Patterico's Pontifications

6/11/2014

Economics Is About Improving People’s Lives, Not Creating Busywork — Why Paul Krugman’s Love of GDP Is Wrong, Part Three

Filed under: General — Patterico @ 6:00 am

As regular readers are aware, I am spending time this week attacking GDP as the ultimate benchmark for measuring the strength of the economy. On Monday, in Part One of the series, I noted that GDP includes government spending even though government spending does not necessarily benefit consumers. Yesterday, in Part Two of the series, I addressed another problem with GDP: it overemphasizes consumer spending to the detriment of capital investment.

Today, I want to show how an overemphasis on the GDP measure can encourage less efficient ways of satisfying consumers’ preferences — and indeed, can encourage destruction of resources. In this way, GDP favors busywork over an actual improvement in consumers’ standard of living. As we will see, this nonsense leads the Krugmans and Keyneses of the world to say it would be a great idea to dig pointless holes — or to prepare for a Martian invasion that will never happen — as long as people are busy!!!

In this post I am borrowing heavily from this excellent blog post by Alex Zorach, which makes the points I want to make quite effectively. I recommend clicking through and reading it, since my post is little more than an attempt to summarize the points made by Zorach.

Zorach’s first point is that a less efficient way of doing something can lead to a higher GDP:

It is also worth noting how GDP counts goods or services when they are sold and resold. Shipping and storage of goods are almost always counted in GDP, as these are considered services that are produced. So a product that is sold directly to the end user, at the point of production, will result in less of a contribution to GDP than a product which is produced, shipped, stored in a warehouse, and shipped again to the same end user for the same price plus shipping costs.

In other words: let’s say that a car manufacturer comes up with a way to sell cars direct to consumers for $20,000, as opposed to selling it through a dealer for $25,000.

It could be that the dealer adds sufficient value to justify that extra $5000. After all, the dealer handles shipping and storage costs that make it more convenient for the average consumer to purchase the car. He provides customers with a way to service their cars and enforce their warranties. In an unhampered market economy (which we don’t have in the case of auto sales; we have discussed here before how government puts its thumb on the scale), consumers can determine whether the value produced by the dealer is worth the extra cost. Some manufacturers would utilize dealers and others would sell direct, and the best sales model would win out.

But assume that a car manufacturer finds a way to cut out the middleman in a way that most consumers prefer. In such a scenario, in an unhampered market economy, dealers will go out of business — and they should. The land used by the dealership will be sold to a company that can put it to better use. The people working for the dealership will have to go find new jobs that are more productive for the economy. But consumers will be far better off. They can get the car for less money, and if the manufacturer finds a more efficient way of delivering and servicing the car, consumers are ultimately in a better position.

The dealerships’ employees will temporarily be worse off — but that is the tradeoff we make in an unhampered market economy. The “creative destruction” of businesses that are not satisfying consumers’ preferences ensures that scarce resources are allocated in the manner that best satisfies those preferences. In other words, the dealerships’ employees will need to find something to do that delivers value — that consumers want. Once they do, they will once again be successful.

But whether a car dealership adds value or not, GDP will be larger if the dealer is involved. That’s because $25,000 is a higher number than $20,000. So if your only desire is to maximize GDP, you’ll pass laws to keep dealers in business — even if market forces dictate that direct sales are preferable, and that the resources spent on dealerships are best reallocated to different parts of the economy.

Ah, but it gets worse. As Zorach points out, GDP also increases when things are destroyed. Imagine a car accident. In its aftermath, GDP increases.

Between health insurance, car insurance, out of pocket expenses, a lot of money changes hands. . . . [T]he medical care, any car repair work, and new cars purchased, and any legal fees, is all included in GDP. Furthermore, the incremental rate by which everyone’s insurance premiums go up to pay for this accident results in more payments to insurance companies, which is also included in GDP. The net effect of the accident is to produce a substantial increase in GDP. Most alarmingly, the more destructive the accident, the greater the increase in GDP.

While it is necessary to have a section of the economy that deals with car accidents, we can all agree that it’s better for citizens when there are fewer car accidents. Yet more accidents equal a bigger economy.

Why is this a problem? Because when we analyze the economy, we’re doing so in order to create a better standard of living for consumers. But when your only incentive is to increase GDP, you don’t care whether eliminating the middleman benefits consumers (as in the first point above) or even your actions are destroying wealth (as in the second point above). All you care about is making people do busywork, even if it does not contribute to a net increase in people’s living conditions.

Do Keynesian economists recognize this fallacy? Nope, not even the Nobel prize winners. Paul Krugman believes that even pointless activity is a good thing, as long as it’s activity. For example, Krugman favorably cited this passage from Keynes in a 2008 blog post:

If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is.

Absurd. In a similar analogy, Krugman said that preparing for an invasion of space aliens would make the economy better off, even if the invasion turned out to be imagined:

If we discovered that, you know, space aliens were planning to attack and we needed a massive buildup to counter the space alien threat and really inflation and budget deficits took secondary place to that, this slump would be over in 18 months. And then if we discovered, oops, we made a mistake, there aren’t any aliens, we’d be better [off].

Ridiculous. As David McIlroy explains:

These people honestly believe that money spent — no matter why it’s spent or the effects of the spending — is the same as creating growth. They don’t understand that if the spending produces nothing of value, the amount of overall value in the economy is lowered and that the average standard of living must go down.

Krugman might tell you that having useless car dealers around would be good — if they would increase GDP. He might even tell you that car accidents are good — if they would increase GDP. He and the rest of the Keynesians think that any economic activity is good. They don’t care whether it makes your life better . . . or doesn’t.

And this has important real-life consequences, because Our Betters in Government listen to guys like this, and implement policies to further Krugman’s wrong-headed goals.

Now that you understand what is driving their warped thinking, you will be better prepared to spot the fallacies in these arguments.

Reject GDP as the be-all and end-all of economic analysis.

76 Responses to “Economics Is About Improving People’s Lives, Not Creating Busywork — Why Paul Krugman’s Love of GDP Is Wrong, Part Three”

  1. These counting manoeuvres are obviously fostered by the government to provide the appearance the economy is doing better than reality. I’ve also been put off the past few years when I hear so-and-so activity costs the economy X amount of dollars. The reason I am put off is the distillation of that kind of thinking means we are all slaves to the all important economic growth numbers. Ah, economics, the true dismal science.

    stmilam (770d4d)

  2. Basically, these metrics treat a dollar spent closing an office to a dollar spent expanding operations.

    JD (5fd660)

  3. And to think that Frederic Bastiat pointed out these pieces of economic nonsense in the 1830s. But , I fear that, like hope, ignorance springs eternal in the minds of some.

