The measure „GDP‟ was invented by Simon Kuznets. He later went on to win the Nobel Prize in 1971 for his empirically founded interpretation of economic growth which has led to new and deepened insights into economic and social structure.
There are some sources that indicate other economists created GDP, for example Keynes. I suppose it doesn‟t really matter who did it first, what is really important here is the fact that GDP was invented in war times to gauge the overall economic capability of the nation.We could say that GDP was designed to be a weapon against your enemy; in this case the enemy was Nazi Germany. It was designed to prove that the US was on the top of the situation.
Simon Kuznets later warned in his first report to the U.S. Congress back in 1934 that “the welfare of a nation can scarcely be inferred from a measure of national income.”He clearly stated not to use GDP as a gauge of well-being of the nation or any indicator of the health of the economy. It is dangerous. It has not been designed for that purpose.
“The comforting distortion; Increases in the gross domestic product (GDP), signify a healthy, growing economy”
The disturbing reality; The GDP is too full of fluff to be an accurate measure of economic health and growth”
Peter Schiff (Crash Proof 2.0)
The gross domestic product -GDP is the market value of all final goods and services produced within a country in a given period of time.
It is often positively correlated with the standard of living. The measure gauges an economic state of the given country using a simple principle – for every seller there must be a buyer. Following this simple idea, GDP counts every single money transaction in the economy ANYWHERE!
We can express GDP equation by
Y= C + I + G + (Ex-Im)
Y = GDP
C = Consumption
I = Investment
G = Government Purchase
Ex = Exports
Im = Imports
C – Consumption.
Household spending on durable and non-durable goods. Tangible and nontangible things we all need every day to survive. This includes everything from a haircut to a new BMW5. This section covers our human needs and desires we spend money on. Everything we buy on the open markets is counted in the consumption box.
Yeah…It is all cool so long as we don‟t put in on a credit card i.e. pay for it with borrowed money.
We often see consumer spending indexes increasing and we think that an economy is growing. Spending is not growth; it is a consequence of economic growth. If we borrow money to finance the consumption, we take it from the future, so we have less to spend in the future so it is not a growth at all. If we spend the money we have saved – then we see genuine spending of the excess money and contribution to the economy. We don‟t have to pay it back in the future with interest and our well-being increases over time. We have more goods and services we can enjoy.
There is one exception to the consumption category – house purchase.
If you buy a new house, the transaction goes to another box called an investment.
The question is; how is the house purchase an investment these days?
We all need a roof over our heads. As we need food to eat and cars to drive. A new BMW is not an investment but consumption.
In my opinion the overall approach for the last number of years that a house is an investment brought us to the edge of total collapse. With excellent help of western governments keeping the interest rates artificially low gave an incentive to the market to “invest” in real estate. We all know the housing bubble story and how it ended up.
Maybe we should put it in „consumption‟ next time we revise the GDP?
All the money we invest should produce an income in the future or should produce more goods and services. It is the sum of all purchases of capital investment in land, equipment, inventories and structure in our economy.
This is the most important part of the equation. This is the core of the economic well-being and the healthy economic future of the nation.
The healthy and wise investment means to allocate the resources in the most efficient way so it can produce more goods and services in the future. Once that is done we can use the profits to further explore opportunities and free up our time to work less and rest more or work more efficiently, improving overall well-being.
That is the real well-being and the goal of the economy driven by healthy forces of free market capitalism!
Guess what? The housing appears here!
Remodel your kitchen or convert your attic on your so called “real estate investment” and the overall well-being of the nation goes through the roof! The market value of your house rises and you are wealthier so you can buy more pints on Friday night in the local pub. No worries at all!
A house is not an ATM machine that we can remortgage every time we need cash. It is not an investment that will produce more goods and services that we can consume in the future.
I think we all learnt the hard way not to treat real estate as an investment.
Besides it was not your money that you bought the house with. It belongs to the bank, all mortgages are guaranteed by government, and government borrows money from bond holders.
How is that investment? How is that well-being?
They are all bankrupt now and your house is worth half the money you paid for it…
G – Government purchase
This is the sum of government expenditure on final goods and services. It includes salaries of public servants, purchase of weapons for the military, and any investment expenditure by a government. It does not include any transfer payments, such as social security or unemployment benefits, these are called “transfer payments” and are all excluded.
