About Austrian Critique Of GDP
A reader wondered about my view of the Austrian critique of the GDP concept given the fact that I frequently use it on my blog.
Actually though, there's several different, to a large extent mutually exclusive Austrian criticisms of GDP, none of which holds for closer scrutiny. I will here discuss the perhaps 3 most common.
The most radical critique essentially argues that national accounting per se is by necessity misleading since you supposedly can't aggregate things as different as haircuts, burgers, cars and guns. But it is in fact possible to aggregate it because there is a thing called money by which the relative value of these things are revealed.
That is similarly why it is possible to aggregate the profits and financial positions of companies and compare different companies even though they make very different products. A financial statement of a company represents an aggregation of the value of the many different activities of a company similar to how GDP statistics represents and aggregation of the value of the many different activities within a country.
Furthermore, if you thiink that aggregation is impossible you wouldn't be able to analyze the business cycle or economy at all, even in a nonnumerical way like in the Austrian business cycle theory.
A related but slightly different critique is related to price indexes, used to convert nominal GDP changes to real GDP changes, that some view as illegitimate because all prices are unique. Yet when done in a proper way they do reveal useful things about how the purchasing power of money in terms of the goods that are produced changes.
It could be noted that just as there are private sector accounting similar to GDP there are private sector price indexes, such as the S&P 500 stock price index or the CRB commodity price index. Consumer price indexes can be useful for the same reason that the S%P 500 or the CRB indexes can be useful.
Another critique, advanced by for example Mark Skousen accepts the legitimacy of growth statistics, yet argues that GDP underestimates the value of output because of its value added approach. Instead of just including final sales, one should also include intermediary transactions.
Yet that would be misleading because the values of intermediary transactions are in fact included in the value of final sales. And if the intermediary transaction, but not the final sale, is made before the end of a quarter or year it is included as inventory build up in GDP.
What GDP does is not counting the value a second time when the retailer (or whoever makes the final sale) sells it to consumers or investment good buyers. In the example of the intermediary sale before the end of the period, the final sale of consumer and investment goods during the next period are added to GDP in the next period while the intermediary goods are subtracted (which formally shows up as inventory reduction) because they no longer exist independently. The purpose of GDP is to estimate the value of what is produced, and the value of a car is only the value that the car buyer pays for it, not the sales price plus the price of steel used in the car plus the value of iron used to make steel and so on.
The absurdity of this approach can be illustrated by the fact that this implies that if the buyer and seller of the car simply sold it back and forth to each other each day then the value of output would increase 365-fold over a year compared to if the original buyers keeps the car! This approach would also imply that if a company instead of outsourcing certain things started to do it themselves, then output will fall significantly despite the fact that the same things are being made in the same quantities.
One response is that GDP is inconsistent since when pure input goods are used it is subtracted, but when investment goods used to make the same final products gradually loses their value that is not similarly subtracted from GDP. This point is actually partially valid, as the reduced value of capital goods in principle the same as the depletion of input goods and that's why Net Domestic Product/Net Domestic Income or in some contexts Net National Product/National Income is preferable, at least assuming similar data accuracy, to GDP since they represent a more consistent application of the value added approach.
However, since depreciation of capital goods is often more difficult to estimate than the use of pure input goods, the accuracy of GDP is probably higher. Moreover, there is usually little difference between the change in Gross and Net Domestic Products so under normal circumstances it makes little difference which one you use.
Only when there is widespread destruction of capital goods, usually due to wars or natural disasters, is the distinction useful, as the far worse values of Net Domestic Product more accurately describes why natural disasters and wars are bad for the economy.
Finally, I should note that though I think that National Accounting in principle is possible and useful, I am often critical about the actual way in which governments makes them and how they are misinterpreted by economists, as for example in the way in which terms of trade changes are ignored in the headline numbers. Furthermore, one should always be aware of the margin of error that inevitably exists because of data collection problems.
Actually though, there's several different, to a large extent mutually exclusive Austrian criticisms of GDP, none of which holds for closer scrutiny. I will here discuss the perhaps 3 most common.
The most radical critique essentially argues that national accounting per se is by necessity misleading since you supposedly can't aggregate things as different as haircuts, burgers, cars and guns. But it is in fact possible to aggregate it because there is a thing called money by which the relative value of these things are revealed.
That is similarly why it is possible to aggregate the profits and financial positions of companies and compare different companies even though they make very different products. A financial statement of a company represents an aggregation of the value of the many different activities of a company similar to how GDP statistics represents and aggregation of the value of the many different activities within a country.
Furthermore, if you thiink that aggregation is impossible you wouldn't be able to analyze the business cycle or economy at all, even in a nonnumerical way like in the Austrian business cycle theory.
A related but slightly different critique is related to price indexes, used to convert nominal GDP changes to real GDP changes, that some view as illegitimate because all prices are unique. Yet when done in a proper way they do reveal useful things about how the purchasing power of money in terms of the goods that are produced changes.
It could be noted that just as there are private sector accounting similar to GDP there are private sector price indexes, such as the S&P 500 stock price index or the CRB commodity price index. Consumer price indexes can be useful for the same reason that the S%P 500 or the CRB indexes can be useful.
Another critique, advanced by for example Mark Skousen accepts the legitimacy of growth statistics, yet argues that GDP underestimates the value of output because of its value added approach. Instead of just including final sales, one should also include intermediary transactions.
Yet that would be misleading because the values of intermediary transactions are in fact included in the value of final sales. And if the intermediary transaction, but not the final sale, is made before the end of a quarter or year it is included as inventory build up in GDP.
What GDP does is not counting the value a second time when the retailer (or whoever makes the final sale) sells it to consumers or investment good buyers. In the example of the intermediary sale before the end of the period, the final sale of consumer and investment goods during the next period are added to GDP in the next period while the intermediary goods are subtracted (which formally shows up as inventory reduction) because they no longer exist independently. The purpose of GDP is to estimate the value of what is produced, and the value of a car is only the value that the car buyer pays for it, not the sales price plus the price of steel used in the car plus the value of iron used to make steel and so on.
The absurdity of this approach can be illustrated by the fact that this implies that if the buyer and seller of the car simply sold it back and forth to each other each day then the value of output would increase 365-fold over a year compared to if the original buyers keeps the car! This approach would also imply that if a company instead of outsourcing certain things started to do it themselves, then output will fall significantly despite the fact that the same things are being made in the same quantities.
One response is that GDP is inconsistent since when pure input goods are used it is subtracted, but when investment goods used to make the same final products gradually loses their value that is not similarly subtracted from GDP. This point is actually partially valid, as the reduced value of capital goods in principle the same as the depletion of input goods and that's why Net Domestic Product/Net Domestic Income or in some contexts Net National Product/National Income is preferable, at least assuming similar data accuracy, to GDP since they represent a more consistent application of the value added approach.
However, since depreciation of capital goods is often more difficult to estimate than the use of pure input goods, the accuracy of GDP is probably higher. Moreover, there is usually little difference between the change in Gross and Net Domestic Products so under normal circumstances it makes little difference which one you use.
Only when there is widespread destruction of capital goods, usually due to wars or natural disasters, is the distinction useful, as the far worse values of Net Domestic Product more accurately describes why natural disasters and wars are bad for the economy.
Finally, I should note that though I think that National Accounting in principle is possible and useful, I am often critical about the actual way in which governments makes them and how they are misinterpreted by economists, as for example in the way in which terms of trade changes are ignored in the headline numbers. Furthermore, one should always be aware of the margin of error that inevitably exists because of data collection problems.
posted by stefankarlsson at 3:24 PM
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