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GDP and the Public Sector

Monday, 07 July 2014 04:28

Lew Daly has an interesting, but unfortunately misdirected, critique of the measurement of the public sector's contribution to GDP. He notes several areas, such as infrastructure and education spending, where the government contributes to our well-being, but which are not directly picked up in GDP as contributions from the government. While the point is true, the piece fundamentally mistakes what GDP is and also grossly understates the government's role in the economy.

First, GDP is a measure of economic activity. It is not a comprehensive measure of societal well-being and anyone who tries to use it as such is showing off their ignorance. GDP can be thought as being comparable to weight. It is difficult to imagine a doctor doing a medical exam and not wanting to know the patient's weight. It is useful and important information. If a person is 50 percent above or below their ideal weight, it likely means they have a serious health issue. On the other hand, someone could be right at the ideal weight for their body type and still be dying of cancer. Any doctor who ended their check-up with writing down what the scale shows has done some serious malpractice.

Similarly, GDP is telling us the value of goods and services the economy produced. It is not telling us whether the pollution that results is killing us, whether it all went to produce weapons and prisons, or whether Bill Gates and his kids pocket it all. We need other measures to evaluate such things, and we have them, but they are not GDP.

On the other point, the problem of assessing the government's role in the economy goes much deeper than Daly suggests. A huge amount of economic activity is undertaken through the incentives of patent, copyright, and trademark monopolies. Pharmaceuticals alone account for more than $380 billion a year in sales (2.2 percent of GDP). The bulk of these expenditures are higher prices that drug companies can charge because the government will arrest any competitors.

These monopolies are effectively prizes that the government offers to incentivize research and development and creative work. They are alternatives to direct government funding of these activities. (The government also does plenty of direct funding, for example the $30 billion a year it spends on the National Institutes of Health.) If anyone wants to add up the government's contribution to the economy, they better count these monopolies.

In the same vein, government regulation does far more to steer markets than Daly suggests. Doctors get high pay because we both restrict the number of foreign doctors and let doctors prevent nurses and other health care professionals from performing many services for which they are perfectly well-qualified. We can tell similar stories about most other highly paid professions. I don't know whether this contribution is a positive or negative in our addition, but it's very big bucks in either case. In the case of doctors alone, if their pay fell to the level of doctors in other wealthy countries it would save us close to $100 billion a year (0.6 percent of GDP).

The same applies to zoning restrictions. We have extensive restrictions just about everywhere. This is why I can't set up a slaughterhouse in front of Bill Gates' house. That raises the value of his estate, but reduces my ability to earn a profit. It's a huge government intervention into the economy, but it's not clear whether we want to count that one as a plus or minus.

In contrast to the story with doctors, the government actively tries to put downward pressure on the wages of manufacturing workers through international competition. This was a main goal of NAFTA and subsequent trade deals. These deals were designed to make it as easy as possible for companies to set up operations in developing countries and take advantage of lower cost labor.

There are a whole other set of rules that structure economic outcomes in enormously important ways. For example, if a union has an unauthorized strike against an employer, the company can run to court and get an injunction. This allows it to threaten union leaders with jail unless they end the strike. By contrast, if the company illegally fires workers for trying to organize a union, they run the risk of having the firings overturned months or years in the future by the National Labor Relations Board.

Even the level of economic activity is largely determined by the government. Our decision to run smaller budget deficits and maintain a high dollar (and thereby incur a large trade deficit) means that GDP is running almost $900 billion a year below its potential and leaving millions of people needlessly unemployed or underemployed.

I have no idea what number we could get by adding up these and other ways in which the government contributes to and/or shapes the economy. I have even less idea what the number could possibly mean.

The point is that we should not imagine that we have an economy sitting out in space to which the government adds to or subtracts from. This is a silly myth that unfortunately carries considerable weight in policy debates. The reality is that the government and the economy are so thoroughly integrated it is impossible to separate the two. This is the fundamental misunderstanding, not our measure of GDP.




Comments (13)Add Comment
written by wallflower, July 07, 2014 7:14
Interesting post by JW Mason on how much of GDP accounting is due to Medicaid and Medicare even though none of the income actually flows through households.
Dean Baker Attacks Zero Sum Simpletons, Gets Blank Stare in Response
written by Last Mover, July 07, 2014 7:56
The point is that we should not imagine that we have an economy sitting out in space to which the government adds to or subtracts from.

Oh contraire said the simpleton sock puppet. How else shall Americans be kept economically illiterate by sock puppets if not by the heralded virtures of simple addition and subtraction?

What better way to fuel the 24/7 indignation of sock puppets offended by violations of simple arithmetic? Any fool can see that such a low common denominator of conceptual understanding is the obvious starting point for a public understanding of economics.

Look America, why do you think Rick Perry traded his cowboy boots for some geeky eyeglasses and a bicycle exercise machine? To prove he's back in the game of adding and subtracting, that's why. Now that he can actually name which government agencies he will eliminate, it stands to reason he must know how many there are now, and how many will be left standing after he purges them.

