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Home Publications Blogs Beat the Press Problems in GDP Measurement and Rent Seeking

Problems in GDP Measurement and Rent Seeking

Tuesday, 23 April 2013 04:16

The Bureau of Economic Analysis (BEA) will adopt a new methodology for measuring GDP this summer. The methodology will treat research and development and the creation of artistic works as forms of capital that depreciate through time rather than one-time expenditures. This will lead to an increase in measured GDP of close to 3.0 percent according to BEA's analysis.

There are three points worth making on this change. First, for you conspiracy buffs, this one has been in the works for close to two decades. The government didn't just come up with it to make President Obama look better. Go back to digging up the Real Story about the plunge in gold prices.

The second point is that the methodology for this will inevitably be very troubling. If Pfizer has a patent for a great new cancer drug we will now pick this up as an increase in the investment component of GDP. Suppose Merck develops a drug that does the exact same thing, except that it gets around Pfizer's patent. According to the new methodology this would further increase GDP.

Of course, this is a battle over rents, not actually an increase in total output. That is a problem. Expenditures for rent-seeking don't make us richer in aggregate. In fact, this is already a problem now, it's just likely to be more of a problem in the future. Consider the situation where a software developer makes their great new software available for free. Our friends over at BEA won't show any gain to GDP even though our living standards will certainly be improved by much more than if they had patented the software and charged for it.

This means that insofar as:

"In other words, the U.S. economy is even more heavily driven by the iPad designers and George Lucases of the world—and proportionally less by the guys who assemble washing machines—than we thought."

It is largely because the government has designed a system where our economy is driven by the iPad designers and the George Lucases rather than the guys who assemble washing machines. The latter are getting screwed by design, not the natural workings of the economy.

Finally, this change will make it more important than ever that we focus on net domestic product rather than gross domestic product. This is not a radical shift requiring some complex new methodology, the data are right here (Table 1.7.6, Line 13).

This is important because we can't eat depreciation. If we want to know how much richer we are getting through time, the net measure is the right focus. The net measure also has the wonderful feature that it helps to correct errors in measuring the value of capital. If we overstate the wonders of Pfizers new wonder drug when counting the capital stock we also overstate the amount of depreciation as the life of the patent shortens.

If we look at net output rather than gross output the uptick in productivity associated with the new economy is much less impressive. The rate of net productivity growth in the post speed up years is still close to a full percentage point lower than it was in the early post-war golden age when the guys who assemble washing machines drove the economy. This fact would be more widely known if the iPad designer and George Lucases of the world were better at their jobs. 

Finally, to preempt some inevitable comments, GDP is not a comprehensive measure of well-being and no one should ever use it as such. It is a measure of the economy's output. It is important, just as it is important to know someone's weight in assessing their health.

If someone is 5 feet and 10 inches and weighs either 100 pounds or 300 pounds, then they probably have a serious health problem. On the other hand, they could weigh 160 pounds and still be dying of cancer. It would be crazy to base an assessment of a person's health exclusively on their weight. On the other hand, it would be difficult to imagine being able to assess their health without knowing their weight. This change by BEA is about adjusting our scale so we get the weight right.

Note: Typo in title corrected.

Comments (23)Add Comment
When Makers Get Recognized They Make Even More
written by Last Mover, April 23, 2013 5:53
Imagine that. Not only will organizations like RIAA, Big Pharma and medical device makers continue to pillage and plunder the nation down to a bare economic skeleton of its former self as they kill off competition far and wide with the collection of economic rent, they will now get even more economic credit for doing it.

Wait for the crowing sock puppets and politicians on this one stepping over each other to get to the microphone first and explain once again how much better off America is for acknowledging the real makers of this great nation who have been understated and ignored before now.

Poor babies, plodding away in the economic shadows like that while takers took their output because no one was measuring it.
written by JSeydl, April 23, 2013 6:27
What follows is a bit of a rant, so be warned.

GDP is not a comprehensive measure of well-being and no one should ever use it as such.

But most economists do. This is the whole notion of Kaldor-Hicks efficiency, which is central to the cost-benefit approaches employed in welfare economics. The idea is that if we pursue projects that yield net overall gains, then we will be roughly approximating utilitarianism, which means that well-being will be maximized. In fact, this is one of the key justifications that economists have put forward for pursuing KH efficiencies.

