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There’s more to good policy than increasing GDP

June 25th, 2012

My latest in The Conversation

There’s more to good policy than increasing GDP

By John Quiggin, University of Queensland

Economists are regularly criticized for worrying about Gross Domestic Product (GDP), and similar measures. The classic statement of the case was by Robert F Kennedy:

“Too much and too long, we seem to have surrendered community excellence and community values in the mere accumulation of material things. Our gross national product … if we should judge America by that – counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage. It counts special locks for our doors and the jails for those who break them. It counts the destruction of our redwoods and the loss of our natural wonder in chaotic sprawl. It counts napalm and the cost of a nuclear warhead, and armoured cars for police who fight riots in our streets. It counts Whitman’s rifle and Speck’s knife, and the television programs which glorify violence in order to sell toys to our children.

“Yet the gross national product does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages; the intelligence of our public debate or the integrity of our public officials. It measures neither our wit nor our courage; neither our wisdom nor our learning; neither our compassion nor our devotion to our country; it measures everything, in short, except that which makes life worthwhile. And it tells us everything about America except why we are proud that we are Americans.”

Much of the time, this criticism is misplaced. For the purposes of medium-term macroeconomic management, that is, trying to maintain full employment and low inflation, it is important to measure how much economic activity is going in aggregate. If aggregate demand is weak, for example, it is sensible to stimulate the economy by cutting interest rates or increasing public spending. GDP is the best single measure of economic activity, precisely because it captures all output, taking existing market prices as the measure of value.

In the longer term though, the problems with GDP start to matter, even in relatively narrow issues of economic policy. In measuring economic performance, as opposed to activity, GDP suffers from three major drawbacks in this respect

  • It’s Gross – that is, depreciation of physical and natural capital is not deducted

  • It’s Domestic – that is, it measures output produced in Australia, even though the resulting income may flow overseas[1]

  • It’s a Product – the ultimate aim of economic activity is not production in itself but the income it generates, which should be taken to include the economic value of leisure, household work and so on

If we want to look at policies that promote our economic welfare in the long term, we need to start with another measure, produced by the same National Accounts that give us GDP, but with the errors above fixed. That measure is Net National Income (NNI): the amount of income accruing to Australians, after replacing depreciated capital.

Ideally, depreciation should be extended to take account of depreciation of, or improvements to, natural capital such as Kennedy’s redwood forests. This is done to some extent in “satellite accounts” prepared by the Australian Bureau of Statistics.

More importantly, in considering economic welfare, we need to take account of the value of leisure and non-market work. This can be done crudely, by looking at Net National Income per hour worked as a measure of welfare. More sophisticated approaches, involving concepts of full income, have been developed, but not implemented in the national accounts.

Net National Income per hour worked doesn’t measure the beauty of poetry or the strength of marriages, but it is a pretty good guide to the success or failure of economic policy in the long run. So, it’s this variable that we should be looking at, when considering what kinds of economic reform policies need to be pursued.

This has been pointed out plenty of times, but too many Australian economists continue to focus on GDP. The latest example is a report released by the Grattan Institute, entitled “Game-changers: Economic reform priorities for Australia”. There’s a lot to like about this report. The discussion is generally sensible, and there’s a good survey of economic policy options.

Unfortunately, the central recommendations are policies that may well raise GDP, while reducing economic welfare for Australians. The report states

“But for now, only three reforms — tax mix reform, female and older people’s workforce participation — can change the game. They should be the core economic reform priorities for Australian governments.”

The report estimates that each of the reforms it considers could raise GDP by about $20-25 billion a year, or around 1.5 per cent.[2] The problem is that GDP is the wrong measure. This is most obvious in relation to female labour force participation, where the issues are briefly discussed. Increased female participation in the labour market is likely to arise primarily as a result of reductions in unpaid domestic work, most importantly childcare. The report argues that market work will be of greater economic value than the unpaid work it displaces. This is dubious, but even if it is correct, the gain will be a small fraction of the measured increase in GDP.