    Michael M. Keohane (1368cd)

  4. They don’t care whether it makes your life better . . . or doesn’t.

    That point was run home to me the other day as I was reading the following, involving a country that is one of the world’s leading examples of Keynesian policymaking going off the deep end (ie, Japan has been trying to spend its way out of a 20-year recession and now has one of the highest debt to GDP rate in the world):

    nytimes.com, June 8: As farmers’ trucks, family cars, delivery vans and even tiny cafes-on-wheels, keis [mini-trucks] are everywhere in Japan. They are more popular than ever, thanks to the country’s high gasoline prices, a preferential tax system and an uneven economic recovery that have made the wee cars enticing value propositions.

    Keis have terrific fuel economies that rival the Prius, but they sell for half the price. Last year, a record 40 percent of all new cars sold in Japan were keis.

    But industry and government officials are increasingly worried that these microvehicles have become a distraction for the nation’s automakers — still bastions of the Japanese economy — and are moving to wean drivers off them. In April the government took what its critics charged was a hard-line route. Kei drivers were hit with a triple whammy of a higher sales tax, higher gasoline tax and higher kei car tax, the last of which the government raised by 50 percent, sharply narrowing their tax difference with regular-size vehicles.

    “We need to rebalance our priorities,” Yoshitaka Shindo, the minister for internal affairs, said ahead of the tax increase.

    Though made by some of Japan’s biggest automakers, including Nissan, Honda, Suzuki and the Toyota subsidiary Daihatsu, the kei — pronounced like the letter K — is not manufactured for export, largely because of its small size and lack of sufficient safety equipment. The engines are limited by law to just 0.66 liter, similar to an engine of a midsize motorcycle. Even Ford’s smallest car, the Fiesta subcompact, has a substantially larger engine.

    That means much of the research and development that go into kei models is wasted, officials warn. Producing kei cars just for domestic drivers also hurts automakers’ efforts to achieve economies of scale, which has become increasingly important in an era of cutthroat global competition.

    ^ Even more pathetic is that Japan hasn’t even been dominated by the left/socialists the way they’ve been prevailing over and roiling the waters in parts of Europe, Central and South America and blue-state America for decades. Their current prime minster replaced an out-and-out liberal not too long ago and yet — as happened with Spain’s former leftist leader being ousted by a right-leading politician in 2011 — he has recently foolishly ramped up sales taxes (btw, Spain’s sales tax rates are over 20%, while Japan’s went from 5% to 8%) and is making a bad situation even worse in the land of the rising sun.

    Buckle up, people, we’re entering increasingly turbulent waters.

    Mark (c36e03)

  5. Heh! Productive activity is what actually creates wealth?* But what about the velocity of money?**

    * I think so too
    ** Teasing monetarists

    nk (dbc370)

  6. The foolishness of using GDP can be seen from the following example. Suppose every family in the neighborhood cut its own grass, did its own laundry and cooked its own food. Now suppose that govt passes a law that says every family must cut the grass next door, do the laundry for next door and cook for next door. And charge a fee of $100 each per week for doing so. The total amount of work would be the same. The income and wealth for each family would be unchanged. But GDP would grow by $15,600 for each family in the neighborhood.

    stan (8ad03c)

  7. Make-work a/k/a workfare is useful as a social and governmental tool. As an alternative to food riots, vagrancy, and prisons. But that costs money, it does not make money.

    nk (dbc370)

  8. The post is ill-named.

    Economics is a social science that studies the production, distribution, and consumption of goods and services, studies the behavior of individuals, households, and organizations in an economy or economic system and the theory and management of economies or economic systems.

    daleyrocks (bf33e9)

  9. my feeling deep down in my wee lil pikachu heart is that the fascist whores led by vajajay jarrett have so hideously butt-raped the American economy that even using GDP as it’s currently formulated as your tool to measure results, there’s so much low-hanging fruit – so many easy cost-effective non-rapey actions to be taken, that you can be assured that growth as measured by the current GDP formulation will translate into nice gains across the board

    the key is to replace the fascist butt-raping whores, not so much to replace how we measure GDP

    happyfeet (8ce051)

  10. I never thought about this critique before (if I’ve seen it before it didn’t resonate at the time). Between this ‘bias to a process baseline’, i.e. process improvements lead to GDP declines, and government spending inclusion I’m convinced that we need something better. As a guest I won’t ask anything of the host but I’m hoping that he wraps up the series with a nomination of an existing metric that factors out these issues. The problem with the creation of a brand new metric (the ‘perfect’) is re-creating historical data: I doubt we’ve been asking the right questions to factor in the impact of process improvements. But I still have a bigger beef with the economists over measuring government spending as a percentage of the economy instead of a per capita, inflation adjusted basis. Basically the economists have allowed the progressives to hide a massive increase in government, thanks to Jobs and Gates, who created huge jumps in productivity.

    East Bay Jay (a5dac7)

  11. “And to think that Frederic Bastiat pointed out these pieces of economic nonsense in the 1830s.”

    Michael M. Keohane – Economic theory assumes rational behavior on the part of participants. That is why Bastiat’s broken window parable, let’s break a bunch of windows to generate economic activity is silly on its face, yet people keep bringing it up. Rational people try to avoid car accidents or serious illness for the most part. The analogy does not work.

    daleyrocks (bf33e9)

  12. Patterico – The main issue I take with you post are the assumptions that every consumer wants the same things and that every consumer has the same view of efficiency which is built into your description of the direct versus dealer car sales example. There is no way for you to know or assume that, just as there was no way for you to know that an exchange of good or services made through the government makes people worse off. It is indeterminate, although the overwhelming presumption is that overall people are worse off, but that is something we are unable to quantify through economics.

