Friday, October 2, 2009

Forget GDP.

Forget GDP. That is the advice offered by several economists, including Nobel prize winner Joseph Stiglitz. Their position is that too much focus on GDP (Gross Domestic Product), at the expense of other more telling indicators, actually contributed to the economic crisis. GDP has long been an important indicator of economic growth made up of all goods and services. But there are some huge problems.

Like most accounting measures, GDP can be manipulated to say what you want it to say. At least in the short term. Take this example. In 2007, a boom year for the US economy, about 41 % of corporate profits came in the financial sector. Translation: profits were generated not through improving or selling goods and services, but through borrowing. Even more chilling, according to the economists, the profit write offs (translation - losses) in 2008 actually wiped out all GDP growth for the past five years. While the world celebrated GDP growth from 2002 through 2007, we were celebrating not real profits, but borrowed profits that we couldn't sustain.

Relying on a measure such as GDP in my estimation, is that it doesn't provide any early warning signs of problems. That should be one goal of a measure - what is the health (or vulnerability) of the system.

It seems that GDP may be a trope, just like shareholder value is often a trope. (see previous blog for more on this) "Our accounting framework affects how we see the world, and our accounting framework is flawed," said Stieglitz. This sounds like something an organizational behavior professor would say. Perhaps at least some economists may have been paying attention in class after all.

The economists did suggest an alternative measure, one that takes into account well-being, environmental impact, and other 'non-economic' indicators. See more at CFO online:

http://www.cfo.com/article.cfm/14443847?f=most_read


9 comments:

Julia Szymkowiak said...

Similar to this article, there was an article released from the EU. I thought this article took the concept discussed in Joseph Stiglitz’s article suggesting that environmental impact should be a relevant consideration of determining economic performance a bit further. Although the article says that GDP is still the predominatly used indicator in the EU, other measures are beginning to be used. The World Wildlife Fund is using a combination of indicators - United Nations Human Development Index (HDI) which is based on human data such as life expectancy and an Ecological Footprint which compares renewable resources to produce consumed items (such as food and wood products) to how much waste is produced making the products. The article concludes that the EU wants to be in the forefront of developing a measure that is sophisticated and takes the environmental and human factors in considerable consideration for determining the future impact to the economic health of countries.

http://ipsnews.net/news.asp?idnews=40180

BAS said...

GDP indicator has become more or less a political tool to show economic progress in a tangible way. This indicator is a good comparison as it is well defined and can be calculated with relative ease. However, GDP has failed to account the qualitative progress a society makes through invention and innovation. The number of patents registered by a country can be used to get an insight on what kind of progress a country is making. As pointed by Stiglitz in the article, GDP does not take into account the quality of productivity but rather the number which was inflated at times due to many complexities of financial markets. Additionally, the lower interest rates fueled an upward spiral demand of real estate which made its way into GDP without actually an increase in productivity. As much as we can be critical of GDP, it is still a useful indicator which should be used in conjunction with other indictors like HDI and productivity indexes to make a logical sense and not be used in isolation. (Bilal Ali Siddiqui)

Erin Hodges said...

The world economy, and the US's place in that economy, is incredibly complex and interconnected. It makes complete sense that we would want to look at more than one factor (GDP) when examining economic growth. I'm confounded as to why we gave so much attention to GDP alone.

I wonder if it has anything to do with the average America's preference for news in "soundbites". Are we unwilling/unable to digest complicated concepts unless they are boiled down to simple statements or statistics? The popularity of internet headlines and cable-tv news tickers might indicate that we are.

Given the complexity of the global and US economies, I hope that economists at least will dive deeper into myriad factors that influence economic growth.

Lokesh said...

As pointed by Julia, the HDI seems more accurate as an indicator of actual growth of the country. I found this interesting article on HDI vs GDP which talks about most of the concerns raised by Joseph Stiglitz about GDP as an indicator of growth and how HDI can answer some of those issues.

http://www.beyond-gdp.eu/download/bgdp-ve-hdi.pdf

tag said...

I believe Erin's comment hits an important point: information overload and the (in)ability to categorize, aggregate and consume it all. There are levels of information coverage ranging from superficial to deep, but that which is most easily spoon-fed must occur at the lowest common denominator. Unfortunately, it is human nature to make broad judgments on single pieces of information (for various reasons not worth getting into). It was either Paulson or Bernanke who stated that "only from crisis can change emerge." In non-crisis times, it takes too much effort to divert resources and dig in.

Brian Kadish said...

In his book, "Crash Proof: How to Profit from the Coming Economic Collapse", Peter Schiff touches on the shortcomings of GDP as a measure of the economy. He cleverly named GDP "Grossly Padded Data". His point was that GDP was never intended to be a measure of the country's economic well-being. GDP was originally GNP (gross national product) and it was only intended to measure wartime production capacity during WWII.