At least the report mentions the costs of increased female participation. By contrast, the extra output that might be obtained encouraging or forcing Australians to work longer is treated as a pure gain. The idea that, after 40 or more years of paid employment, workers might benefit more from retirement than from the extra earnings they could generate by staying on the job, is not even considered. Again, a correct evaluation would show a much smaller increase in GDP.

The final policy option is tax reform, with a primary focus on reducing corporate taxes. The argument here is similar to that of the Henry Review, which found that cutting corporate taxes would increase investment and therefore GDP.

But let’s take a stylised (though not totally unrealistic) example and see how it works out. Suppose a foreign company sets up a plant in Australia, bringing in $1 billion of its own capital equipment. Suppose further that the business is sufficiently capital-intensive that the impact on employment can be disregarded, and that any input materials used would otherwise have been exported unprocessed.

Suppose that the business yields the standard return on capital obtained in the international market, say 8 per cent. Then it’s easy to see that annual Gross Domestic Product has increased by 8 per cent of $1 billion, or $80 million. How about Net National Income? The $80 million in capital income all flows overseas, so the impact on NNI is a big round zero.

Which measure should matter to Australian policymakers? The answer, pretty clearly is that the presence or absence of the plant makes no difference to the economic welfare of anyone in Australia, so NNI gives the right answer and GDP the wrong one.

Of course, the stylised example isn’t perfectly accurate. Increased capital investment may lead to higher demand for labour and therefore to higher wages for Australians. But these indirect effects will be an order of magnitude smaller than the effects on GDP, and may be offset partially or completely (for example, if the increased demand is met by increasing immigration).

More subtly, the same kind of argument applies to the case for preferring taxes on consumption to taxes on investment. If we tax consumption, we are likely to increase savings and therefore have higher income in the future. But that isn’t necessarily a good thing. To assess the impact on economic welfare we need to take into account both the present costs (less consumption now) and the future benefits (more consumption later). Under standard assumptions, these two will approximately cancel out for low and moderate rates of income

There is plenty of room for debate about the best direction for Australian economic policy in the medium term. But as long as this question is framed in terms of maximizing the growth rate of GDP, we are going to get the wrong answers.

John Quiggin is a Federation Fellow in Economics and Political Science, and author of Zombie Economics: How Dead Ideas still Walk among Us.

Footnotes

  1. As the Kennedy quote indicates, discussion used to focus on measures of Gross National Product. The switch to GDP reflects the fact that, in macroeconomic terms, it doesn’t matter much whether economic activity produces income for Australians or for foreigners. This switch further illustrates the point that GDP is not designed as, and should not be used as a measure of economic welfare.

  2. Note that even on the overstated estimates here, these “game-changers” taken together would only raise GDP by 4-5 per cent, over a period of at least a decade. That’s only equivalent to a year or two of economic growth, and much less than the average year-to-year variation in household incomes. While it would certainly be good to raise incomes by 5 per cent, relative to trend, over the next decade, it would scarcely represent a game-changing transformation of the Australian economy.

John Quiggin does not work for, consult to, own shares in or receive funding from any company or organisation that would benefit from this article, and has no relevant affiliations.

The Conversation

This article was originally published at The Conversation.
Read the original article.

  1. BilB
    June 25th, 2012 at 09:32 | #1

    Good article, JQ, which I am going to have to read a number of times with wikipaedia at the ready.

    This is the best approach to exorcising zombie economic ideas. Thinking differently and/or developing new ideas, new theories.

  2. Martin
    June 25th, 2012 at 11:12 | #2

    So what is the current NNI/hr for Australia? For anywhere else (US, Germany, China,…)?

  3. Freelander
    June 25th, 2012 at 12:48 | #3

    In the quest for choice we have lost choice; in the quest for freedom we have lost freedom.

    In the name of freedom and choice and expansion of private freedoms we have increasingly been debarred from public choices, and increasingly private and public choices can only be facilitated with cold hard cash.

    Observe the monetisation of the American political process and the increasing number of Americans too poor to have a voice.

  4. Freelander
    June 25th, 2012 at 12:58 | #4

    As well as noting gdp per capita is gross, and so on, increasingly important is that it is average. A better, although still imperfect measure would be median gdp per capita.

