Sunday, June 20, 2010

The GDP Fixation

Every Friday I receive a free investment letter from John Mauldin, an investment advisor who has enough credibility to get on CNBC, hold conferences with top speakers and produce an investment letter read by millions. Recently, he has been harping on GDP (as in GDP = C + I + G + (X-M), where C is consumption, I is investment, G is government spending, X is exports and M is imports). Now, if we accept that increased GDP is good, then any decrease in G is bad. However, some economists disagree and suggest that G should, in fact, be subtracted from the equation, as government spending is spending that people would otherwise forgo or channel into activities other than invading Iraq, bailing out banks or purchasing car companies that have failed to be competitive. Such an economist is Murray N. Rothbard who, in America's Great Depression, describes a measure he calls the Gross Private Product, or GPP. To quote him (pg 224),
In the pleasant but illusory world of "national product statistics," government expenditures on goods and services constitute an addition to the nation's product. Actually, since government's revenue, in contrast to all other institutions, is coerced from the taxpayers rather than paid voluntarily, it is far more realistic to regard all government expenditures as a depredation upon, rather than an addition to the national product. (emphasis in original)
So, Rothbard's equation is
GPP = C + I - G + (X-M)
where G now represents the maximum of government revenues and government spending - the value it extracts from the economy. Rothbard elaborates more on GPP and the reader may want to follow up on his ideas. In fact, I think that Rothbard may be too harsh on government spending, as there is some value produced in some spending - it's just impossible to know what it is as it is not subject to consumer sovereignty or profit and loss.

Now, if Mauldin were like Paul Krugman - that is completely ignorant of the Austrian School of economics and a shill for Democrats - I wouldn't blame him. However, Mauldin does know about the Austrian School and was apparently present when Gary North and Mark Skousen interviewed F. A. Hayek. Mauldin does disagree with the Austrian Business Cycle Theory (ABCT) and has said in his newsletter that he is more inclined to Irving Fisher's views; but how can a thinking person suggest that G - government spending - must not be reduced too quickly as it will lead to a reduction in GDP and further economic pain? Yes, a reduction of government spending will injure some parts of the population, but that capital is then freed up for productive uses. The longer we delay that reduction the greater - and wider - will be the pain.

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dc.sunsets said...
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dc.sunsets said...

If we accept the calculations made by some who note that now, for every dollar borrowed and spent by the state, less than a dollar in new value is created, we can imagine that subtracting G in its entirety is closer than ever to reality.

Karl Denninger's "economics posts" on his blog are very instructive in this regard. The implication is that, sooner or later, the excess "contribution" to GDP of government debt-based spending will collapse as a fact of simple mathematics. This now represents at least 10% of "official GDP," and add-on effects of such a collapse (since feedback loop effects are certain, as tax receipts will fall, too) will be unlike anything anyone living has ever seen.

If we then assume that the underlying capital structure has been weakened by decades of neglect, it's easy to suggest such a contraction will exceed 30% of GDP. It could be 50% by the time a low is discovered.

This is the effect of justifying decisions based on erroneous measurement of choices. If we "weigh" our potatoes with a broken scale, our choice of competing actions will be equally broken.