    Let me explain, economics predicts individual behavior along things called utility curves. I believe the Austrians call them preference or value curves. They are essentially price/quantity curves or in the aggregate a demand curve. They are ordinal curves, however, not cardinal curves, which is a mistake Rothbard consistently claims establishment economists make in their analysis, but he is wrong. In your example you assume out of thin air that every car purchaser must want to save money by buying direct from a manufacturer. You have no evidence for that assumption. You are making the unknowable assumption that you can divine the shape of every consumers’ value curve, that some do not want to walk into a dealer and see and feel the actual car and have its features explained to them and actually walk off the lot driving a new car.

    Since we see many industries operating with parallel distribution channels, direct(internet) and retail, I see no reason why your argument is persuasive.

    The same holds for the destruction of goods portion. GDP is a flow measure for a given year not a stock measure. If it were something like a stock measure like a balance sheet, I could see an argument being made for subtractions of assets, but that is not the purpose of the measurement.
    Paying for repairs to cars and medical treatments has positive utility who own the cars and are receiving the treatment. I don’t understand the logic of why you would want them excluded from GDP.

    Would you subtract food purchases once the food is consumed or clothing purchases once the clothing is worn out and replaced? The possibilities are endless!

    daleyrocks (bf33e9)

  13. Spam alert!:

    JPMorgan downgrades Q1 GDP another time, to -1.6%.

    Corporate loan activity off:

    http://www.zerohedge.com/sites/default/files/images/user5/imageroot/2014/06/bofa%20business%20lending%202.jpg

    PBOC(China) bond auction fails, US Ten-year worst in 9 mo. Spain on verge of default.

    gary gulrud (46ca75)

  14. “JPMorgan downgrades Q1 GDP another time, to -1.6%.”

    gary – Unexpectedly!

    daleyrocks (bf33e9)

  15. Daleyrocks : Classical economic theory does not assume rational economic behavior on the part of individuals – the theory works just as well if some or even all of the participants are irrational. Only where there is government interference is rational behavior necessary.

    Michael M. Keohane (1368cd)

  16. Your car dealer example is incomplete. Yes, GDP is affected if the price of a car is $20,000 instead of $25,000, but that presumes the $5,000 that isn’t spent on a car isn’t spent on something else.

    My bigger gripe is with the thinking that generates lines such as “… if the spending produces nothing of value”. By definition, money spent produces something of value (actually, to be precise, money is traded for something of value to the spender that WAS produced). ‘Value’ is in the eyes of the buyer. If I spend money on something, I’m doing so because I am getting something that in my mind is equal in value to the money I’m spending. You may not value it the same, and you probably don’t, which is why you’re not willing to spend the same amount of money on it, but it has value to me, just as you get value from what you spend your money on.

    I do agree that focusing on GDP is misguided. GDP is but one metric that, together with a bunch of other stats, can be used to measure whether we’re moving in the right direction.

    steve (369bc6)

  17. Economics is a social science that studies the production, distribution, and consumption of goods and services, studies the behavior of individuals, households, and organizations in an economy or economic system and the theory and management of economies or economic systems.

    Sammy, is that you?

    That would make for a rather long headline.

    I think if you want to be a little less hyper-literal then the concept I attempt to convey in the headline is relatively clear: the principal goal of human activity should be to improve the lives of existing and future humans — not to be busy with no point.

    Patterico (5a517e)

  18. “That would make for a rather long headline.”

    Patterico – I was not suggesting it as a headline, rather as an explanation, but whatever.

    daleyrocks (bf33e9)

  19. “GDP is but one metric that, together with a bunch of other stats, can be used to measure whether we’re moving in the right direction.”

    steve – To the extent that GDP is a measure of national income, as opposed to wealth, and is prepared to any degree similarly across countries, it serves as a basis of comparison.

    Knowing what it measures and what it doesn’t measure just arms the user with knowledge about its limitations but does not invalidate its use as a statistic. If the data critics claim limit its utility are actually collected or subject to collection, I’m all in favor of seeing more explanatory information, but not just having bureaucrats digging holes for the sake of digging holes.

    daleyrocks (bf33e9)

  20. In your example you assume out of thin air that every car purchaser must want to save money by buying direct from a manufacturer. You have no evidence for that assumption. You are making the unknowable assumption that you can divine the shape of every consumers’ value curve, that some do not want to walk into a dealer and see and feel the actual car and have its features explained to them and actually walk off the lot driving a new car.

    I suggest re-reading the post more carefully. When you do, you will see that I acknowledge that it may well be that the dealer provides a worthwhile service, and that the market will determine whether people want to pay for that service. Then I ask people to envision a scenario where the services provided by the dealer are insufficient to justify their price — meaning that they would go out of business if government did not interfere. My point is that, given those assumed facts, eliminating the dealers (as the market would do) promotes efficiency and consumer satisfaction, while interference with the market to maximize GDP may not.

    Asking readers to imagine a hypothetical, to illustrate a point, is different from arguing that the hypothetical is true.

    Your objection is analogous to a reader who is asked to imagine that he lived in New York, to illustrate the effects of a law in a big city, who objects: “But you have no evidence that I live in New York!” To which the answer is: yeah, I know that, but I’m making a point.

    You might say: why are you talking about a scenario where dealers do not serve a useful purpose if you can’t show that is true? Two reasons.

    First, counterfactual analogies can illustrate concepts. If I replied to Krugman’s Martian invasion hypo by saying: “But there is no planned Martian invasion!” then I would be justly accused of missing the point. Much as you seem to have missed the point of my post.

    Second, for some consumers, the dealer is unnecessary. Some people want to buy the Tesla straight from the manufacturer. For those people, eliminating the dealer satisfies their preference — but if maximizing GDP is the goal, we would pass laws disallowing the dealer from being cut out (as indeed New Jersey does).

    My argument is not that the GDP number needs to be massaged or replaced by a different number — that’s step two. I’m on step one: discrediting the motion that increasing GDP should be our ultimate goal.

    Patterico (515732)

  21. Paying for repairs to cars and medical treatments has positive utility who own the cars and are receiving the treatment. I don’t understand the logic of why you would want them excluded from GDP.

    Of course it has positive utility, if we do not deliberately cause the accident or make people sick — and I do not argue that we should not count it. The point is to recognize that dealing with unavoidable problems has social utility, but there is no social utility in creating problems in order to give work to the businesses dedicating to dealing with problems.

    That is where Krugman and Keynes go wrong. They focus on activity to the exclusion of the utility of the activity.

    I think venerating GDP for GDP’s sake is the reason they offer such nonsensical suggestions.