  5. Ikonoclast
    June 25th, 2012 at 13:03 | #5

    I would suggest maintaining traditional measures like GDP as well as instituting new meaures like NNI. In addition, we beed better accounting of natural capital destruction (mostly what happens) and regeneration (rarely what happens) and accounting for at least some forms of “non-economic” work currently unmeasured.

    Of course, in maintaining these old and new measures, the questions then become;

    When do use them?
    How do we weight them?

    Would it be possible to conduct broad based questionairres on peoples’ “economic and social happiness” over time and see which results correlate better with which measure (GDP, NNI, GINI etc.) ?

  6. Freelander
    June 25th, 2012 at 13:10 | #6

    Economic Nirvana would have been achieved if the Howard Abbott Work till you Drop policy had been fully implemented.

    The faster they drop the smaller our future health liability and the quicker they get their ultimate reward in heaven.

    Win, Win, All ’round!

  7. Ernestine Gross
    June 25th, 2012 at 14:45 | #7

    JQ’s book, Zombie Economics, contains a lot of interesting detail and critique of the post Keynes macroeconomics. The main conclusion I drew from reading this book is that the splitting of ‘economics’ into micro and macroeconomics is not helpful and the uselessness of this approach is evidenced by the so-called microfoundation of macroeconomics which consists of introducing 1 person, as characterised in micro-economics. I’ve never ‘believed’ in macroeconomics – belief is the right word because the question Why is never addressed; there is hand-waving and lose hypothesising instead, sometimes supported with some ultimately arbitrary set of statistics, and there are endless debates that seem to be ‘resolved’ by political (speak PR) pressure among clubs. The latter is another conclusion I drew from JQ’s Zombie Economics. All this is not to say that some work in macroeconomics, applying non-linear dynamic models (say catastrophy theory), isn’t interesting.

    The language of macroeconomics – including ‘managing the economy’ is so widely accepted now that it may take a long time before the idea is accepted that the various governments (there are many in the ‘global economy’) are only a set of agents in a complex system of partially segmented local economies with local traditions, which when sufficiently disturbed may dissolve the social clue of trust.

    GDP and variations thereof are the equivalent of financial accounts. We know what happens to companies when the accountants take control. I do understand I am sticking my neck out when I say the focus of some current politicians in several countries as well as media commentators on ‘GDP, ‘income’ (average or median), ‘inflation’, ‘unemployment’ is not helpful for people. It leads to a ‘league table’ mentality which gives false pride or misery for a few people in power and does nothing for anybody else. Worse still, business people are conditioning their decisions on macro-economic data (isn’t it said if one has to tell business people that there is a demand for coffins when GDP declines as a consequence of some horrific event such as an outbreak of the plague?!)

    With due respect to all macroeconomists, I’ve learned more about ‘the economy’ from following the development in axiomatic economic theory since Arrow-Debreu-McKenzie. The idea that ‘market clearing’ is a sufficient condition for a notion of ‘an equilibrium’ that is meaningful to real life people is not found in this literature (but persists as a Zombie in macroeconomics) and reasons as to why financial market liberalisation does not necessarily lead to a Walras equilibrium are known since Radner’s work in the mid 1970s (even if ‘everybody’ is ‘competitive’ – price taking – and all resources are ‘privately owned’ – so privatisation per se is not a solution). What have the macro-economists been reading in the meantime? The elephant in the room is the financial system. Macroeconomic aggregate demand management has nothing to offer to deal with this animal.

    Questions of practical relevance to Mr and Mrs average, such as: What is the benefit for us if we get cheaper goods and a higher dividend on our compulsory financial investments if we have to either work longer hours or not have a job at all? are meaningful questions in my preferred theoretical framework but not in macro-economics. Here we are, enough said.

  8. Tom
    June 25th, 2012 at 16:42 | #8

    @Ernestine Gross

    It’s a complicated matter, a lot of economists do hope for better lifes for everyone however some of the measures that can help to achieve this objective can be difficult for the general public to understand thus making it politically infeasible.