GDP is central in this story. When we pursue policies that yield net gains in GDP, we will be approximately maximizing social welfare, according to the economist. However, this says nothing about rights or about egalitarian considerations; or about non-anthropocentric things like intrinsic value. When economists talk about GDP per capita being the relevant measure for living standards, they're implicitly ignoring many other moral factors that may be worthy of consideration. And importantly, there may be cases where people would actually be better off with a policy that leads to a lower level of GDP if the policy, say, yields better results in terms of rights and distributive justice.

Economists may respond by saying that they’re field is very specialized – that while non-utilitarian considerations may be important, they’re beyond the scope of economics and for the philosophers to ponder. But this ignores the performative aspects of what economists do. Economists see themselves as describers, putting forth theories about how individuals make decisions. But economists are not just describers; they are also prescribers. Because of the influence of their research – R-R being just one obvious example – the ideas that economists come up with end up changing the way societies function, because social institutions are erected in line with the conclusions that economists derive from their models. This would all be fine and dandy if “approximate utilitarianism” were superior among the various schools of moral theory. But it’s not. Not even close.

What’s the solution? Economists need a better understanding of political philosophy. Some do – e.g., Amartya Sen – but nowhere near enough. The whole Rawlsian movement should have changed this, but it didn’t. Rawls wrote his masterpiece in a language that most economists could understand, but they didn’t listen. They said, “We’re doing science here, and we can’t be bothered by this mushy philosophy stuff.” So they continued to maximize, and the world continues to change to better fit their implicit conception of the good. It’s appalling.

If it were up to me, I’d abolish all formal studies of economics in higher education. There would be no more stand-alone economics degrees – no more utility-maximizing drones funneled into central banks, governments, and development agencies. Every econ topic would be taught alongside rigorous criticisms from political philosophy. Students would always get both sides of every story. And the media would stop treating the modern-day economist as if he is some sort of god, who has all the answers.

The reality is that the modern-day economist is basically a wannabe mathematician, who isn’t even that good in math and who is utterly incapable of thinking outside of his preferred comfort zone.
Probelm with Spelling
written by Jim, April 23, 2013 6:27
See the title of your note!
written by LSTB, April 23, 2013 7:10
Dean writes:

GDP is not a comprehensive measure of well-being and no one should ever use it as such. It is a measure of the economy's output.

This is the real rub, now, isn't it? GDP includes all kinds of non-outputs to parties that produce nothing, e.g. rental payments to landowners. Yet it also excludes all kinds of unpaid outputs like someone's hours pounding out Linux code that (hopefully) benefits everyone. I just hope the BEA's assessment of capital consumption allowances is accurate.
written by liberal, April 23, 2013 7:27
LSTB wrote,
...rental payments to landowners.

Yep. Though "only" 10-20% of GDP.
When Preaching to the Choir, All Messengers Must Be on the Same Page
written by Last Mover, April 23, 2013 7:54

It's not that complicated. Utilitarianism simply means the greatest good for the greatest number, which is entirely consistent with creating the largest economic pie possible per achievement of productive, allocative and distributive efficiency.

That any link in this chain can be intentionally undermined to prevent this outcome doesn't mean the economic discipline itself has necessarily failed as a means of explanation and prediction.

In most cases as demonstrated and repeated incessantly by Dean Baker the opposite is the case. Economic issues that are relatively simple and straightforward are routinely mangled and obscured beyond recognition, buried in piles of ideology so unnecessarily complex they tip over and implode into themselves, emerging as reincarnated zombies of propaganda economics that manage to live on permanently in the minds of the brainwashed and perpretrators who will march onwards down the path of arrogance and ignorance seeking their particular self interest.

There are winners and losers in this game and no matter how concentrated the winners and how dispersed the losers, the winners will prevail as long as the messengers and message are one in the minds of the beholders.

The old economic adage about the fallacy of composition and ability to see the parade still holds true. When one person stands up to see the parade better he or she can see better. When everyone stands up no one can see better.

The difference is that winners of the past who once deserved the front row seats to see better from earnings that reflected what they were worth no longer applies.

The current "winners" have evolved into economic predators who have taken over the entire stadium and orchestrated the parade from beginning to end, undermining and abusing every principle of the very economics they continue to preach to the audience as they feed from the trough of economic subsidies that sustain them.
written by JSeydl, April 23, 2013 8:21
It's not that complicated. Utilitarianism simply means the greatest good for the greatest number, which is entirely consistent with creating the largest economic pie possible per achievement of productive, allocative and distributive efficiency.

