Here’s a summary of The Economist’s important critique of GDP and suggestions for reform

May 6, 2016 3 By Duncan Green

‘Laws are like sausages, it is better not to see them being made’ said Otto von Bismarck. Turns out you can probably economist GDP coveradd GDP to that list.

Last week’s Economist had a comprehensive takedown of the uses and abuses of Gross Domestic Product as an indicator of wellbeing, economic health or pretty much anything else. People have been critiquing GDP ever since it was created, but the Economist piece matters both because it shows that GDP is actually getting less useful over time, and also because it’s the Economist saying so. As a service to non subscribers, here’s a flavour of the critique from a 3 page briefing and some suggestions for reform from the accompanying leader.

First some of the more unpalatable ingredients of the GDP sausage:

‘In a world where houses are Airbnb hotels and private cars are Uber taxis, where a free software upgrade renews old computers, and Facebook and YouTube bring hours of daily entertainment to hundreds of millions at no price at all, many suspect GDP is becoming an ever more misleading measure.

The modern conception of GDP was a creature of the interwar slump and the second world war. A measure created when survival was at stake took little notice of things such as depreciation of assets, or pollution of the environment, let alone finer human accomplishments. In a famous speech in March 1968, Robert Kennedy took aim at what he saw as idolatrous respect for GDP, which measures advertising and jails but does not capture “the beauty of our poetry or the strength of our marriages”.

Economist GDP fig 1A problem with GDP even when it is being asked to do nothing more than measure production is that it is a relic of a period dominated by manufacturing. In the 1950s, manufacturing made up more than a third of British GDP. Today it makes up a tenth. But the output of factories is still measured much more closely than that of services. Manufacturing output is broken down into 24 separate industries in the national accounts; services, which now make up 80% of the economy, are subdivided into only just over twice that number of categories.

A bias toward manufacturing is not the only distortion. By convention GDP measures only output that is bought and sold…. This convention means that so-called “home production”, such as housework or caring for an elderly relative, is excluded from GDP, even though such unpaid services have considerable value.’

So much for the critique, and here are the interesting suggestions for sorting it out:

‘Measuring prosperity better requires three changes. The easiest is to improve GDP as a gauge of production. Junking it altogether is no answer: GDP’s enduring appeal is that it offers, or seems to, a summary statistic that tells people how well an economy is doing. Instead, statisticians should improve how GDP data are collected and presented. To minimise revisions, they should rely more on tax records, internet searches and other troves of contemporaneous statistics, such as credit-card transactions, than on the standard surveys of businesses or consumers. Private firms are already showing the way—scraping vast quantities of prices from e-commerce sites to produce improved inflation data, for example.

Second, services-dominated rich countries should start to pioneer a new, broader annual measure, that would aim to GDPcapture production and living standards more accurately. This new metric—call it GDP-plus—would begin with a long-overdue conceptual change: the inclusion in GDP of unpaid work in the home, such as caring for relatives. GDP-plus would also measure changes in the quality of services by, for instance, recognising increased longevity in estimates of health care’s output. It would also take greater account of the benefits of brand-new products and of increased choice. And, ideally, it would be sliced up to reflect the actual spending patterns of people at the top, middle and bottom of the earnings scale: poorer people tend to spend more on goods than on Harvard tuition fees.

Although a big improvement on today’s measure, GDP-plus would still be an assessment of the flow of income. To provide a cross-check on a country’s prosperity, a third gauge would take stock, each decade, of its wealth. This balance-sheet would include government assets such as roads and parks as well as private wealth. Intangible capital—skills, brands, designs, scientific ideas and online networks—would all be valued. The ledger should also account for the depletion of capital: the wear-and-tear of machinery, the deterioration of roads and public spaces, and damage to the environment.

Building these benchmarks will demand a revolution in national statistical agencies as bold as the one that created GDP in the first place. Even then, since so much of what people value is a matter of judgment, no reckoning can be perfect. But the current measurement of prosperity is riddled with errors and omissions. Better to embrace a new approach than to ignore the progress that pervades modern life.’