    Say for example, if our country operates tomorrow under what Professor suggested using NNI as a measurement and creating policies that aims at increasing NNI. What will happen then if Gina Rinehart tries to get workers from overseas? Under NNI certain business strategies will be revealed to have no benefit to NNI or very little indirect benefits while the cost of the depletion of natural resource can be even greater than the benefit. I am simplifying a lot of things here.

    Pressures from the media and businesses will also be significant and this will not be easy on politicians if the voting public gets easily persuaded by the mainstream media, such is shown in poker reform, MRRT, carbon pricing etc. With the current political system in Australia, it is also tempting for politicians to chase short term interest.

    Other measures such as nationalisation or tax reforms can also benefit the lower quintile of the income group. Certain redistribution through tax reforms may be benefits to the stability of the economy but will not show as an increase in NNI (unless median instead of average figure is taken). These are easily targets of “communism” accusation and it will be difficult for the general public to understand the benefit or indirect benefit of these policy changes.

    While post Keynesian macro had been a failure, it’s policies are much easier to sell to the general public. This is one of the reason why modern macroeconomic is a disaster.

  9. Freelander
    June 25th, 2012 at 17:48 | #9

    NNI should increase because Gina will get more income and the workers get paid in Australia and the Australians she didn’t hire can work elsewhere in the economy, albeit in not as well paying jobs.So one Aussie battler better off and many others — not so much ….

  10. June 26th, 2012 at 04:56 | #10

    One of the best articles I’ve read from you in a while JQ… a well worn issue, but worth repeating. The purpose of life is not to work forever and die in a gold-platted coffin.

  11. Avi Waksberg
    June 26th, 2012 at 10:17 | #11

    @Martin
    The ABS produces a measure of NNI called ‘Real net national disposable income’. The last 4 quarters of which sum to $1.14 tril, while GDP was $1.35 tril over the same period.
    These come from the National Accounts:
    http://www.abs.gov.au/AUSSTATS/abs@.nsf/allprimarymainfeatures/52AFA5FD696482CACA25768D0021E2C7?opendocument

  12. Avi Waksberg
    June 26th, 2012 at 10:23 | #12

    For international comparisons of NNI the World Bank is pretty good:
    http://data.worldbank.org/indicator/NY.ADJ.NNTY.CD

  13. NME
    June 26th, 2012 at 12:37 | #13
  14. Fran Barlow
    June 27th, 2012 at 07:09 | #14

    Hmmm … it appears a response on this from me on this topic has vanished into the ether.

  15. Jim Rose
    June 27th, 2012 at 08:15 | #15

    great inventions of 20th century capitalism were the five-day week and retirement.

    we now seem to have to work until we drop to pay the taxman. that is not progress.

    people seem to forget the disutility of labour

  16. Freelander
    June 27th, 2012 at 09:40 | #16

    Capitalism flourished in mixed economies, a successful compromise that people preferred to some uncompromising socialist models then on offer. Unbridled capitalism, raw in tooth and claw,the variant we have regressed to,the variant that prevailed in the time of Dickens and Marx, not so popular.

  17. Dan
    June 27th, 2012 at 11:15 | #17

    @Jim Rose

    Evidence please. Last time I checked we were one of the lowest-taxed countries in the OECD.

  18. Tom
    June 27th, 2012 at 12:31 | #18

    @Dan

    http://stats.oecd.org/Index.aspx?QueryId=21699

    Just to avoid other readers to believe fact free statements, Australia is one of the lowest taxed countries in the OECD.

