It’s the perfect way to round out a week of posts documenting the flaws in GDP as a measure of the health of the economy.

The news report below opens: “Workers at a Missouri company are telling their story, after the government paid them to do nothing.”

You’ve probably heard about this before. The story broke a month ago. The company was supposed to process a giant influx of ObamaCare applications — but the expected flood never came. So the office was filled with employees who got paid to sleep and played games. The story today is that nothing has changed. In fact, they’re still hiring! And they pay overtime!

These people are contributing absolutely nothing to the economy. All they do is drain taxpayer money.

But their services are included in GDP.

If this company were being paid directly by consumers, they would go out of business, because consumers don’t pay money for nothing. But the government does.

This is the kind of stuff Paul Krugman wants more of. Won’t someone please give him another Nobel Prize?

This is Part Four of my continuing series on GDP, or, Why Paul Krugman Is Wrong About Almost Everything.

The lessons learned from the Great Depression continue to influence the way we manage the economy today. Understanding why it ended, therefore, is of paramount importance even today — because it affects how we manage crises such as the bursting of the housing bubble. Historians used to argue that FDR ended the Great Depression with the New Deal; they are now starting to concede that this argument is not only wrong but ridiculous: the New Deal both intensified and prolonged the economic slump during the 1930s.

But it’s only within the last year that I learned that the historians’ fallback argument is also totally wrong. They claim World War II ended the Great Depression. It did not.

I will now turn over the microphone to Tom Woods, who does a tremendous job of explaining why this claim is patently absurd — and does so in about 7 minutes.

If you don’t have time to watch the video, let me summarize Woods’s main points, and add a few thoughts of my own.

It’s true that unemployment plummeted during World War II. If you wanted a job, you could have a job. But does that represent a normal healthy business expansion? Not hardly. Ten million people were drafted, and many others volunteered, for patriotic reasons (and to stay out of the infantry, which is a pretty rotten assignment if you like staying alive). A mere reduction in unemployment numbers does not tell the whole story, if you don’t explain how you got there. After all, as Woods notes, you could simply execute ten million jobless people, and that would reduce unemployment too. So, sure: when the government drafts people by force, and threatens them with prison if they do not comply, unemployment goes down. But as Robert Higgs dryly notes: “that’s not how we normally reduce unemployment in this country.”

The claim that the wartime itself was a prosperous time — with government rationing, price controls, and other forms of austerity, is laughable. (What’s more, the price controls distort the data regarding true purchasing power.) There were no new cars, and virtually no consumer appliances that required metal, which was gobbled up by the government to manufacture war equipment. Food, clothing, gasoline, and other basic items were sharply rationed, and living space was cramped and overcrowded. The war was a time of deprivation, which the populace viewed as a necessary sacrifice, to be sure — but sacrifice does not equate to prosperity.

Nor does it make sense that sending the most skilled sector of the labor force off to fight, leaving a workforce with much less work experience and skill (women and elderly men) would logically lead to giant growth rates of 13% a year. Something must be wrong with this measure.

And the problem is . . . using GDP as our measure. Woods also notes that World War II was a time of supposed prosperity because GDP shot up during the war. But if you fall for the idea that GDP is the only meaningful measure of prosperity, then you will be forced to conclude that 1946 was a depression year. Seriously. 1946.

This page provides GDP growth numbers per year since 1930, and lists the best and worst years. The best years for GDP were, admittedly, during the war. And the second worst year for GDP in the last 84 years was 1946, a year in which GDP shrunk by almost 11%. 1946 is second only to 1932 in having a dismal GDP — and 1932 was the absolute depth of the Great Depression.

And yet —

And yet, do you remember the Great Depression of 1946? The stories of people starving in the streets? The reason you don’t isn’t because you’re young. It’s because 1946 was a boom time for the United States. As Tom DiLorenzo explains:

Far from creating a depression, prying all of that money from the hands of politicians and bureaucrats and returning it to its owners – working Americans – created the largest increase in private sector economic growth in all of American history in 1946. According to statistics found in the 1995 Annual Report of the U.S. Council of Economic Advisors, based on Commerce Department data, real inflation-adjusted private sector GDP increased by 29.5 percent in that year. In no other year has the U.S. economy ever grown even half that fast. Private investment skyrocketed and stock prices soared, in complete and total contradiction of what every Keynesian economist in the world had been predicting.

So, 1946 was the best year ever for the U.S economy — and yet the GDP numbers would suggest that 1946 was a year of depression.

So what’s going on here? If you have been following my series on GDP all week, you already know the answer.

In Part One of the series, I noted that GDP takes into account government spending. GDP represents the prices of finished goods. But the only meaningful prices in our society are prices that are determined through voluntary exchanges in the free market. By contrast, government spending is often inflated and bears no relationship to satisfying consumer preferences. This was especially true during the war, when much of the economy consisted of government purchases from firms manufacturing war materiel.