    Patterico (68d1df)

  22. Patterico – I have no problem understanding your hypothetical of a car manufacturer putting its dealers out of business, laying off dealer employees, and selling direct to customers as a way of being more “efficient.” I also have no problem looking for alternative measures for what you desire to measure than GDP, since it is not designed to perform the function you want it to.

    Read my comment again and try to understand my objection to assuming omnipotent knowledge of the preference curves of individuals who may prefer purchasing cars physically at a dealer in spite of your view of its inefficiency, because such preference curves are inherently unquantifiable.

    daleyrocks (bf33e9)

  23. “Of course it has positive utility, if we do not deliberately cause the accident or make people sick — and I do not argue that we should not count it.”

    Patterico – I thought Zorach was complaining about that stuff in the link you asked people to read.

    daleyrocks (bf33e9)

  24. “Daleyrocks : Classical economic theory does not assume rational economic behavior on the part of individuals – the theory works just as well if some or even all of the participants are irrational.”

    Michael M. Keohane – I don’t know whether you have a dividing line between classical and modern economic theory, but rational choice was the underlying assumption of the theory I was taught, although irrational choices abound and government involvement was irrelevant.

    daleyrocks (bf33e9)

  25. Daley–I think you need to define “rational” here. Austrians say human action is rational — not that it is necessarily correct.

    As for broken windows, the same crowd that thinks WWII ended the Great Depression (a myth I will address tomorrow) thinks that Cash for Clunkers was a great idea. To me, Cash for Clunkers is the broken window parable come to life, as we joyfully junked perfectly serviceable cars for the supposed good of the economy (and environment).

    Patterico (7d6a02)

  26. Patterico – I thought Zorach was complaining about that stuff in the link you asked people to read.

    Zorach’s point, and mine, is that it is a mistake to equate GDP with wealth and prosperity.

    Patterico (7d6a02)

  27. Cash for Clunkers was as obscene as it was senseless.

    And it wasn’t even cash for clunkers. It was cash for fat-ass illiterate useless united autoworkers.

    Blech.

    happyfeet (8ce051)

  28. “Daley–I think you need to define “rational” here. Austrians say human action is rational — not that it is necessarily correct.”

    Patterico – I think humans act rationally and modern economics is based on that assumption, that people make decisions which in their best interest based on the information they have available to them. The problem we have looking at decisions people make is we don’t necessarily know what information they used to make decisions or how they weighted it, whether it was false, etc.

    GDP is an income measure, not a wealth measure.

    daleyrocks (bf33e9)

  29. Oh, Cash for Clunkers was stupid. We hashed that out here.

    daleyrocks (bf33e9)

  30. I don’t think the Fed Gov acts rationally.

    JD (0b1656)

  31. “I don’t think the Fed Gov acts rationally.”

    JD – Under this administration I think it acts politically. I think Cash for Clunkers was a political decision based on the auto bailouts, not an economic decision.

    daleyrocks (bf33e9)

  32. 13. I neglected one leetle note of interest. Day before yesterday, Japan, second largest public debtor after Amerikkka, had exactly zero trades of its bonds, notes and bills.

    Everybody, the world over is good with its holdings of Japanese debt.

    Unexpectedly.

    gary gulrud (46ca75)

  33. But whether a car dealership adds value or not, GDP will be larger if the dealer is involved. That’s because $25,000 is a higher number than $20,000. So if your only desire is to maximize GDP, you’ll pass laws to keep dealers in business — even if market forces dictate that direct sales are preferable, and that the resources spent on dealerships are best reallocated to different parts of the economy.

    Once again, Patterico, I find your view slightly skewed, as if you’re seeing things through a distorting lens. You’re looking at the right things, and seeing them almost as they are, but not quite.

    If your object is merely to keep GDP from falling by the $5000 difference between the manufacturer’s price for direct delivery and the dealer’s price, you don’t need to keep the dealers in business. You can eliminate the dealers (freeing them up to do more useful things) and keep the GDP where it was, by allowing the manufacturer to sell directly to the public, but imposing a minimum price on all cars. In fact, you could boost GDP by imposing a minimum price of $50K on all cars. Simply make it illegal to sell a car for less than that. The manufacturers would be happy, because they’d be raking in all that extra profit. In fact, why not make it $100K, or $1M?

    See where I’m going with this? It now becomes obvious why this is incorrect. Yes, charging $1M a car would tremendously boost GDP, if car sales remained constant. But of course it wouldn’t. Basic economics says if you raise the price of something you lower demand, and vice versa. Now back to your original example. Dropping the price of cars by $5K would lower GDP on each sale, but it would increase sales, and thus raise GDP.

    Therefore the purpose of the dealer-protection laws we discussed a while ago is not to raise GDP, and they would have been enacted just as readily if we didn’t care about GDP. Their purpose is simply to protect the dealers’ cushy monopoly, and save them from having to look for something more useful to do. This purpose is exactly the same as that of any protectionist laws, such as the teacher tenure law that just got struck down in CA. It’s about using the law to extract a little bit of money from each of a large set of people, little enough that it’s not worth anybody’s while to fight against it, and give it all to a small set of people, each of whom gets enough to make it worth their while to fight for it. Think of a law that requires every single American to give you a dime. You could invest several million in getting it passed, and still profit; anyone who tries to prevent its passage must do so at a loss.

    Between health insurance, car insurance, out of pocket expenses, a lot of money changes hands. . . . [T]he medical care, any car repair work, and new cars purchased, and any legal fees, is all included in GDP. Furthermore, the incremental rate by which everyone’s insurance premiums go up to pay for this accident results in more payments to insurance companies, which is also included in GDP. The net effect of the accident is to produce a substantial increase in GDP. Most alarmingly, the more destructive the accident, the greater the increase in GDP.

    The flaw here, once again, is not that all these activities don’t really boost the economy. They do, so it’s correct that GDP includes them. The problem is that the accident itself destroys valuable assets, thus making us poorer. That capital loss ought properly to be reflected in the GDP. That it isn’t is a flaw in calculation. But that’s where the loss is, not in what we do to recover from it. The same applies to the feared Martian (or Japanese) invasion: the prospect of invasion itself is a giant loss; what we do to prevent or mitigate it is valuable economic activity, and properly belongs in GDP. Now we can see why simply making up an invasion that we know isn’t really coming wouldn’t be the same. If there’s no danger of invasion then the work done to prevent one is useless, and ought not to be counted.

