Wednesday, June 13, 2007

Michael Mandel's Phantom "Phantom GDP"

Although, unlike some of the more extreme Austrians, I view GDP and national income as valid concepts in principle, I am certainly open for criticizing these statistics as actually performed by statistics bureaus.

For example, price inflation is likely often underestimated in these statistics, which in turn means that real growth is lower. And I have criticized the fact that nominal production growth is deflated by selling prices, rather than the prices of the goods the inhabitants of a country buy.

I now see, via Paul Craig Roberts, that Michael Mandel of Business Week argues for a systematic overestimation of GDP growth in America, which he calls "phantom GDP". Being interested in the subject of possible distortions, I read his more detailed explanation of this alleged distortion with great interest. Uultimately, however, his argument fails.

His argument is in short that when production moves offshore and the price of the good falls as a result, the price fall results in an increase in real private consumption. But because the produced goods had not previously been imported no price adjustment are made to imports, meaning that real imports aren't increased the way real consumption are increased. And as real GDP is calculated by adding real exports and real domestic demand and subtracting real imports, an upward adjustment to real domestic demand (including real private consumption) but not to real imports implies an upward adjustment to real GDP.

So far he is right in his analysis, but he is wrong when he argues that this paints a misleading picture of economic growth. The reason why it is right to adjust upwards the real value of consumption given a certain level of nominal consumption if prices fall is because this means consumers have more real goods and services. But there is no need to make the same adjustment to imports. The reason for this is that if we get more goods from foreigners without paying them anymore this means that we don't give them more of our goods and services in return, and so there is no need to subtract more from domestic demand in order to arrive at the real value of what we produce and earn. We are, in that scenario, making a terms of trade gain, and as terms of trade gains implies that our real income and real production increases, this means that it is quite proper not to subtract more from our GDP if the price of imports is lower.

Mandel is only right in the sense that according to the standard method of deflating GDP with the prices we produce, this represents a distortion. But as that method in itself represents a distortion, this "distortion" only means that official numbers distort less than they would have if the standard method were more consistently used.


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