In Part Two, I noted how GDP does not fully take account of capital spending. During the war, government spending went up for production of war-related goods, but private investment cratered for consumer goods. But the freefall in capital investment gets masked by GDP’s failure to fully account for capital spending.

In Part Three, I noted how GDP is boosted by activity even if it does not contribute to consumer well-being. Almost no economic activity during the war benefited consumers. Woods notes that fully 40% of the labor force was employed in some form or fashion in the armed forces, and were thus not producing consumer goods. Consumers don’t buy tanks, so while those goods might have been necessary for the war effort, they were a waste from the consumer’s point of view. So, if the government was spending a ton of money on tanks, and nothing on consumer goods, this hurt consumers — but it was great for GDP.

The Paul Krugmans of the world argue, not just that the war provided the economy with a shot in the arm, but that the war itself was a time of great prosperity. Hopefully this post has caused you to rethink that silly assertion. Makers of tanks do well in wartime. As Robert Higgs has noted, the undertaker does well. But most people are miserable in war. Perhaps nobody has put it better than Austrian economist Ludwig von Mises, who said: “War prosperity is like the prosperity that an earthquake or a plague brings.”

So what did get us out of the Great Depression? I don’t mean to sound flip, but I think that the end of the Great Depression had a lot to do with the fact that Franklin Delano Roosevelt had finally died. He had mounted a war on business for 13 years, and thrown businessmen into a state of complete uncertainty about their future. In a future post, reviewing a book about the Great Depression, I will detail some of FDR’s atrocities, but suffice it to say that businessmen never knew what was coming next. The end of American’s war against Japan and Germany mattered — but to businessmen, it mattered almost as much that FDR had ended his war on them.

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.

As I mentioned yesterday, I am spending time this week attacking GDP as the ultimate benchmark for measuring the strength of the economy. Yesterday, in Part One of the series, I noted that GDP includes government spending even though government spending does not necessarily benefit consumers.

Today, I want to address another problem with GDP: it overemphasizes consumer spending to the detriment of capital investment.

I am going to give you the same video I showed you yesterday, featuring Austrian economist Jeff Herbener, interviewed by Tom Woods. If you are short on time, skip to 4:55, where Prof. Herbener notes that GDP indicates only the value of the final goods and services produced.

GDP is generally defined as the market value of the final products of an economy, including goods and services. But GDP does not measure all economic production. There is an entire production process that goes into the production of any good, whether it be a consumer good or a capital good. This does not get included in the calculation.

For example, when a car is sold, the price of the car is included in GDP. Economists do not include, for example, the cost of the steps in the production process that provide the building blocks for the car — such as the mining of iron ore, the production of steel, or the machinery and computer modeling that serve to transform that steel into the skeleton of an automobile.

The reason is that the final price of the car is thought to represent the cost of all stages of production of the automobile, ideally together with a profit for the company. If one counted the value of the production process and the cost of the car, it is said, that would represent “double counting” of the costs of the production process.

That’s fine if your only goal is to learn the final value of the good. But leaving the production process out of the equation, and including only purchases of final goods and services, distorts the significance of the total. That’s because eliminating the work that goes into making the product gives an outsized significance to the act of purchasing that final product. As Professor Herbener has elsewhere explained:

If all one is interested in determining the the dollar value of all that has been produced in the economy, then, counting the steel, and other parts of the car along with the car would be double counting. But the dollar value of what has been produced in an economy is, perhaps, the least interesting thing we could know about it.

If we really want to understand an economy, we have to know how all the different resources people have get allocated into all the different production processes. The monetary value of all production tells us nothing about this.

. . . .

When we trace back the production of consumer goods to their sources, then, we see that the amount of demand entrepreneurs have for all the producer goods necessary to make some consumer good far outweigh the demand consumers have for it. In other words, the far greater portion of production in an economy is of producer goods, which is explained by entrepreneurial demands, which results in investment spending. Consumer demands and consumption spending are a far smaller portion of all demands and total spending and the production of consumer goods is a smaller portion of the production across the entire economy.

By excluding the cost of production processes from GDP, economists overemphasize the importance of consumer spending. Based on measures of GDP, we are told that consumer spending is 70% of the economy, and that investment is only 15% or even as little as 10%. But that is radically wrong. That may be true when it comes to the value of the final goods. But those goods did not come out of nowhere. They had to be produced.