    I don’t think I’ve been as clear as I should in this last paragraph. Please let
    me know if you get my point.

    Milhouse (b95258)

  34. The same holds for the destruction of goods portion. GDP is a flow measure for a given year not a stock measure. If it were something like a stock measure like a balance sheet, I could see an argument being made for subtractions of assets, but that is not the purpose of the measurement.
    Paying for repairs to cars and medical treatments has positive utility who own the cars and are receiving the treatment. I don’t understand the logic of why you would want them excluded from GDP.

    This is more or less what I was getting at. Let’s suppose you have a year in which your salary doubles, but your uninsured house burns down. At the end of the year you are undoubtedly worse off than you were at the beginning, and yet the income increase is real. What happens to GDP in the case of an accident or an invasion (or merely a scare) is like that.

    Milhouse (b95258)

  35. That is where Krugman and Keynes go wrong. They focus on activity to the exclusion of the utility of the activity.

    I think venerating GDP for GDP’s sake is the reason they offer such nonsensical suggestions.

    I think it more likely that the opposite is true. If they elevate GDP above its proper place, it’s because that lets them justify stupid proposals that they want to make for other reasons.

    Milhouse (b95258)

  36. To me, Cash for Clunkers is the broken window parable come to life,

    That is exactly correct.

    Milhouse (b95258)

  37. Zorach’s point, and mine, is that it is a mistake to equate GDP with wealth and prosperity.

    GDP is the increase in wealth and prosperity, from a baseline. Accidents, illness, invasions, crime, etc., move that baseline backwards, thus wiping out some or all of the increase represented by the GDP.

    Milhouse (b95258)

  38. I don’t think the Fed Gov acts rationally.

    JD – Under this administration I think it acts politically.

    As opposed to which administration?

    Milhouse (b95258)

  39. I have no problem understanding your hypothetical of a car manufacturer putting its dealers out of business, laying off dealer employees, and selling direct to customers as a way of being more “efficient.” I also have no problem looking for alternative measures for what you desire to measure than GDP, since it is not designed to perform the function you want it to.

    Read my comment again and try to understand my objection to assuming omnipotent knowledge of the preference curves of individuals who may prefer purchasing cars physically at a dealer in spite of your view of its inefficiency, because such preference curves are inherently unquantifiable.

    I still think you’re missing my point. I know you’re a sharp guy, so I will assume a failure to communicate on my part. Let me try again.

    Once again, this all has absolutely nothing to do with my view of the inefficiency of dealers. I will say a third time that dealers perform a valuable service for some. Because you seem to assume that I am making a value judgment about dealers, or alternatively that I am positing some insane hypothetical where I couldn’t possibly know what a consumer prefers or why, let me tweak my hypothetical in such a manner that it hopefully addresses both objections.

    Let’s posit a car company that sells the same car in two different ways. It can sell it to you direct for $20,000, or through a dealer for $25,000. (For the moment we will put aside Milhouse’s objection that decreased price increases demand, which is true, but is a separate issue that I will address in a separate comment.) Let’s assume that some consumers choose the dealer-sold car. In fact, we’ll interview one now. Hello, Mr. Consumer Who Prefers to Buy From a Dealer! Why did you pay an extra $5,000? Well, Patterico, there are too many reasons to list, but I trust this dealer, he gave me the chance to test-drive several models, and he will provide a reliable place to take my car when it has trouble. I didn’t have to drive across the state to pick up my car, and I know that if it’s a lemon he’ll do right by me.

    Thank you, sir! Well, I certainly won’t quarrel with your decision. For you, that extra $5,000 was worth it. Now let’s talk to Mr. Consumer Who Prefers to Buy Direct. Why did you buy from the manufacturer, sir? I wanted to save money. Thanks for your time, sir!

    So, I think we can all agree that it’s a good thing that the dealer exists, because the first man gains satisfaction from the services that the dealer provides. But I think we can all agree that it’s a good thing that the second man had the option to buy direct from the manufacturer, because he gained satisfaction from saving money.

    Hopefully, this example shows that a) my opinion whether the dealer’s services are a good idea or not is totally irrelevant to the hypothetical, because it’s the consumer’s choice that matters, and b) it’s not impossible to know which option the consumer prefers, because he was given a choice and exercised that choice.

    In this example, I think it’s clear that the ability of each consumer to use the dealer or not is a Good Thing, because the choice gives the consumer the ability to best satisfy his particular preferences. But (again placing aside Milhouse’s supply/demand issue for the moment) a politician or Krugmanesque Keynesian who worshiped GDP above all else would likely want the dealer involved in the transaction — because all that busywork “adds value” and boosts GDP.

    Well, no, it doesn’t add value for the consumer who doesn’t want the dealer involved in the transaction. Just the one who does.

    Does that help?

    Patterico (9c670f)

  40. Milhouse: I will address your points serially, but let me state at the outset that 1) I agree with the vast majority of what you say, 2) I think you add a lot to people’s understanding of these issues, and 3) I just think you misunderstand me in most of the places where you think you and I disagree. (Not all.) Again, as with daleyrocks, this could be lack of clarity on my part. I’ll do my best to be clear in the comments that follow.

    But I greatly appreciate your participation in the comments to these posts.

    Patterico (9c670f)

  41. Once again, Patterico, I find your view slightly skewed, as if you’re seeing things through a distorting lens. You’re looking at the right things, and seeing them almost as they are, but not quite.

    If your object is merely to keep GDP from falling by the $5000 difference between the manufacturer’s price for direct delivery and the dealer’s price, you don’t need to keep the dealers in business. You can eliminate the dealers (freeing them up to do more useful things) and keep the GDP where it was, by allowing the manufacturer to sell directly to the public, but imposing a minimum price on all cars. In fact, you could boost GDP by imposing a minimum price of $50K on all cars. Simply make it illegal to sell a car for less than that. The manufacturers would be happy, because they’d be raking in all that extra profit. In fact, why not make it $100K, or $1M?

    See where I’m going with this?

    I do, and it’s a good thing to remind people that changes in price affect demand.

    It now becomes obvious why this is incorrect. Yes, charging $1M a car would tremendously boost GDP, if car sales remained constant. But of course it wouldn’t. Basic economics says if you raise the price of something you lower demand, and vice versa. Now back to your original example. Dropping the price of cars by $5K would lower GDP on each sale, but it would increase sales, and thus raise GDP.