  19. Daniel
    June 27th, 2012 at 12:33 | #19

    To properly assess the increase participation of female workers into the labour force, several areas should be considered to remove the “dubious” tag.
    An obvious fact is that a typical housewife conducts several jobs around the house; chef, cleaner, babysitter, driver, accountant etc. Therefore a real value can be put on a housewife to see how much a housewife is financially worth, regarding to labour.
    Using Kennedy’s logic, more attention needs to be placed on a mothers emotional and physical impact on a child(ern), of course this is more difficult to price. However, I am sure studies have been conducted somewhere around the world which assesses the impact to a child’s development when both parents work compared to only one. Again this could be given a monetary value based on the child’s potential impact to society e.g. likely hood of the child graduating school/university or being involved with a crime. Of course there are the social and economic classes and geographical locations that impact individual households resulting a in mother being forced to work to pay the bills and not having the ability to stay home (and going deeper have a direct impact on the child’s development), which again emphasises the point of understanding what the long term social and economical benefits are to the household (as stated in this report the GDP lacks foresight). This assessment could also be a tool used to see if it is more beneficial for a mother to go to work or raise the children at home, or a combination of the two.
    If the result is that a mother stays at home full time, then another assessment would need to be done to see how it impacts society i.e. loss of jobs for childcare workers.
    Therefore, adding up all these parameters could be a way to assess the impact of a housewife on the GDP or NNI.

    P.S. I do realise this issue would hardly affect the GDP or NNI, but it seems one that deserves a great deal of attention

  20. Tom
    June 27th, 2012 at 13:29 | #20

    @Daniel

    These types of social problem is very difficult to measure using economic figures, but the push for maximising GDP arguably relates to these problems.

    Speaking from personal experience, I had a friend who told me long time ago why his relationship with his wife is bad. From his perspective, whenever he have dinner with his wife at home, the conversation a lot of times involve work. When his wife don’t feel happy at work (happens a lot, because as people know corporate politics in China is a very dark art), she will tell that to him and when my friend already faces pressures from work, the conversation don’t end well a lot of times.

    Sharing experience with other people sometimes helps to relief stress compared to when you hold it inside yourself, however in this kind of situation, it can be harmful for family relationships.

    However, it doesn’t always have to end like this. Working helps people socialising and this can be beneficial for psychological health of the person, and a happy workplace can bring a lot of jokes and stories to the dinner table. However this is not to say housewives don’t have their own social circle.

  21. Freelander
    June 27th, 2012 at 14:50 | #21

    We don’t need domestically grown children, or children at all.They are costly little bludgers, contribute nothing to the economy, get up to all sorts of troublesome mischief, and many, when fully grown turn out to be completely defective and a continuing drain on the public purse.

    We can obtain any additional labour for free from overseas, and check them out and send them back if they turn out to be defective. Indeed, we can probable auction available places.

  22. Dan
    June 27th, 2012 at 14:59 | #22

    @Freelander

    Hear hear, although there are types of fine technical work for which their small, nimble fingers and sharp eyesight are boons. This work can generally be offshored, though.

  23. Freelander
    June 27th, 2012 at 16:26 | #23

    I’m practicing before I apply to become Tony Abbott’s policy advisor!

  24. Dan
    June 27th, 2012 at 16:58 | #24

    Ditto. I guess we’ll pass each other in the foyer come interview day.

  25. Robyn Seth-Purdie
    June 29th, 2012 at 14:41 | #25

    Glad you responded to this. The Grattan Institute’s report’s recommendations certainly felt wrong and you’ve adduced some good reasons why they can’t be accepted at face value. I’d like to add to your suggestions about what needs to be included in capital depreciation: I think you could demonstrate that human capital – in the form of healthy life expectancy and/or “happiness” – is reduced both by some forms of work (particularly work that is high stress coupled with low control) and by extended periods of unemployment. In regard to the latter, I would like to see the concept of the “natural” rate of unemployment consigned to zombiehood. It’s a rate that seems to have crept up from 2% post war to 3% in the book you wrote with John Langmore (a book that seems to have been remaindered in policy terms but should not have been) to around 5% now. Of course participation rates now are higher than they used to be, but household income levels are of icnreasing importance as the social wage provided by government continues to diminish. Epidemiologist Michael Marmot in his study of socio-economic health gradients in the UK has listed “fair employment and good work for all” as one the 6 policy objectives required to reduce health inequalities. Good quality employment for parents is particularly important for the developmental health of the next generation – and hence, inter alia, for longer term productivity.

    Going back to your comments on the unwisdom of counting all paid work done by women toward GDP without discounting for the loss of domestic production, years ago I was involved in some work on non-income aspects of poverty. Available data indicated that people on the same income could fare very differently according to It seemed clear on the basisdeomstic production

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