Security and Medicare benefits that must be funded by that household wealth. So if we are not broke our kids and grandkids will be.

This is no way to run a nation. We need better metrics. We need better policies. But what we really need is some common sense. Only a fool would think that we can keep on increasing entitlements without having to pay for them. Only a fool would think that we can constantly stimulate GDP growth without ending up with a distorted and dysfunctional economy. Our ancestors knew how to tighten their belts in order to secure a better future. Only a fool would think that not saving for the future will secure us anything but hell on earth.



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