    I’m with you right up until those last four words. I would say “and thus might raise GDP.” Or, might lower it. Or, might leave it unaffected.

    As you know, sellers sell (and buyers buy) at the market clearing price. If you drop the price of cars, it should increase demand. Whether it increases demand sufficiently to raise the manufacturer’s total revenue depends upon the intersection of the supply and demand curves. You might drop the price by $5k, sell a few more cars, but not enough to make up the loss. You might (as you posit) drop the price by $5k, sell a bunch more cars, and see total revenue increase. Or, you might drop the price by $5k, and sell just enough extra cars to make up what you lost by lowering the price. Which of these three scenarios will occur depends upon a bunch of factors.

    Therefore the purpose of the dealer-protection laws we discussed a while ago is not to raise GDP, and they would have been enacted just as readily if we didn’t care about GDP. Their purpose is simply to protect the dealers’ cushy monopoly, and save them from having to look for something more useful to do.

    You may well be right, and I am not arguing otherwise. My point is not: a fealty to GDP is what leads to these protectionist laws. My point is: if your only allegiance is to GDP, you might conclude that keeping the dealer in business is a Good Thing even if some consumers don’t want the dealer — because the dealer going out of business means a loss of jobs and lower GDP.

    You make the point that such a simplistic analysis ignores the fact that decreasing the price could theoretically boost GDP. (As I just said, it also might not.) Well, sure. The simplistic analyses by politicians often ignore a lot of relevant factors. As someone noted upthread, these analyses ignore the fact that the extra $5000 might be spent on other goods. (True, and they might not be.) Also, a loss of jobs is a ultimately a good thing for consumers as a whole in the unhampered market economy, because it means that a business that is not efficiently utilizing its resources to satisfy consumer needs is surrendering its resources to other lines of production that will satisfy consumers. A politician obsessed with keeping today’s job numbers up will not accept this argument, and will ignore the benefits of job loss for the consumers at large, just as a politician obsessed with boosting GDP at all costs may pass laws to protect people who serve no purpose, and in so doing will ignore the benefits that would accrue from leaving the market alone.

    The flaw here, once again, is not that all these activities don’t really boost the economy. They do, so it’s correct that GDP includes them. The problem is that the accident itself destroys valuable assets, thus making us poorer. That capital loss ought properly to be reflected in the GDP. That it isn’t is a flaw in calculation. But that’s where the loss is, not in what we do to recover from it. The same applies to the feared Martian (or Japanese) invasion: the prospect of invasion itself is a giant loss; what we do to prevent or mitigate it is valuable economic activity, and properly belongs in GDP. Now we can see why simply making up an invasion that we know isn’t really coming wouldn’t be the same. If there’s no danger of invasion then the work done to prevent one is useless, and ought not to be counted.

    I don’t think I’ve been as clear as I should in this last paragraph. Please let me know if you get my point.

    I think I do, and I don’t see where we are disagreeing. My point is that a fealty to GDP above all else leads economists (even Nobel Prize winners!) to make imbecilic statements about how making up an invasion that we know isn’t really coming would be a good thing, when it is easy to see it would be a waste. I don’t see a “flaw” in my analysis and I think that here we are entirely in agreement.

    Patterico (9c670f)

  42. How convenient for the government to forget what the concept of waste means. But I’ll tell you this for certain – those in power still know how to improve their personal lifestyles. There will be no wastage there.

    Amphipolis (e01538)

  43. This is more or less what I was getting at. Let’s suppose you have a year in which your salary doubles, but your uninsured house burns down. At the end of the year you are undoubtedly worse off than you were at the beginning, and yet the income increase is real. What happens to GDP in the case of an accident or an invasion (or merely a scare) is like that.

    Yes, but what’s worse is that Krugman thinks the homeowner would be better off. Read this again:

    If we discovered that, you know, space aliens were planning to attack and we needed a massive buildup to counter the space alien threat and really inflation and budget deficits took secondary place to that, this slump would be over in 18 months. And then if we discovered, oops, we made a mistake, there aren’t any aliens, we’d be better [off].

    This is the World-War-II-ended-the-Great-Depression argument again, and I plan to take that one on directly tomorrow, but in brief, Krugman actually thinks WWII was a good thing economically, because it got everyone working. Never mind the fact that people were, in almost every conceivable way, worse off during the war than they were before it started. Virtually nothing we manufactured during the war increased anyone’s standard of living; millions were conscripted, which does not generally make life more pleasant; and those who remained home suffered numerous material deprivations for the war effort.

    But GDP went up! And for Krugman, that is enough.

    If one treats the war as inevitable, then our response made us better off than if we did not fight it — just as our health insurance paying us for our broken leg makes us better off than if we had the broken leg and no health insurance. But it seems to me, based on the quote above, that Krugman would break our legs to put a few doctors and other health industry workers to work. I think, based upon the above, that he would manufacture a pretend Martian invasion if he could. I think that, putting aside the loss of lives, he thinks a world war is a fine economic prescription for ending a depression.

    If Bastiat posited the broken windows fallacy, and Cash for Clunkers was the broken window parable come to life, then the “WWII ended the Great Depression” or “hey, how about a fake Martian invasion?!” are examples of the broken window parable writ large.

    The fact that these people fall for this nonsense really matters.

    Patterico (9c670f)

  44. GDP is the increase in wealth and prosperity, from a baseline. Accidents, illness, invasions, crime, etc., move that baseline backwards, thus wiping out some or all of the increase represented by the GDP.

    Now we have reached our one point of serious disagreement. GDP does not represent an increase in wealth and prosperity at all! GDP exploded during WWII while our wealth and prosperity plummeted. And in 1946, we had a huge economic boom, as evidenced by the explosion in private production — yet GDP figures were so low that reliance on GDP alone would lead one to conclude that we were in a depression.

    These paradoxes flow directly from the infirmities inherent in an overreliance on the GDP statistic — infirmities that I have been discussing all week, such as the inclusion of government spending, the overemphasis on consumer spending, and the way that busywork is favored over efficiency and real prosperity.

