Natural disasters, like Hurricane Sandy, provide periodic reminders, not of the shortcomings of GDP necessarily, but what GDP is designed to measure and what it is not designed to measure.
The definition of GNP I think I recall from my college days is that it is the total dollar value of all goods and services produced during a year. The shift from GNP to GDP a few years back put the emphasis on production by labor and property located in the United States rather than production by U.S. entities worldwide. Production of new cars, new houses and haircuts count, but purchases of used houses and used cars don’t count. There is a spending side (consumption, investment, government spending, etc.) and there is an income side (wages, interest, profits, etc.).
Generally and loosely speaking, a higher GDP, reflecting both higher spending and higher incomes, is a good thing. However, if the higher GDP is boosted by hurricane clean-up and repair, that’s not so good. The problem is we don’t get a subtraction for the destruction of existing assets; just an addition for replacing them. At least one might think of the clean-up as “shovel ready” projects. Wars are similar in that they generate GDP without bringing with them a higher standard of living.
My favorite example in school of the short-comings of GDP (GNP then) was provided by the question what happens if a man marries his maid. If she keeps doing the household chores as a wife, they are taken out of the market place and GDP shrinks. Getting hair cuts at home or eating at home more and eating out less would have a similar impact on GDP without necessarily reducing standards of living. Just remember that GDP was designed to measure output in the marketplace, not to measure economic well-being.
The above is generally well known. However, in pouring over the latest employment/unemployment statistics, it dawned on me (I’m a little slow) that a similar phenomenon is at work there as well. Obviously, rising unemployment and slow falling unemployment shrinks the output/income of a country relative to its potential. Unemployment is waste.
However, I was struck by the fairly sharp decline in the labor force participation rate, which has shrunk about three percentage points from around 66 percent before the recession to 63 percent currently. Furthermore, employment as a percentage of the total population has declined from over 63 percent before the recession to around 58.5 percent. A smaller percentage of the population is working, with significant implications for our national prosperity.
The most important driver of our prosperity over time is productivity, or output per hour or per day worked. Ideally, productivity will grow briskly because of new technology, innovation and trade, but in the short-term higher output per hour worked can be a substitute for hours worked. More people would be employed today had productivity not grown in recent years. The solution, of course, is not to hinder productivity growth to save jobs, but to create the economic environment that achieves both. We must allow Joseph Schumpeter’s creative destruction to work, by letting the old and obsolete go to make room for the new and more productive.
It’s easy to forget that during a recession or painfully slow recovery. A good rule of thumb for government involvement might be to avoid trying to save jobs, but to get out of the way of the creation of new jobs. That way the market will determine which should go and which should stay and the macro economic environment will provide the growth context.
But, the main point of this rambling piece is not to confuse what our statistics are designed to measure and blame an orange for not being an apple.