To gain insight into the state of an economy, most financial experts and commentators rely on a statistic called the Gross Domestic Product (GDP). The GDP framework looks at the value of final goods and services produced during a particular time interval, usually a quarter or a year.
This statistic is constructed in accordance with the view that what drives an economy is not the production of wealth but rather its consumption. What matters here 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 driver of economic growth.
All that matters in this view is the demand for goods, which in turn will give rise almost immediately to their supply. Because the supply of goods is taken for granted, this framework ignores the whole issue of the various stages of production that precede the emergence of the final good.
However, in order to manufacture a car, there is a need for coal to be employed in the production of steel, which in turn will be employed to manufacture an array of tools. These in turn are used to produce other tools and machinery and so on, until we reach the final stage of the production of a car. The harmonious interaction of the various stages of production results in the final product.
Within the GDP framework, the aspect of funding economic activity never emerges. In this framework goods emerge because of people’s desires. In the real world, it is not enough to have demand for goods – one must have the means to accommodate people’s desires. The means are various final goods that are required to sustain various individuals in the various stages of production.
The key source for the means of sustenance is individuals’ real savings. For instance, John the baker produces ten loaves of bread and consumes two loaves of bread. The unconsumed eight loaves of bread constitutes real savings. John the baker could exchange the saved eight loaves of bread for the services of a technician in order to improve his oven i.e. the improvement of his infrastructure. With the help of an improved infrastructure, John could lift the production of bread – increase the economic growth. Note that the eight saved loaves of bread sustain the life and wellbeing of the technician whilst he is working to enhance the oven.
Observe that real savings is the determining factor as far as future economic growth is concerned. If a strengthening in economic growth requires a particular infrastructure whilst there is not enough real savings to make such an infrastructure –the desired strengthening in the economic growth is not going to emerge.
The GDP framework is hostile to savings given that in this framework more savings weakens consumption and weakens the so-called Keynesian multiplier. The GDP framework 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. The so-called economy is a metaphor—it does not exist.
By aggregating the values of final goods and services together, government statisticians concretize the fiction of an economy by means of the GDP statistic. However the GDP framework cannot tell us whether final goods and services that were produced during a particular period of time are a reflection of real wealth expansion, or a reflection of capital consumption.
For instance, if a government embarks on the construction of a pyramid, which adds nothing to the well-being of individuals, the GDP framework will regard this as a factor that contributes to economic growth. In reality, however, the building of the pyramid will divert real savings from wealth-generating activities, thereby stifling the production of wealth.
GDP and the real economy – what is the relationship?
There are serious problems regarding the calculation of real gross domestic product (GDP). To calculate a total, several things must be added together. To add things together, 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, which they divide by an average price of those goods. There is, however, a serious problem 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 the rate of exchange in the first transaction is $1000/1TV set. The price in the second transaction is $40/1shirt. In order to calculate the average price, we must add these two ratios and divide them by 2. However, $1000/1TV set cannot be added to $40/1shirt, implying that it is not possible to establish an average price. On this Rothbard wrote,
Thus, any concept of average price level involves adding or multiplying quantities of completely different units of goods, such as butter, hats, sugar, etc., and is therefore meaningless and illegitimate.[1]
The employment of various sophisticated methods to calculate the average price level 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.[2]
Now, since it is not possible to quantitatively establish the status of the total of real goods and services, obviously various data like real GDP that government statisticians generate should not be taken too seriously.
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 independently.
Goods and services are not produced in totality and supervised by one supreme leader. This in turn means that the entire concept of GDP is devoid of any basis in reality as far as the market economy is concerned. It is an empty concept. 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:
The attempt to determine in money the wealth of a nation or the whole of mankind are as childish as the mystic efforts to solve the riddles of the universe by worrying about the dimension of the pyramid of Cheops.[3]
Furthermore,
If a business calculation values a supply of potatoes at $100, the idea is that it will be possible to sell it or replace it against this sum. If a whole entrepreneurial unit is estimated at $1,000,000 it means that one expects to sell it for this amount, the businessman can convert his property into money, but a nation cannot.[4]
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 monetary pumping. Since GDP is expressed in dollar terms, it is obvious that its fluctuations will be driven by the fluctuations in the amount of dollars pumped 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 real wealth formation.
Once it is realized that so called real economic growth, as depicted by real GDP, mirrors fluctuations in the money supply growth rate it becomes clear that an economic boom has nothing to do with real economic expansion.
On the contrary, such a boom is about real economic contraction since it undermines the pool of real wealth – the heart of real economic growth. (Note that boom is generated by the increase in the money supply growth rate, which gives rise to various bubble activities that undermine the process of wealth generation).
It is no wonder that in the GDP framework, the central bank can cause real economic growth, and most economists who slavishly follow this framework believe that this is so. Much so-called economic research produces “scientific support” for popular views that, by means of monetary pumping, the central bank can grow the economy. It is overlooked by all these studies that no other conclusion can be reached once it is realized that GDP is a close relative of the money stock.
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 indicator that any entrepreneur would rely upon is profit and loss. How can information that the so-called “economy” grew by 4 percent in a particular period help an entrepreneur generate profit?
What an entrepreneur requires is not general but rather specific information regarding the demand for his specific product, or products. The entrepreneur himself has to establish his own network of information concerning a particular venture.
Things are quite different, however, when the government and the central bank tamper with businesses. Under these conditions, no businessman can ignore the GDP statistic since the government and the central bank react to this statistic by means of fiscal and monetary policies.
The entire army of economists is busy guessing whether the central bank will lower, or raise, interest rates.
By means of the GDP framework, government and central bank officials generate the impression that they can navigate the economy. According to this myth, the “economy” is expected to follow a growth path outlined by omniscient officials. Thus, whenever the growth rate slips to below the outlined growth path, officials are expected to give the “economy” a suitable push. Conversely, whenever the “economy” is growing too fast, the officials are expected to step in to cool off the “economy’s” growth rate.
If the effect of these policies were confined only to the GDP statistic then the whole exercise would be harmless. However, these policies tamper with activities of wealth producers and thereby undermine people’s well-being.
Likewise, by means of monetary pumping and interest rate manipulation, the Federal Reserve doesn’t help generate more prosperity, but rather sets in motion “stronger GDP” and the consequent menace of the boom-bust cycle—i.e., economic impoverishment.
Conclusion
We can thus conclude that the GDP framework is an empty abstraction devoid of any link to the real world. Notwithstanding this, the GDP framework is in big demand by governments and central bank officials since it provides justification for their interference with businesses. It also provides an illusory frame of reference to assess the performance of government officials. In addition, 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 wealth. Hence, despite “good GDP” data many more individuals may find it much harder to make ends meet.
[1] Murray N. Rothbard, Man Economy and State, Nash Publishing p 734.
[2] J. Steven Landefeld and Robert P. Parker. Preview of the Comprehensive Revision of the National Income and Product Accounts: BEA’s New Featured Measures of Output and Prices in BEA Survey of current business July 1995.
[3] Ludwig von Mise Human Action 3rd revised edition, Contemporary Books, Inc. P 217
[4] Ibid