Here we can talk about all the stuff the government buys with our hard earned money.
As we all know the government is the worst to allocate resources wisely. The public sector do not have an incentive to make money in order to stay afloat in the same way private business does. Therefore government expenditure will be stripped of any free market supply and demand concepts. All they need are the bonuses and pay rises. The examples are everywhere. Moneenageisha roundabout in Galway is one of them. Such a waste of taxpayer‟s money. It is not an infrastructure improvement, it‟s a joke. How does this kind of government spending improve our economy?
The other great example would be the education system or social welfare system in the US, total disaster has yet to show its teeth. The worst thing about this is that every euro spent by the government is a wasted euro and also this euro does not go to the investment category and it will never be used to produce more goods and services to improve the economy. Now the Irish businessman has a euro less to invest.
This box can‟t be any good for overall well-being of the average Paddy.
Well – again. Government is bankrupt…
A net export is expressed by exports minus imports.
This is the second most important part of the equation. It shows the difference between the stuff we produce and sell to other economies and the stuff we had to import because we do not have resources or a competitive advantage to make it but want to consume it.
Coming back to the basics of the economy;
Principle number 8;
“An economy‟s standard of living depends on its ability to produce goods and services”
Putting it simply, we as a nation have to sell things (exports) to generate revenue. The more stuff we sell the wealthier we become. It‟s simple. China is the best example of that principle.
The more exports the economy can produce, the more competitive it is on the international stage and the more business it attracts.
The more competitive the economy is the more jobs it can create and more wealth is to be distributed.
The important thing to point out here is that the greatest economies are the ones with a minimum of government and regulations.
The freer the economy is the more competitive it becomes as there is no bad resources allocation by government bodies and the capital is used in a much more effective way. And again China and Singapore are the best examples.
But GDP as a measure of national exports do not even include important facts about the real imports versus exports.
Let‟s talk about the US.
Dell an American well known manufacturer of computer devices has most of its production outsourced in Asia. They assembly and send all final goods back to the US market – GDP counts it as an import despite the fact that DELL is an American organization.
Toyota manufactures cars in US and then ships it to the market in Great Britain – American GDP counts this as export, despite the fact that Toyota is not a US owed company.
As we can conclude the above and come back to the core sentence that GDP is “The best single measure of economic well-being of the nation” we can say that it is probably far from it.
There are also other things to consider that GDP do not count properly as;
Income distribution – A small percentage of the population controls the majority of wealth. Well-being? I don‟t think so.
Black market activities – illegal transactions still impact economies. Columbia‟s drug exports are probably the main source of income.
Household transactions such as childcare, elderly care, volunteer‟s work opportunity costs etc. – money changes hands- not recognised by GDP.
National disasters (Australian floods, hurricane Katarina clean-up bill, oil spills will add to GDP)- The economy do not benefit from natural disasters right?
Natural resources depletion – Shortages of commodities used to produce goods and services are not accounted in GDP, although diminish the economy.
There are also other aspects to consider like the level of national debt, national savings, ratio between production and consumption (normally 70% consumption and 30% production).What if the consumption is financed by borrowed money and government spending (G) comes from bond market or printed money and not from genuine investments. Is that a growth? IMF Irish bail out money will probably add to national GDP. How is that improving our economy?
Yet despite all this misinterpretation, manipulation and fluff, GDP is widely used to gauge economic growth. Outrageous debt levels are justified because they are in line with historical percentage relationships to GDP.
If the economy does not produce anything and finances its consumption with borrowed or printed money and it consumes imported goods only – it will not go far.
Just take a look at trade accounts or trade balances of the US, study US national debt levels, US GDP and compare it to the deficits they run. Watch closely the national treasury rapidly rising yields; you will probably see that that party will be over soon, as it was for Ireland.
It is a Simple accounting aspect of liquidity. All companies unable to fund themselves go bust very quickly. The Same rule applies to governments.
And once that light is gone, the Irish exports are gone too.
Maybe the time has come to revise the way we measure economic growth and our own well-being?
The recent history has proven that this model might not work and perhaps we should learn economics from the Chinese?
Source by Roman Sadowski