Quote of the Day: Why GDP is an Enron-Style Accounting Fiction

First up, it’s worth it to address the number’s origins. Though attempts to measure country economic growth go back to at least the 17th century, Coyle writes that what we know as GDP today “is one of the many inventions of World War II.” War is the health of the state as Randolph Bourne correctly uttered long before WWII, so it wouldn’t surprise him that a number explicitly designed to increase the size of government reached full flower during the last global war.

Where it gets interesting is that prewar measures of economic growth explicitly showed “the economy shrinking if private output available for consumption declined, even if government spending required for the war effort was expanding output elsewhere in the economy.” Of course those numbers did. Though it would be folly on the best day for number crunchers to divine economic growth, there was at least some honesty in the numbers: government spending correctly subtracted from growth. 

If the reason why government spending reduced growth isn’t apparent, it’s important to remind readers that governments have no resources. This is true no matter one’s ideology. They’re only able to spend what they tax or borrow from the private economy first. In that case, for government spending to be counted as economic growth would be for those attempting to measure economic activity to engage in fraudulent double counting. The growth already took place; that’s why there were resources for government to consume in the first place. Thinking about this further, while WWII will be discussed in greater detail in a little bit, readers ought to think about the popular view inside the economics profession about WWII “ending” the Great Depression with all of this in mind.

For now, what’s important here is Coyle’s acknowledgment that for the longest time “’the economy’ was the private sector.” (my emphasis). Government couldn’t add to economic growth through spending simply because government spending very definitely was the process whereby government shrank the real economy through political consumption of capital extracted from the private sector. The money that politicians spend must come from somewhere, so for every dollar spent by politicians, that’s one less dollar for the private sector to allocate toward consumption, investment, or both.

To state the obvious, GDP was and is perfect for the political class simply because the false accounting that has defined it from day one promotes the obvious fiction that government spending adds to economic growth. Coyle is clear about the latter, that there was substantial resistance to what GDP became precisely because it was so blatantly false in its accounting, but she’s also clear about what informs its modern definition: “GDP was constructed around Keynes’s model of how the economy works,” and the Keynes model was one that said government could use “both fiscal policy (the level of tax and spending) and monetary policy (the level of interest rates and availability of credit) to target a higher and less volatile rate of growth for the economy.”

In short, Keynesianism is the ultimate economic fantasy, which helps explain why it’s so popular with the deluded types who enter politics, not to mention academic economists shielded from the real-world implications of their droolings. Wouldn’t it be nice if government spending could boost growth during troubled times, but by definition it can only reduce it. If readers feel otherwise, they must explain how it is that Barack Obama, Mitch McConnell, Harry Reid, Nancy Pelosi, and John Boehner can allocate capital better than you, Amazon’s Jeff Bezos, FedEx founder Fred Smith, Paul Tudor Jones, Warren Buffett, and Ken Fisher. This isn’t about ideology. Politicians simply can’t allocate capital more skillfully first because they’re arguably not suited to it, but most important because they lack the market signals that happily starve the bad ideas of Bezos, Smith, Jones, Buffett and Fisher.

Some will reply that government must consume when the citizenry is not consuming, but this form of thinking is every bit as silly as the thought process that says political allocation of capital is the path to future Microsofts, Intels and Cisco Systems. Lest we forget, short of stuffing money under a mattress, money saved does not lay idle. Banks don’t take in deposits in order to stare lovingly at the cash; rather they pay for deposits (liabilities) by immediately turning those liabilities into assets. Money saved is immediately lent to those with near-term consumptive needs, or it’s lent to entrepreneurs and businesses eager to grow. Keynesianism presumes a world that has never existed in which banks warehouse deposits, and that is defined by politicians who are more expert than the private sector at investing funds extracted from the private sector.

That’s what’s so interesting about Coyle’s faux evenhandedness about whether or not the comical notion of a “fiscal multiplier” is real. She writes as though sometimes it multiplies growth and sometimes it doesn’t, but whatever government spending does to the false measure that is GDP, it can’t boost real economic growth. It can’t unless Coyle and her fellow astrologers really can say with a straight face that Sens. Ted Cruz and Chuck Schumer are better allocators of capital than are Cliff Asness and Tom Steyer. Not very likely. And if they believe it, it’s time for this debate to take place.

Considering the calculation of GDP, expenditure is the most common approach; and it’s one that reveals the Enron-fiction that is GDP in living color. Once again, government spending adds to growth despite it plainly subtracting from it, and then if we import more than we export, GDP actually declines. In short, that which reduces the size of the private sector boosts economic growth in the deluded GDP sense, while that which plainly reveals a growing private sector (imports which reflect increased production stateside, and increased foreign investment in the U.S.) actually reduces the economy’s size per GDP.

(bold mine)

This is from a critical review by John Tammy at the Forbes.com on Diana Doyle’s new book GDP: A Brief But Affectionate History. 

The whole article is a recommended read