Tom Woods recently interviewed an economist named Tim Delmastro who successfully lobbied the government to provide a number called “gross output.” This number measures spending at all stages of production — a concept central to Austrian economics. As Delmastro notes in the interview, the GDP number consists of consumer spending (70%) and government spending (20%) with business investment coming up as a distant third. This misleads people into thinking that increasing consumer spending is the most important thing to do in the economy. But when you measure “gross output” and get a more accurate picture of the economy, you learn that consumer spending is only about 30 to 40% of the economy, while business investment is actually over 50% of the economy. (The “gross output” number is actually quite poor under Obama, by the way. Shockingly.)

At 8:21 in the video below, Woods makes the killer point that drives this point home: we are always told we need more consumer spending. If we followed that advice and took it to its logical conclusion, everyone who receives money for a good or service should just go spend it on consumption. As Woods says:

But meanwhile, people are told, or are under the impression, that what we need is more consumer spending. Spend spend spend spend. But if we followed that advice . . . to a “T,” and everybody, as soon as he got money, just spent it on another consumer good . . . let’s say you buy ten gallons of milk from me, and I take that money and I buy a shirt, and the shirt guy buys a hat, and the hat guy buys a gallon of gas . . . then no wages get paid [and] all the production structure we just described grinds to a complete halt. But that would be Nirvana, because you have all the consumption you want!

Woo-hoo!

Tomorrow, in part three of the series, we identify the basic problem with GDP. Namely: it does not measure what we should be most interested in when we study economics: how to allocate scarce resources. See you then.

P.S. Once again: if you choose to sign up for Woods’s “Liberty Classroom” to learn more about concepts like this, please do so though this link. Do yourself a favor and at least check out Woods’s free samples to see what you think.

I want to spend some time this week attacking GDP as the be-all and end-all of economic analysis. It’s a very important point, because it explains why the Paul Krugmans of the world think it’s great for the economy to boost government spending . . . or to have people dig holes and fill them in, so long as they’re doing something . . . or to do anything humanly possible to get consumers to spend, spend, spend. All of these wrongheaded policies flow directly from the overemphasis on GDP.

I want to keep my points bite-sized, so I am going to make this a multi-part series. Today, I address the fact that GDP takes into account government spending, even though government spending does not necessarily satisfy people’s preferences.

The video at the bottom of this post is worth your time. It features Austrian economist Jeff Herbener and historian (and author and prolific podcast host) Tom Woods. This video will provide the basis of two of my posts attacking GDP.

If you’re short on time, jump to 1:50 in the video, and watch for three minutes, stopping at 4:55. Here, Woods asks about the fact that government expenditures are included in GDP. Herbener explains that government expenditures are disconnected from our preferences — and are disconnected from the voluntary nature of the exchange, meaning that the prices are not market-determined, and are therefore inflated.

At 3:51, Woods plays devil’s advocate. Doesn’t government spending put people to work and put money in people’s pockets? Herbener explains: “The only way we can tell whether something in a net addition to human welfare is through voluntary purchase.”

At this point, you’re either nodding your head in agreement, or an objection is popping up in your mind: “Wait, how do we know that only voluntary purchases satisfy preferences? Don’t government actions satisfy people’s preferences? Isn’t that why people vote?”

The short answer is: sure, government actions satisfy some people’s preferences, by taking money from one group and giving it to another. (Government’s economic action ultimately boils down to that.) When you take from Peter and give to Paul, Paul’s preferences are satisfied, to be sure! — but Peter’s may not be. We can’t know for sure, because Peter was not given a choice. His choice was: pay your taxes, or have men with guns take you to jail. That’s not much of a choice at all, for most people.

In the free market, however, voluntary exchange satisfies the preferences on both sides of the transaction. When a car is sold, it’s because both the dealer and the purchaser think they are better off once the sale is finalized. Otherwise, the sale would not happen.

This is the type of activity that we want to maximize: transactions in which all parties benefit. But when we include government spending in GDP, we are including transactions that don’t necessarily benefit both sides — meaning that they don’t necessarily make consumers better off.

This is just one reason among many that maximizing GDP should not be the top economic goal of society.

Here’s the video. Tomorrow, we will discuss another part of the same video, to examine how GDP overemphasizes the importance of consumer spending to economic well-being.

P.S. Woods plugs Liberty Classroom at the end of the video. If you decide to sign up, please do so though this link, which benefits this site at no cost to you. Three people have signed up through this link so far, and the commissions I have received have more than repaid the $50 I spent to join. (I got the course for half price using discount code “DISCOUNT” . . . which still works.) In essence, Tom Woods has paid me to learn Austrian economics and non-P.C. history, and to spread the word to other people. I have access to nine interesting courses, and have listened (on my commute) to about 70 lectures on topics as diverse as Western Civilization, Keynesian economics, Austrian economics, U.S. Constitutional history, and logic. And I’m just getting started!

I highly recommend at least checking out the free samples to see if they appeal to you.

P.P.S. I’d love to get some feedback from the folks who subscribed.