    Patterico (9c670f)

  45. GDP is a sum total

    percent GDP change can be calculated from the prior year’s quarter (annualized) or from the previous quarter

    yes?

    please to explain if I am misapprehending this vital statistic

    happyfeet (8ce051)

  46. yeah i think that’s a little off

    here is a good explainer, at least of the part where i get confuzzled

    Output can be measured in three (theoretically equivalent) ways: by adding up all the money spent each year, by adding up all the money earned each year, or by adding up all the value added each year. Some economies, including Britain, combine all three methods into a single GDP figure, whereas others, like America, produce different statistics for each.

    happyfeet (8ce051)

  47. i remember i used to be able to explain the difference between gnp and gdp

    makes me wonder what else I’ve totally and utterly forgotten

    happyfeet (8ce051)

  48. Gross national product includes iPhones because Apple is an American company (they say). GDP is not supposed to since it’s China’s product, not America’s.

    nk (dbc370)

  49. It would make no sense, for Great Britain’s last three centuries, not to count GNP as its primary measure of national wealth because that cold little island would have starved to death in the dark on its domestic product.

    nk (dbc370)

  50. thank you yes that’s the gist of it

    happyfeet (8ce051)

  51. that reminds me of something i looked up this week brb

    happyfeet (8ce051)

  52. Red Bull is headquartered in Fuschl am See, an Austrian village of 1500 inhabitants near Salzburg. The building sports no logo and is heavily guarded. The company does not grant any interviews.

    I’m kinda fascinated now.

    happyfeet (8ce051)

  53. it’s so willy wonka

    happyfeet (8ce051)

  54. here’s a pic

    happyfeet (8ce051)

  55. Real protection of a trade secret or just a phony air of mystique for Red Bull’s semi-poisonous polluted water? I wonder. I should write down the ingredients for the coffees milkshakes the daughter gets Starbuck’s to concoct for her. One or more of them might be a hit. I’m not kidding when I say double skim latte chocolate chip caramel mocciato with whipped cream and cinnamon, I’m probably forgetting another ingredient or two.

    Did you hear that Coca-Cola is the model for the Chinese government’s new domestic propaganda campaign? If you can sell sugar water, you can sell anything with the right advertising, is their reasoning.

    nk (dbc370)

  56. not sure at all Mr. nk but i like their style

    happyfeet (8ce051)

  57. Everything goes better with Mao
    I’d like to buy the world a Little Red Book and a toy company
    Communism, it’s the real thing

    nk (dbc370)

  58. that’s the song i sing

    what the world wants today

    happyfeet (8ce051)

  59. Patterico – I think you are correct that as with your money creation and gold standard posts we are having issues communicating. I disagree with some of the assumptions you are making about “efficiency,” “busy work,” the inclusion of government in GDP and am waiting for the metric you propose using for “real prosperity.” In the interim, I will probably avoid stepping any further on the post.

    daleyrocks (bf33e9)

  60. as long as it trends I’m not gonna complain about the data

    you pick your battles in this fallenest of whirls

    happyfeet (8ce051)

  61. GDP is the increase in wealth and prosperity, from a baseline. Accidents, illness, invasions, crime, etc., move that baseline backwards, thus wiping out some or all of the increase represented by the GDP.

    Now we have reached our one point of serious disagreement. GDP does not represent an increase in wealth and prosperity at all! GDP exploded during WWII while our wealth and prosperity plummeted. And in 1946, we had a huge economic boom, as evidenced by the explosion in private production — yet GDP figures were so low that reliance on GDP alone would lead one to conclude that we were in a depression.

    I would say that all that activity did increase our wealth and prosperity, but Pearl Harbor and the German declaration of war, and the fear this put us in for our long-term safety, dramatically moved the baseline backwards. They’re like the house burning down in the same year that your salary doubles. Victory in 1945 put the baseline back where it was, so that despite poor GDP we ended the year better off, like a year in which your income plummets but you inherit a fortune. How does that sound to you?

    Milhouse (b95258)

  62. Did you hear that Coca-Cola is the model for the Chinese government’s new domestic propaganda campaign? If you can sell sugar water, you can sell anything with the right advertising, is their reasoning.

    But will it bring their dead ancestors to life?

    Milhouse (b95258)

  63. In 1946, we had more factories than we knew what to do with itching to make other things now that they weren’t producing war meteriel; a large workforce thanks to keeping our war dead to less than one-half of one percent of the total death toll; a hungry public that had scrimped and stinted for four years; and ample raw materials.

    nk (dbc370)

  64. It’s a waste of wealth to make things you’ll blow up next week; it’s real wealth to make things that improve people’s lives.

    nk (dbc370)

  65. Patterico, I was too busy to comment when you were repeating the Rothbardian attack on fractional reserve banking, and by now that post is so far back I don’t know where to find it, and even if I did nobody is still checking it for new comments, so I’ll write this here:

    On this point, at least, Rothbard was full of *#!%. Bank accounts are not like safe deposit boxes, where you store your money and expect them to keep it safe for you and not touch it. If they were that, then you would expect to always pay for the service. You would not expect them to do it for free, let alone to pay you for the privilege. And if you think there’s a demand for that sort of account, you can try providing it and see how many customers you get. Anyone who deposits money with a bank knows that the bank is not keeping your money in a vault, and when you withdraw
    money you don’t expect to get the same bills back that you put in. Everyone knows that you are not giving them your money to look after, you are lending it to them to do business with. That’s why they pay you interest, instead of charging you a storage fee.

    (Yes, they do charge for accounts with low balances, because in these low-interest days the profit they make from lending your money to other people isn’t enough to cover the cost of maintaining the account; when interest rates were higher they didn’t need to charge these fees, and they still don’t if you maintain a high enough balance. That just proves my point; a warehouse service would charge more for a higher balance, not less! A warehouse service might even run
    very small accounts for free, as a goodwill gesture, while charging big bux for the high accounts.)

    So when they lend out the money they borrowed from you there is no fraud. And Rothbard was dishonest to claim that it is. They keep enough in reserve so that they can repay people’s loans at a moment’s notice, provided that not everyone wants their loans repaid at the same time. And they have arrangements with their colleagues so that even if an unusual number of people do want their loans repaid at the same time, they can cope. They are far from the only businesses that would fail if all of their debt were recalled on the same day. We don’t call such businesses fraudulent, and nor should we say that of banks.

