Problems in GDP Measurement and Rent Seeking

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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.