But what I found to be Schiff's most interesting point is how open the GDP metric is to manipulation. For instance, a value is determined for free checking accounts by the government and added to the GDP figure. Another example Schiff cites is "...if $10 billion worth of computers are purchased, but they have five times the computing power of computers previously purchased in some benchmark year, the government reports sales of $50 billion when it calculates GDP."

It is concerning that the public's perception of the economy is so rooted in such a flawed measure. But even more alarming is that our debt levels are often compared to GDP numbers. Just yesterday, reports surfaced that our country's record $1.4 trillion deficit represents 9.9% of the national GDP. If GDP is as flawed as Stiglitz and Schiff claim, I wonder how our deficit truly stacks up with our country's real economic growth?

Zane said...

I agree with this article in the sense that GDP does little to distinguish between real growth, and growth facilitated by barrowing. While this may provide an indication of growth for politicians, it does little to measure the true progress of an economy.

Like Julia I agree that the HDI index from the United Nations takes into account a much wider range of criteria for the measurement of an economies development progress. However, this indicator seems to be much more long term oriented and therefore my fail in being able to measure economic growth in the short term.

GDP can still be useful as a measure of economic output, but may need to be combined with other indictors to give a more accurate picture of economic health. Some such indicators can be the Manufactures Index, and Transportation index. Both indexes track the level of corresponding activity within an economy. Together with GDP they can paint a wider picture of economic activity, and even give early warning signs of weakness when they diverge from GDP.

willsull13 said...

On the trope of GDP: What is all the Buzz about?

A premise of the posting, that “Our accounting framework affects how we see the world, and our accounting framework is flawed,” relates to several of the concepts discussed in the organizational behavior curriculum. One may even argue that the statement correlates to the premise of the curriculum that yields an early warning which states “THIS CLASS MAY SERIOUSLY CHALLENGE YOUR ASSUMPTIONS ABOUT LEADERSHIP.”

Just as too much focus on GDP may have actually contributed to the economic crisis – perhaps too much focus on the conventional wisdom on leadership may actually contribute to an ineffective approach to leadership by an individual or an organization.

In a similar context, what do the actions by policy leaders and economist who rely on such a measurement tell us about how they will make decisions in the face of shifting goals and new information?

It is clear that there is more than meets the eye in terms of the viability of the GDP measure. However, this measure has been engrained in our social fabric: it is a “buzz word” that permeates its context in an academic framework to a Wall Street that seems to rely on it as a red-flag mechanism for determining the health of country economic performance.

The effects of this and other similar “buzz words” are all around us. From the Key Performance Indicators that corporations cascade through their organizations to measure efficiency and productivity to entire news stories anchored on headlines that read “The Dow closed above 10,000” – we often find ourselves entrenched in “buzz words” that may really not matter that much at all.

Perhaps, in today’s information age, effective leaders develop the skill-set that allows them to apply their empirical knowledge towards disseminating all of the “buzz words” prevalent in society and business today and cautiously pursue a critical approach towards all of the buzz.

Willsull said...

On the trope of GDP: What is all the Buzz about?

A premise of the posting, that “Our accounting framework affects how we see the world, and our accounting framework is flawed,” relates to several of the concepts discussed in the organizational behavior curriculum. One may even argue that the statement correlates to the premise of the curriculum that yields an early warning which states “THIS CLASS MAY SERIOUSLY CHALLENGE YOUR ASSUMPTIONS ABOUT LEADERSHIP.”

Just as too much focus on GDP may have actually contributed to the economic crisis – perhaps too much focus on the conventional wisdom on leadership may actually contribute to an ineffective approach to leadership by an individual or an organization.

In a similar context, what do the actions by policy leaders and economist who rely on such a measurement tell us about how they will make decisions in the face of shifting goals and new information?

It is clear that there is more than meets the eye in terms of the viability of the GDP measure. However, this measure has been engrained in our social fabric: it is a “buzz word” that permeates its context in an academic framework to a Wall Street that seems to rely on it as a red-flag mechanism for determining the health of country economic performance.

The effects of this and other similar “buzz words” are all around us. From the Key Performance Indicators that corporations cascade through their organizations to measure efficiency and productivity to entire news stories anchored on headlines that read “The Dow closed above 10,000” – we often find ourselves entrenched in “buzz words” that may really not matter that much at all.

Perhaps, in today’s information age, effective leaders develop the skill-set that allows them to apply their empirical knowledge towards disseminating all of the “buzz words” prevalent in society and business today and cautiously pursue a critical approach towards all of the buzz.