That any link in this chain can be intentionally undermined to prevent this outcome doesn't mean the economic discipline itself has necessarily failed as a means of explanation and prediction.

My point was to say that economists aren't just explaining and predicting; they are also changing, whether they actually know it or not. The R-R blunder is the latest example. But what I'm saying is that the problem cuts much deeper than R-R - that the whole utilitarian construct becomes embedded in society when we give as much power to economists as we have done in recent decades.

The point here is that utilitarianism is not a superior moral philosophy. Say it's 19th Century America, and slavery is rampant. Suppose, moreover, that there's some policy that could improve the welfare of slave owners and not lower the welfare of slaves. Should we do it? The economist would say yes: It's a Pareto improvement, and social welfare would increase from the policy. However, there are rights issues that come prior to welfare maximization in this case. The problem is that there is injustice in the status quo, which will not be corrected no matter how many Pareto improvements are made.

This is the whole problem with measures like GDP: they allow us to ignore injustices that may exist in the status quo and to just seek Pareto improvements.
written by JSeydl, April 23, 2013 8:42
Btw, I'm not implicating Dean here in any way. He obviously cares a great deal about more than just maximizing the pie - e.g., about climate change, workers' rights, etc. My comments are more general and directed toward the economics profession as a whole, based on my experiences.
Spending is not progress
written by Bill H, April 23, 2013 9:33
If I am paying you $50 to mow my lawn and you are paying me $50 to mow your lawn we are contributing to the GDP. If we each increase the other's pay rate to $100 we have doubled our contribution to the GDP, but no additional lawn mowing is being done, no additional lawn is produced, and no additional wealth is created.

The fact that this has been in the works for decades does not make it valid. Bank robbers plan their robberies for years, too, but that does not make them acts of kindness.
production, consumption, income
written by pete, April 23, 2013 9:44
Basically, macro folks have not come to grips with international economics. The fact is that u.s. companies are about 50% invested overseas. Yet, their income, some of it, is counted in U.S. accounts. Certainly my 403 funds reflect profits from Caterpillar building and selling tractors in China. Is that an export? Is that in GNP or GDP? Both? Neither? Do I really care?

Looking at GDP or GNP and relating it to, say, unemployment, is difficult.

Regarding spending on R&D, this is like counting spending on fertilizer buy a farmer. Of course this would be double counting, since the corn will be counted when sold. Should be final products and services for consumption, i.e, those that produce happiness, not intermediate goods like fertilizer and R&D.
@ Bill H - Doubling Down
written by Ron Alley, April 23, 2013 9:49
Just think about the magic in that increase from $50 to $100. Not only is the contribution to GDP doubled, but the impact on the environment remains constant. Therefore, the environmental impact per dollar of GDP is reduced by half. You have found the secret to reducing the environmental footprint of GDP!

Seriously, isn't your point that services should not be counted in measuring GDP?
written by liberal, April 23, 2013 10:27
pete wrote,
The fact is that u.s. companies are about 50% invested overseas.

Maybe, but is is really true?

How much of overseas "earnings" are in fact really domestic earnings that have been rebranded as offshore in order to escape the corporate income tax?
Rent and Rentier
written by JParks, April 23, 2013 7:25
While these terms, Rent and Rentier, carry weight and meaning to those who are fluent in econospeak, and totally acceptable in polite discussion, which Dean's forum most certainly exemplifies, their use contributes to perpetuating the practice.

I am also aware of how the use of anything approximating the real definitions lays one open to being attacked and marginalized as being too shrill and unserious.

Here comes the "but"! When a discussion dances around the pros and cons of our country's assets, and how they may or may not be sold to satisfy a perceived balance sheet, I want to get shrill!

Our greatest assets, the 99%, are already being bought and sold, piece by piece, by a corporatocracy that has reduced the representatives of our government to water carriers. Well paid water carriers, but water carriers nevertheless.

If I want to continue to have influence over the votes of congress, I have an increased "investment component" to assure that my future m(b)illions will be fulfilled. This is perhaps even better than a "Patent" that has a finite term.
There, I've done my part to increase the GDP...I'm a true Amurrican!

Honestly, why can't we just quit using nice terms like Rent and Rentier and call it for what it is!? Legalized racketeering.

Thank for the opportunity to rant about rent.
written by liberal, April 24, 2013 7:55
Honestly, why can't we just quit using nice terms like Rent and Rentier and call it for what it is!? Legalized racketeering.

