We often think of economy as based on supply and demand; or, in other words, how much is
produced and the price to purchase it. This article will serve to debunk that popular belief,
focusing on what we should really be looking at about the economy: GDP (Gross Domestic
Product). Introduced by macroeconomist Milton Friedman in 1934, GDP has become a first-line
metric for evaluating economic growth. The Bureau of Economic Analysis uses this to measure
our country’s total economic activity including the value of all goods and services produced within our borders.
One key takeaway from Friedman’s work was that any changes in GDP must be tied to
something else that is different. This helps remove the assumption that economic growth and its
accompanying increase in GDP is always a good thing, and may even indicate a period of
economic decline. The problem with this, as we will see, is that we often misinterpret the
changes we see within GDP as indicators of actual improvements in our national economy (or
lack thereof). This leads to an increase in the number of experts touting their preferred ways to
fix what they mistakenly believe to be broken economies.
The aforementioned experts do agree on one thing: the importance of GDP. As such, many of
them will assert that nominal GDP growth is an indicator of improving conditions within the
United States – and the world – economy. The problem with this way of thinking, according to
economist Dean Baker, is that we should be comparing and contrasting our nominal GDP
figures with what we actually produce and consume. To illustrate this point, Baker has an
analogy: “Think of nominal GDP as your paycheck at work. The more that your paycheck grows
each year because you keep increasing the amount you produce to keep up with inflation, then
those increases in pay average out. If there were no real wage growth (and this would also be
hidden by the same effect), then you would expect to see a drop in your nominal dollar salary.
However, you would also expect that your nominal take-home pay would be lower if you worked
less and did not produce more or if prices of what you were producing declined.” Therefore, we
should be concerned about the type of work we’re producing and whether we’re actually
receiving an increase in our standard of living.
To get the real value of GDP, consider this: if prices for everything go up at the same rate
(inflation), then it appears as though there is no growth in out-put because your paychecks may
be growing by a fixed rate, but everything else is too. This is called “growth without production,”
and that’s what we should really be concerned about. It’s not the nominal number that we
should be looking at, but something closer to “the real value of GDP.”
Let’s start with the basics: GDP is a measure of economic activity and change, and this is
measured by calculating the total value produced each year across all sectors of the economy.
This value is then distributed according to sector (eg: energy; healthcare; education; housing;
etc.), and combined to yield the amount of money spent on buying and producing these items.
All in all, our country produces $19.2 trillion each year. $10.1 trillion is produced by the private
sector, while $9.1 trillion is produced by the government (federal, state and local).
Of this $19.2 trillion, our economy produces $14.7 trillion that we consume domestically
(including through government services), and $4.5 trillion that we export to other countries. This
creates an imbalance where we consume more at home than we produce domestically, and also
produce more than we consume abroad. This creates a huge demand for US dollars from these
other countries in order to buy goods from us, which is what makes up our trade deficit ($441
billion per year). We represent 33% of the world economy and we buy 4.5% of it. This is
obviously not sustainable and we will need to continue to improve how we utilize our resources
and develop our economy so as to not use up all available resources within this country. http://macledge.com/
It’s important that we view GDP as simply a measure of value added at each sector or activity
level, because without this perspective, we end up overvaluing certain sectors (eg: oil) and
undervaluing others (eg: healthcare). Our GDP may rise because oil prices went up, but we
were able to increase production, price out lower wages and actually grow our economy at the
same time. The problem is that we tend to focus on the nominal growth of GDP and not
consider real growth.
One major criticism of GDP is that it fails to measure income distribution and social welfare.