Frank Shostak: Is GDP an Accurate Measure of Reality?

To gain insight into the state of an economy, most economists rely on a common statistic named the Gross Domestic Product (GDP). The GDP looks at the value of final goods and services produced during a particular period, usually a quarter or a year.

Using this measurement statistic assumes that what drives the economy is not the production of goods and services, but rather consumption. In GDP, what matters is the demand for final goods and services. Since consumer outlays are the largest part of the overall demand, it is commonly held that consumer demand is the key productive factor in the economy. Because the supply of goods is taken for granted, this framework ignores the various stages of production that precede the emergence of final goods.

Usage of GDP assumes goods emerge because of consumer demand. In the real world, it is not enough to have a demand for goods, there must be the prior means of sustenance to satisfy consumer demand. In other words, there must be final consumer goods and services to sustain individuals in the various stages of production. That requires real savings. Savings are the determining factor as far as the future economic growth is concerned. If economic growth requires particular infrastructure, but there is not enough pre-existing savings to sustain through the period of capital development, then economic growth is not going to emerge.

GDP usage gives the impression that it is not the activities of individuals that produce goods and services, but something else outside these activities called the “economy.” However, at no stage does the so-called “economy” have a life of its own independent of individuals. In fact, GDP cannot inform us whether the final goods and services produced during a particular period are a reflection of wealth generation or capital consumption. By aggregating the final goods and services, government statisticians concretize the fiction of an “economy” by means of the GDP statistic.

GDP and the real economy - what is the relationship?

There are also serious issues regarding the calculation of real gross domestic product (GDP). To calculate a total, several things must be added together. First, in order to add things, they must have some unit in common. However, it is not possible to add refrigerators to cars and shirts to obtain the total of final goods. Since the total real output cannot be defined in a meaningful way, obviously it cannot be quantified. To overcome this problem, economists employ total monetary expenditure on goods and services, which they divide by an “average price” of those goods and services. There are several problems with this.

Suppose two transactions were conducted: In the first transaction, one TV set is exchanged for $1,000; in the second transaction, one shirt is exchanged for $40. The price or in the first transaction is $1000/1 TV set. The price in the second transaction is $40/1 shirt. In order to calculate the “average price,” we must add these two ratios together and divide them by two. But $1000/1 TV set cannot be added to $40/1 shirt, implying that it is not possible to establish the “average price.”

The employment of various sophisticated methods to calculate the “average price” cannot bypass the essential issue that it is not possible to establish an average price of various goods and services. Accordingly, various price indices that government statisticians compute are simply arbitrary numbers. If price deflators are meaningless, so is the real GDP statistic.

Even government statisticians admit that the whole thing is not real. According to J. Steven Landefeld and Robert P. Parker from the Bureau of Economic Analysis:

In particular, it is important to recognize that real GDP is an analytic concept. Despite the name, real GDP is not “real” in the sense that it can, even in principle, be observed or collected directly, in the same sense that current-dollar GDP cannot in principle be observed or collected as the sum of actual spending on final goods and services in the economy. Quantities of apples and oranges can in principle be collected, but they cannot be added to obtain the total quantity of ‘fruit’ output in the economy.

Now, since it is not possible to quantitatively establish the total of real goods and services, obviously various data like real GDP that government statisticians generate is questionable. The whole idea of GDP gives the impression that there is such a thing as the “national output.” In a market economy, however, wealth is produced by individuals and belongs to them. Goods and services are not produced in totality. Hence, the entire concept of real GDP is devoid of any basis in reality as far as the market economy is concerned. According to Mises, the whole idea that one can establish the value of the national output, or what is called the gross domestic product (GDP), is somewhat far-fetched.

So, what are we to make out of the periodical pronouncements that the economy, as depicted by real GDP, grew by a particular percentage? All we can say is that this percentage has nothing to do with real economic growth and that it most likely mirrors the pace of inflationary monetary pumping. Since GDP is expressed in dollar terms, it is obvious that its fluctuations are driven by the fluctuations in the quantity of dollars artificially added into the economy. From this we can also infer that a strong real GDP growth rate most likely depicts a weakening in the process of true wealth formation.

Once it is realized that the so-called economic growth, as depicted by real GDP, mirrors fluctuations in the money supply growth, it becomes clear that an economic boom has nothing to do with the wealth expansion. On the contrary, such a boom inflicts damage to the pool of real savings – the ultimate heart of economic growth. (Note that the boom is generated by the increase in the money supply, which gives rise to various bubble activities that undermine the process of wealth generation).

What is the purpose of having information regarding so-called economic growth?

One is tempted to ask: why it is necessary to know the growth of the so-called “economy”? What purpose can this type of information serve? In a free unhampered economy, this type of information would be of little use to entrepreneurs. The only indicators that entrepreneurs would rely upon are profit and loss. How can any information that the “economy” grew by 4% during a particular period assist an entrepreneur to generate profit? What an entrepreneur requires is not general but rather specific information regarding the demand for his specific product. The entrepreneur himself has to establish his own network of information concerning a particular venture.

Alternatively, things are quite different when the government and the central bank tamper with businesses. Under these conditions, no businessman can afford to ignore the GDP statistic since the government and the central bank react to this statistic by means of fiscal and monetary policy. For example, through inflationary printing and the artificial lowering of interest rates, the Federal Reserve doesn’t help generate more prosperity; it rather sets in motion “stronger” GDP and the consequent menace of the boom-bust cycle (i.e., economic impoverishment).

Conclusion

We can conclude that the GDP lacks any link to the real world. Notwithstanding this, the GDP measure is in big demand by governments and central bank officials since it provides justification for their interventions. The movements in GDP cannot provide us with any meaningful information about what is going on in the real economy. If anything, it can actually provide us with a false impression. A strong GDP growth rate, in most cases, is likely to be associated with the intensive squandering of the pool of real savings. Hence, despite “good GDP” data, many more individuals may find it much harder to make ends meet.

Frank Shostak is an Associated Scholar of the Mises Institute. His consulting firm, Applied Austrian School Economics, provides in-depth assessments and reports of financial markets and global economies. This article was first published HERE