Martin Feldstein: GDP Doesn’t Measure Quality

For the Philippines, this week marks 'GDP week'. The Philippine government will issue its estimate of statistical economic condition for the 1Q 2015. 

The consensus opinion sees the Philippine economy as undergoing something sort of a perpetual magical boom. They hardly realize that this has been an inflationary credit boom, which implies boom-bust cycles.

Yet, last quarter’s nitty gritty from supposedly 6.9% growth, plus recent data hold deep contradictions relative to popular wisdom. Even more, headline numbers contradict economic reasoning. For instance, according to government data, prices have been slumping broadly from both supply side and demand side. This comes even as credit continues to swell, despite having fallen from its peak at the 2H last year. Yet the consensus believes that the establishment will report a boom! A likely boom from statistical pumps!

Nonetheless, the following post (and series of posts for today) has been intended to show why the romanticization of statistical growth has been severely misplaced.

Harvard economist and the president emeritus of the National Bureau of Economic Research (NBER) and former chairman of the Council of Economic Advisers and as chief economic advisor to President Ronald Reagan Martin Feldstein, writing at the Wall Street Journal talks of the difference between quality and quantity. (bold mine)

Government statisticians are supposed to measure price inflation and real growth. Which means that, with millions of new and rapidly changing products and services, they are supposed to assess whether $1,000 spent on the goods and services available today provides more “value” or “satisfaction” to American consumers than $1,000 spent a year ago. Even more difficult, they are tasked with estimating exactly how much it costs now to buy the same quantity of “value” or “satisfaction” that $1,000 could buy a year ago.

These tasks are virtually impossible, and the problem begins at the beginning—when an army of shoppers go around the country at the government’s behest to sample the prices of different goods and services. Does a restaurant meal with a higher price tag than a year ago reflect a higher cost for buying the same food and service, or does the higher price reflect better food and better service? Or what combination of the two? Or consider the higher price of a day of hospital care. How much of that higher price reflects improved diagnosis and more effective treatment? And what about valuing all the improved electronic forms of communication and entertainment that fill the daily lives of most people?

In short, there is no way to know how much of each measured price increase reflects quality improvements and how much is a pure price increase. Yet the answers that come out of this process are reflected in the consumer-price index and in the government’s measures of real growth.

This is why we shouldn’t place much weight on the official measures of real GDP growth. It is relatively easy to add up the total dollars that are spent in the economy—the amount labeled nominal GDP. Calculating the growth of real GDP requires comparing the increase of nominal GDP to the increase in the price level. That is impossibly difficult.

Read the rest here.