What more could you ask for America? What do you want anyway, an economist like Dean Baker who gets things approximately right by looking at an economy inseparable from government? Or politicians, their sock puppets and an embarrassing number of economists who get things exactly wrong by treating the economy like some kind of free market gyroscope spinning away in outer space on a glide path to utopia?

It's coming in the next presidential election America, Rick Perry standing at the lectern studiously explaining why multiplying a positive number representing free markets, with a negative number representing government, always results in a negative answer.

Take the lessons learned from economic predators who run the American economy. You can take the government out of the economy but you can't take the economy out of government.
written by djb, July 07, 2014 8:20
I am trying to study how to decrease value of dollar in exchange but i find the easily searchable to be full on nonsense like blaming social security for weakening the dollar etc

Any know an easy reference on how to weaken dollar to increase exports over imports?
Plaza Accord lowered dollar and reduced the trade deficit
written by Dean, July 07, 2014 10:20

you can read about it here http://en.wikipedia.org/wiki/Plaza_Accord

Good policy from the late 1980s.
Plaza accord and lobbies
written by W.T. Eff, July 07, 2014 10:31
Dean, so why isn t manufacturing lobbying effectively for similar policy? This seems like a no brainer, economically, so what's the political issue?
WTEff...oh but they do lobby...
written by pete, July 07, 2014 10:49
The reason the budget continues to grow under all sorts of Demopublican regimes is pretty clear. Everybody wants a piece of the pie. And of course, stimulative spending is exactly meant to make businesses profitable so they will be able to hire more workers, effectively driving real wages down. Standard Keynesian/Akerlof-Yellen model. So business is (should be) very supportive of artificially increasing demand. It is labor which gets snookered into working for lower wages, kind of an involuntary servitude of sorts. Traditionally labor fought this sort of shenanigan, until they were coopted.
Many Companies Benefit from an Over-valued dollar
written by Dean, July 07, 2014 10:58
companies like Walmart have set up low cost supply chains in the developing world. They don't want to see the price of the goods they import rise. The same applies to major manufacturers like GE, they have many of their operations overseas. And, the financial sector generally likes a higher valued dollar because it makes them a bigger player in other markets.

Social Classes
written by Ellis, July 07, 2014 11:05
The government policy that Baker outlines seems pretty consistent: to guarantee the profits of the capitalist class. The government is a tool of the ruling class. Why pretend otherwise?
plaza accord
written by djb, July 07, 2014 12:04
"The Plaza Accord of 1985 had improved the profitability of U.S. manufacturing, as the G-5 powers (France, Germany, Japan, the United Kingdom, and the United States) agreed to subsidize U.S. exporters by artificially lowering the exchange rate of the U.S. dollar."

this is what I got
Daly's Basis Premise is False
written by Robert Salzberg, July 07, 2014 2:52

"TODAY’S polarized debates about the role of government often boil down to a single issue: the size of government compared with the size of the overall economy, as measured in gross domestic product.

This is true on both sides of the debate. One recent proposal featured in The Wall Street Journal argues for a “golden fiscal rule” that the size of government as a percentage of G.D.P. should always be shrinking; liberals frequently cite the higher ratio of government spending to G.D.P. in many European countries."

While the Radical Right like to vent about Big Government, the fundamental debate isn't about the relative size of government.

The fight always has and always will be what should the government do and how government should it do it.

As far as spending goes, the Right obsessively pushes for more military spending and more military intervention. Isn't that Big Government?

The RIght also wants to tell all Americans who they can marry, deny women reproductive rights, and most recently, deny as many people as possible the right to vote. Who's really for Big Government?

The Left wants decent health care, education, infrastructure, retirement, and social supports for those who needs it.

I'll believe the Right is serious about reducing the size and scope of government when they advocate for reducing the size of our military and stop pushing for the government to intrude on women's reproductive rights. I expect a long wait.
written by urban legend, July 07, 2014 3:10
"For example, if a union has an unauthorized strike against an employer, the company can run to court and get an injunction. This allows it to threaten union leaders with jail unless they end the strike. By contrast, if the company illegally fires workers for trying to organize a union, they run the risk of having the firings overturned months or years in the future by the National Labor Relations Board."

Excellent contrast that should be repeated often. (And the companies violating the law usually are assessed only back-pay less any money earned in the interim, right?
written by urban legend, July 07, 2014 3:14
Trademark law has a different origin and purpose from patent and trademark law. It is not correct to refer to it as a "monopoly."
written by Squeezed Turnip, July 07, 2014 4:48
written by urban legend, July 07, 2014 2:14
Trademark law has a different origin and purpose from patent and trademark law. It is not correct to refer to it as a "monopoly."

The purpose of trademark is law is to exclude copying. In that sense, its origins and purposed are identical with those of patent and copyright law. (Unless you really do mean that trademark law has a different origin and purpose from itself, which is kinda silly.)

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.