Well, I prefer the term "legalized theft," but whatever.

It's not either/or. Using terms like legalized theft in the absence of any explanation doesn't inform anyone. The more descriptive term (rent) can be augmented by the more pejorative phrase.

By the way, "rent" itself isn't necessarily theft. It's what happens to the rent. If it's returned to its creators (e.g. via a land value tax, which allows government to collect rent on behalf of those who (including government) created it), things are fine. It's when it's unjustly appropriated by parasites that we have a problem.

An exception would be of course situations where (unlike land) the existence of rent is completely artificial (like IP laws).
We Have Always Been Rentiers
written by Benedict@Large, April 24, 2013 10:49
“the U.S. economy is even more heavily driven by the iPad designers and George Lucases of the world — and proportionally less by the guys who assemble washing machines — than we thought.”

Another view via Peter Frase:
This is no doubt how the matter will be described going forward. But the new measurement strategies are only manifestations of a choice to attribute a greater share of our material wealth to designers and directors, and that choice has more to do with class struggle than with statistics. ["We Have Always Been Rentiers", http://jacobinmag.com/2013/04/...-rentiers/ ]
The timing is still suspicious...
written by Wisdom Seeker, April 24, 2013 3:01
Even if a proposal has been sitting around for a really long time, the final decision to implement it can be driven by political/timing considerations. Such as the need to make GDP appear larger in order to make national debts seem proportionately smaller.

It's still true that this "modest" 3% change in the ruler will allow Congress to spend yet another $500 billion on whatever it deems fit, while still claiming that debt/GDP is below the economic threshold of concern... add to that the massacre of Reinhart & Rogoff and no doubt we can have deficit spending forever... even if the policies we're pursuing aren't doing much to actually increase the sustainable national production pie...

Not about compensation, about Macro theory
written by Lrellok, April 24, 2013 5:47
This has nothing to do with measuring anything, and everything to do with forcing data to conform with theory. Since the mid 80's wages and tech investment as a share of GDP have both moved like they where tied at the wrist. When Tech went up, wages went up. When tech went down, wages went down. This fact completely refutes the claim that technology is displacing workers and crippling wages. If technology was responsible for income dropping, then we would expect tech and wages to move inversely, IE as increased machines would displace workers, the spending on machines would go up as the spendingon workers goes down.
The fact that we see the opposite shows that the current understanding of income inequality is entirely flawed, and the commerce department is trying to keep it flawed to preclude meaningful reforms. This is an absolute disgrace, and shows how far the field of economics has strayed from real science.
written by kharris, April 25, 2013 11:56

Normally, I take issue with GDP ranters, because they misunderstand what they are ranting about. This time, I applaud.

In the same way that salt-water economists turned simplifying assumptions about rationality and market perfection into fundamental beliefs about reality, there is a strong likelihood that economists will aggrandize the measure they have, rather than acknowledge its limits.

One of the rules of thumb in management is that you can't manage what you don't measure. That makes it all the more odd, and perhaps damning, when pundits and policy makers sneer at the notion of welfare. There is good reason to want to know what our economic output is, as a component of overall measurement of social circumstances, but from the day GDP was created, it should have been clear we needed to keep working to broaden measurement of circumstances.
written by kharris, April 25, 2013 12:22
Wisdom Seeker,

Realistically, there is no longer a reason (if there ever was) to think there is a "threshold of concern" for the debt/GDP ratio. So taking 3% on to GDP should not change the debt debate. The same crowd who want most to limit spending is the crowd who needed a "threshold of concern". It doesn't make sense to argue that they would run the deficit up another $500 bln. Them other guys, who should now feel free to ignore earlier notions about thresholds, are the ones who would want to spend more. Neither in reality nor for cynical purposes of argumentation should bumping up measured GDP have a big influence on the deficit debate.
written by JSeydl, April 25, 2013 12:30
Thanks, kharris. I didn't mean to sound so cynical. Some progress is being made. For example, Sachs is doing useful work on creating happiness indexes. But if economists are going to go down that route, they really need an understanding of political philosophy. Sen's and Martha Nussbaum's writings on human capabilities are essential starting spots for thinking outside the framework of subjective welfarism.
There is still a threshold, we just can't measure it
written by Wisdom Seeker, April 25, 2013 3:57
@kharris - Oh come on, you don't honestly believe this isn't just another example of sticking lipstick on the pig?

