Economics – Fail

Apparently economists have just realized that the calculation of GDP is deeply flawed.

A widening gap between data and reality is distorting the government’s picture of the country’s economic health, overstating growth and productivity in ways that could affect the political debate on issues like trade, wages and job creation.

Well yes, but it is distorting it in ways that the government likes. This has been obvious for a long time, and I had assumed that the distortion was being intentionally ignored. I guess I fell into the trap of over-estimating the intelligence of economists. The issue is a very simple one. GDP is calculated by subtracting imports from GNP, which in essence is gross end user sales of goods and services. The article mentions $100 and $50 carburetors (sic). But the real problem is more like $100 and $5. When the  carburetors are bought from overseas, they still sell for pretty much the same price so GNP is unaffected. The cost of the imports is so low that GDP hardly declines as a result of the subtraction. But the carburetor makers are laid off, so the work force shrinks. Since measured output (GDP)  is essentially unchanged, productivity rises. Economists are surprised.

What we’re seeing today, where an increase in GDP is failing to generate more jobs, is simply a result of the fact that employment in the goods-producing and other sectors, where import substitution is occurring, is falling so fast that it is more than offsetting any rises in services employment engendered by Nancy’s stimulus spending. But the fall in domestic value-added associated with the job losses is simply not being measured. So GDP is heavily overstated. Of course.

Fixing this measurement problem, if indeed it is considered a problem, will be very difficult. The data needed to fix it is not being captured at source and will be very difficult to infer. I think the interesting question is, what would be the cost of the goods and services being imported be, if they were being produced domestically? The answer to that question would tell us what the “true” trade balance really was.

What do I mean by “true” trade balance? Over the long term, the cost of imports from countries such as China will rise as they approach full employment and their standards of living improve. So the import bill will converge on the “true” cost of imports – what they would cost if we had to make them ourselves. Or looked at another way, how much domestic production has been replaced by imports. Which is probably a scary number.

But even before then, there’s another problem. What does the U.S. sell (export) to cover the import bill? Right now, we’re handing out I.O.U.s. At some point, that won’t be good enough.

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