    Milhouse (b95258)

  66. The esteemed Dr Krugman seems to remember only part of history. It’s true enough that World War II was a huge economic benefit to the United States, but he forgets why! The manufactured goods we had to produce were quickly expended, and had to be replaced, creating a cycle of manufacturing; if we were preparing for an invasion of space aliens which never came, the replacement cycle wouldn’t occur, because the first round of goods wouldn’t be used up.

    Second, World War II was an economic advantage to us because our industrial competitors were busy blowing up each other’s industrial plant. Our industry remained untouched, and we ended the war with 45% of the world’s industrial capacity. To duplicate that, we’d need the Klingon’s to actually attack, and to use their disruptors and quantum torpedoes on everyone else, but not on us.

    Finally, it almost seems as though our Nobel laureate economist doesn’t realize what causes recessions. Recessions occur when productive capacity exceeds demand, and some producers go out of business. Businessmen are just as imperfect as anyone else, and some of them take bad decisions based on erroneous estimates of what will happen in the future. And individual workers too frequently take poor individual economic decisions based on their own erroneous estimates of what the future will bring. Well, if we have a huge project to build stuff to defend our planet from the Klingons, yeah, a bunch of people will be employed in the process of building things, but many of them will start taking bad decisions based on guesses of how long their current jobs manufacturing phaser rifles will last . . . which is exactly what happened in 2008!

    People were taking bad decisions, because they thought that the values of their homes would continue to appreciate, and that they would keep their jobs, with steady raises, enabling them to pay off those bloated mortgages. Banks and other lenders kept making those stupid loans because they had always been working, and because they never understood that they’d get stuck as badly as they did when so many mortgages collapsed in such a short time. Five years later, and the banks still have a huge backlog of non-performing mortgages on which they haven’t foreclosed, because they don’t think that they can sell the houses. (The average time between defaulting on payments and foreclosure used to be seven months; now it’s over 2½ years.)

    The economic historian Dana (3e4784)

  67. The manufactured goods we had to produce were quickly expended, and had to be replaced, creating a cycle of manufacturing;

    Kind of like Walmart appliances?

    nk (dbc370)

  68. It can be said that WWII did pave the way for economic good times, but not because of all the make-work activity being forced upon Americans by the destructiveness of battle, but because of the industrial output of Europe and Asia, particularly Japan, being turned to rubble. In effect, when it came to having to furnish the world’s supply in the equation of supply and demand, WWII put us in the driver’s seat. So if Walmart had existed back then, just about all their merchandise would have originated from — would have had to originate from — the USA. And if Toyota or Kia had existed back then….

    Mark (10ada1)

  69. Toyota did exist back then.

    http://www.toyoland.com/history.html

    In December 1945, Toyota was given permission by the United States military to startup up peacetime production. Toyota Motor Corporation had learned from the American War Department’s industrial training program, which worked on process improvement and employee development; the program, abandoned in 1945 by the United States, lived on in Japan as Taiichi Ohno built kaizen and lean manufacturing around it. (From globalspec).

    Sammy Finkelman (2d4607)

  70. I would say that all that activity did increase our wealth and prosperity, but Pearl Harbor and the German declaration of war, and the fear this put us in for our long-term safety, dramatically moved the baseline backwards. They’re like the house burning down in the same year that your salary doubles. Victory in 1945 put the baseline back where it was, so that despite poor GDP we ended the year better off, like a year in which your income plummets but you inherit a fortune. How does that sound to you?

    I have a new thread on WWII not ending the Great Depression. I say we take that particular discussion there to that thread.
    Read that post and see what you think.

    Patterico (9c670f)

  71. So when they lend out the money they borrowed from you there is no fraud. And Rothbard was dishonest to claim that it is. They keep enough in reserve so that they can repay people’s loans at a moment’s notice, provided that not everyone wants their loans repaid at the same time. And they have arrangements with their colleagues so that even if an unusual number of people do want their loans repaid at the same time, they can cope. They are far from the only businesses that would fail if all of their debt were recalled on the same day. We don’t call such businesses fraudulent, and nor should we say that of banks.

    Name another business that contractually entitles an overwhelming share of its debtors to insist on repayment on demand.

    Patterico (9c670f)

  72. 6. nk (dbc370) — 6/11/2014 @ 9:25 am

    Make-work a/k/a workfare is useful as a social and governmental tool. As an alternative to food riots, vagrancy, and prisons. But that costs money, it does not make money.

    They could also do useful, even maybe necessary work.

    But the public employee unions would oppose that.

    http://www.cvhaction.org/sites/default/files/Signed%20Statement%20against%20Workfare-allsigs_May9_.pdf

    Statement against Workfare and in Favor of Paid Civil Service Jobs

    We strongly oppose unpaid workfare programs
    In New York City and across the country.

    Sammy Finkelman (2d4607)

  73. 16. Patterico: Sammy, is that you?

    No, I would try for something that used fewer big words. I don’t think I would say anything even close to it. And I DON’T LIKE THE WORD SCIENCE for things like this.

    Sammy Finkelman (2d4607)

  74. Patterico (9c670f) — 6/12/2014 @ 8:04 am

    Name another business that contractually entitles an overwhelming share of its debtors to insist on repayment on demand.

    The book or magazine and newspaper business. (only for dealers)

    By the way, this repayment on demand, or expectation of repayment on demand, is exactly what causes financial crisis. It can only happen with things where people expect to get paid back on demand, even when that is not legally required..

    In 1929, that included the value of stocks bought and sold on the stock market. Cash reserves were put into stocks. Stocks bought on margin.

    Sammy Finkelman (2d4607)

  75. 56. Oh, now what they’re doing is they’re just trying to justify dictatorship in principle.

    Sammy Finkelman (2d4607)

  76. Name another business that contractually entitles an overwhelming share of its debtors to insist on repayment on demand.

    1. You mean creditors.

    2. Any business that runs a line of credit with a bank. The bank can reduce the credit limit any time it likes, and call in whatever is over the new limit. Or anyone who has a margin account with a broker; cf “margin call”.

    3. I doubt that the overwhelming share of any bank’s debt is made up of on-call deposits.

    4. Even if banks were the only businesss with such a profile, it would be irrelevant. So what if there isn’t anyone else who allows creditors instant access to their money? The fact would remain that they are creditors, not bailors. If banks choose to take the risk of borrowing on such terms, in return for lower interest rates, why is that anyone else’s business? And how can Rothbard call it fraud?

    Milhouse (b95258)


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