Independent of the economic pissing contest of the week, there is an upper limit to the amount of debt a government, or a people can take on before the monetary system falls apart. Infinity is certainly too high. 500% of GDP is unheard of. Our current level is historically unprecedented except for the three instances where the nation's survival was at stake. The global level is also at historical extremes. Reinhart & Rogoff didn't find a smoking gun, and their partisans should be ashamed, but the overreaction among the pro-spending crowd is just as bad. In historical reality, many nations including Weimar Germans, Zimbabweans and Argentines have all found that there is a limit. A large fraction of the investing community think Japan is close to popping as well.

Just because you can't put your finger on the limit for the U.S. doesn't mean it's not there. As you say, it's hard to manage what you don't measure, so it's hard to manage a debt against an unmeasurable limit, but that doesn't make the limit real. Just as your car has a limit beyond which you cannot push the engine, though you don't know what it is until it tells you...

Another point is that economic policymakers and investors live in a world of international comparisons, and in that world debt/GDP is a prominent player in the statistical tables. The U.S., like other countries, has a long and storied history of "adjusting" methodology in ways that improve the metrics. For some reason we lack a history of adjusting methodology in ways that make ourselves look bad. It happens from time to time but much less often than, say, reducing the inflation estimate to make GDP growth look better. Or reporting lowball "preliminary" unemployment claims numbers which almost invariably look better in the immediate headlines than the prior week's upwardly "revised" numbers, even though the eventual archival data series doesn't show it.

If we're going to start adding intangibles to GDP, then perhaps we should measure water that is no longer polluted (or has become polluted), air that is now cleaner (or not), families that stay together (or don't), and all of the other things that add up to a high quality of life but are currently omitted from the production statistics? But let's keep the things we can actually count accurately in a basket that can be measured well, and make a new basket for the terms whose values are much harder to estimate. Because otherwise we're bound to deceive ourselves yet again, choosing to change the ruler in order to persuade people that things are better than they are.
written by kharris, April 26, 2013 8:38
Wisdom Seeker,

I have a longstanding reflex to ignore any response that begins with "Oh, come on..." and insists that the other guy must actually disagree with himself. It's a cheap rhetorical trick to get onlookers to join you in doubting the sincerity of the targeted view - mine in this case.

First the use of "threshold" surely makes your view wrong. Surely, whatever problems result from high debt levels mount progressively as debt (more likely as interest costs) rise. A threshold implies something like R-R's 90% number. The gut response to identifying a single number should have been doubt. R-R identified 90% by chopping ratios into 4 size categories, so even if their work hadn't been a mess, it wouldn't have identified a threshold. All they would have done would be to point out that only somewhere above 90% does trouble begin.

You've offered up ridiculous counter-examples, but those counter-examples have nothing to do with what I actually wrote. I was writing about our current context in the US. That has nothing to do with most of what you wrote.

So I hope that was fun for you. But, oh come on, you don't really think you were in the same discussion as me, do you?
The real "threshold" is when the creditors pull the rug out
written by Wisdom Seeker, April 26, 2013 12:16
@kharris -

I apologize for the "Oh, come on". I was irritated by your implication that there's no reason to be concerned about rising debt/GDP levels. Obviously we disagree on several topics.

Regarding the curious timing of the GDP revisions: I work in a government-funded semi-bureaucratic organization. I have seen firsthand that many changes are "in the works" for a long time, but most don't get implemented and the others only get implemented when politically convenient. The workers generally are thorough and ethical but the management lives with different incentives. I think the timing is suspicious and find it hard to believe that you don't believe that.

Regarding the concept of a national debt limit, a point beyond which Debt/GDP cannot increase without impairing economic performance: as many wise people have said for decades (and certainly prior to R&R's research), there are many instances in history where countries have blown up their economies due to excessive debt. And as I pointed out, the U.S. is entering uncharted territory in terms of our own history. The international history shows that bond yields do not actually provide an empirical signal of trouble until it is too late. The "point of no return" (let's not call it a threshold?) is not fixed, and one can expect it to vary from case to case due to a wide range of factors (captive bond purchasers vs. external debt, bonds issued in own currency vs external currency, credibility of the government, past history, etc.). Surely you must agree that a "point of no return" does exist. And how will we know when the debt is too much, and bring it back into balance before it's too late?

History may show one of us to be right and given our current trajectory I certainly hope it is you, though I doubt it.

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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.