GDP: Grossly Distorted Picture
February 14, 2015 Filed in: Economics | Education | Finance | Money
To understand the absurdity of the GDP, one must understand the absurdity of pricing.
The Gross Domestic Product (GDP) is an economic convention that has come under a lot of attack recently because of its failure to properly reflect the quality of life under the economy. Alternative ways of measuring ‘happiness’ are now being debated, and new acronyms are being forged like GPI; Genuine Progress Indicator. Obviously, a quantitative measure cannot measure quality. They are like two rails of a train that never intersect, but travel a long distance as a pair. Trying to quantify quality will have the same difficulty as trying to qualify quantity. However, there is a bigger problem. The original GDP measure is meaningless even at measuring what it purports to measure. It is a Grossly Distorted Picture. The GDP only measures inflation.
Inflation, of course, is another hotly debated topic. In general, there is a intellectual disconnect between micro-economics and macro-economic. Economists are constantly offering up signs of ‘good news’ and ‘bad news’ based upon whatever metric they select. The conventional wisdom is that ‘a rising tide lifts all boats’ (JFK) which is the baseline desire for perpetual growth. As we can clearly see, as the economy scales, the problem inherent in the economy scale too. Growth itself is not going to solve inequality or imbalances or deficits. This is because the micro is inseparable from the macro. The GDP is useless information, and should never be used as a tool of public policy. Whenever someone mentions the GDP, or uses its statistics in defense or criticism of anything, you can be assured that they have no idea of what they are talking about.
To understand the absurdity of the GDP, one must understand the absurdity of pricing. The economy began with the creation of a fiat currency, which was followed by the creation of fiat value. The rest is just basic cause and effect. Let’s assume a farmer picks an apple and sells it for 1 cent to a cooperative. The cooperative sells it at 2 cents to cold storage, cold storage sells it to the supermarket for 4 cents, and the supermarket sells it to us at 8 cents. Everybody in the supply chain has enjoyed a 100% mark- up (1, 2, 4, 8) and their profit profiles are very different (1, 1, 2, 4). The supermarket made 4 cents and the cold storage business made 2 cents. This is the type of detail that economists investigate. By studying variations, they think they can predict and/or control economic trends.
Let’s take the same apple, and instead of using a 100% profit at each step, let’s use a 50% profit at each step. The farmer picks an apple and sells it for 1 cent to the cooperative, the cooperative sells it to cold storage for 1.5 cents, cold storage sells it to the supermarket for 2.25 cents, and the supermarket sells it to us at 3.375 cents. The same apple has moved from tree to table at two different prices, 8 cents or 3.375 cents.
Economists measuring the GDP are not focusing on individual prices but the aggregate sales of the businesses. So, let’s assume that each business sold a million apples this year. Under the 100% profit economy, the farmer had $10,000 in sales, cooperative had $20,000 in sales, the cold storage facility had $40,000 in sales, and the supermarket had $80,000 in sales. The GDP would be the total of all the businesses: $150,000. Let’s call this economy A.
The same one million apples with a 50% profit margin would yield this: The farmer had $10,000 in sales, the cooperative had $15,000 in sales, the cold storage facility had $22,500 in sales, and the supermarket had $33750 in sales. The GDP would be $82,250. Let’s call this economy B.
To suggest that economy A is a better or healthier than economy B is absurd. The numbers are bigger, but nothing else. What is being measured is only the difference in the rate of inflation. The same number of apples are available, and the same number of apples are bought, sold and consumed. However, we can note a qualitative difference between these two economies. In both economies, the income of the farmer is the same. In the A economy, the farmer has more difficulty purchasing his own output. This explains why a farmer can feed thousands of people, but have trouble feeding himself.
Every business is a gatekeeper, and the profit margins that they use has a dramatic effect on the quality of life for everyone. The final consumer pays all the profit of everyone who touched the apple. While all the businesses are ‘buying low and selling high’ the final act for everything that we consume is to ‘buy high.’ In order for us to ‘buy high’ we must demand an ever greater revenue stream whether it is in higher wages, profits or taxes. Businesses, individuals and governments are all responding to the same mathematical pressures. The reason that there ‘isn’t enough money’ is because we create inflation. We are literally pricing ourselves into our own misery. Encouraging growth, describing profits as healthy, and promoting land and housing appreciation is like advocating for a contagious cancer.
Economists have failed to understand the link between micro and macro economics, the link between inflation and the GDP, and the quality of life issues inherent in inequality caused by larger profit margins. For elected officials and administrators to use GDP statistics for pro-growth public policy decisions is both dangerous and senseless. Free market theorists could not be more wrong about an invisible hand that automatically provides the best choice. Math is about cause and effect. The economy is explainable, predictable and controllable using the math that drives it. We cannot ignore the consequences of the numbers we write down. By writing down different numbers, we can have different results, but the first step is in having a better understanding of the numbers, and that is why the GDP is a Grossly Distorted Picture.