Politicians pay too much attention to this outdated indicator of economic growthby Diane Coyle / February 20, 2014 / Leave a comment
Published in February 2014 issue of Prospect Magazine
The 1870s and 1880s were a period of rapid industrialisation and innovation. Alexander Graham Bell’s telephone, Nikola Tesla’s twophase induction motor, Herman Hollerith’s punched cards, the electric fan, the seismograph, the motorcycle—all of these advances were made in this period.
So presumably the “new economy” that these inventions helped bring about can be seen in the economic statistics of the 19th century. But no: the Statistical Abstract of the United Kingdom for 1871-1885 contains just a few pages of figures on the new technologies of the period—textile factories, railways and so on. In contrast, there are almost 200 pages of the finest detail on the traditional economy: agricultural production and trade. In other words, economic progress has always outstripped our ability to measure it.
Today’s principal economic indicator, Gross Domestic Product (GDP), was invented to serve a specific purpose, namely measuring the production available for the war effort and the sacrifice required of consumers at a time of real scarcity. The man often thought to be the inventor of GDP, Simon Kuznets, had in fact argued against it. He would have preferred the government to measure economic well-being.
The exigencies of the time meant Kuznets lost that argument, but the debate over the precise determinants of GDP has been revived. Critics of the metric point out that it does not take account of the many adverse consequences of some forms of economic activity. It does not account for the effects of pollution, of urban traffic congestion, or of crime. On the other hand, neither does it take account of the huge benefits of innovation and the sheer variety of goods and services in a modern economy. It was designed specifically not to incorporate any effects on well-being, but simply to measure the monetary, market-based economy.
This does not mean that GDP should either be retired or fundamentally changed. Having a measure of economic activity is essential for setting fiscal and monetary policy, and GDP is the product of 70 years of research and development. Of course it will need further improvements. National statisticians should be looking urgently at how the financial sector is measured. An adjustment to the way in which finance was measured, made just before the financial crisis, resulted in the sector’s biggest ever contribution to UK GDP growth in the last three months of 2008. This is absurd; the definition overstates true financial sector economic activity. (Adam Smith would have excluded banking as a productive activity altogether.)