Tag Archives: macroeconomics

GDP as an End in Itself

A friend of mine was telling me today that Europe is a basket case, past its prime, beyond hope. I should point out that my friend was talking about the economies of Europe, and he tends to view things as pretty black and white.

I lived in Europe for 7 years, and I like Europe. Sure, it has its problems, but it’s no basket case. Okay, some of southern Europe is a basket case, but most of Europe would be doing pretty well right now were it not for the debt ailments of the south and the austerity treatments intended to cure them.

What my friend was really saying was that the Gross Domestic Products (GDPs) of European countries are probably not going to grow as quickly as the U.S.’s GDP will in the future.

This may or may not be true. I probably could come up with evidence in favor or against. No one can predict the future with any certainty, and my guesses aren’t much better than anyone else’s. But I’m not going to argue that issue one way or another.

My problem is with using GDP growth as the end-all only-thing-that-counts gauge of how a country’s doing.

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I’ve written before about problems with Gross Domestic Product. GDP is the total amount of goods and services produced by a country in the course of a year. Growth in real GDP is the single best measure we have for economic progress, but there are so many problems with it that focusing on it to the exclusion of all other factors does more harm to a country than good.

GDP isn’t an end in itself, or at least shouldn’t be, any more than we earn our incomes just to roll around in piles of cash. People earn money in order to live and try to be happy. A country produces GDP so that its people can live and try to be happy. GDP is just a means to an end, a way for the people of a country to try and try to be happy.

Increases in GDP can be great for quality of life. GDP includes everything from MP3 players to heart transplants, an everything in between. That covers a lot of stuff that can make our lives richer and fuller and more rewarding, giving people more opportunities and chances for that happiness that we all crave.

But you want to know a little secret? Increasing GDP doesn’t necessarily mean the people are better off. There’s an old economist joke. Actually, there are thousands of old economist jokes. But one comes to mind:

Two economists are walking home together after work. The first one says to the other, “I’ve had a horrible day, and I’m very angry. I really want to punch someone in the face. Tell you what – I’ll give you $500 if you’ll let me punch you in the face.”

The second economist thinks about it for a second. He could use some extra cash, so he takes the deal. The first economist punches him in the face and gives him $500.

“There!” says the first economist. “I feel much better now.”

The second economist says, “But now I’m angry and want to punch someone in the face. Tell you what. I’ll give you your $500 back if you’ll let me punch you in the face. Deal?”

The first economist is now in a great mood and so agrees. The second economist punches him in the face and gives him the $500 back.

They continue walking along, and the first economist says, “Now I’m in a bad mood again. We’re back where we started, only now we both have sore faces.”

The second economist says, “Yeah, but look on the bright side. We’ve increased GDP by $1000!”

Unfortunately there’s a little too much truth for comfort in this joke. Technically, the two had increased GDP by $1000, though it’s unlikely that the Bureau of Economic Analysis would ever find out about it and include it in their figures.

The point is that increasing GDP doesn’t necessarily make anyone better off. It’s just a number, a measure of economic activity. Nothing about it says that economic activity is actually good.

Don’t get me wrong. Holding all else constant, increasing GDP is better than not increasing GDP any day of the week. But the problem is, all else is never constant. Things are never that simple.

So I take issue with the idea that Europe is a basket case, or beyond hope, or in any generalizable way destined for future failure or insignificance.

Yes, Europe generally has higher and more progressive taxes than we do in the U.S., and that has implications for future GDP growth Europe. But that’s hardly the end of the world.

GDP for the sake of GDP is not just misguided. It’s silly, wasteful, and counter-productive, just like money for the sake of money. It’s time we move past this obsessive focus on GDP as an end in itself, and start thinking about what GDP is for and why we want it to grow.

Recessions as Economic Earthquakes, Business Cycles, and the Australian Miracle

Economists know a lot about recessions. We know things that influence them, the dynamics of how they develop, what affects how they evolve, and hundreds of different ways to analyze and quantify them.

But we still can’t predict them. And, for all practical purposes, we can’t say definitively what “causes” them.

Recession are kind of like earthquakes. Seismologists and geologists understand a lot about earthquakes. But they still can’t predict them.

You’ll hear some “experts” saying that they know exactly what causes recessions. They might think they know, and even believe they know. But they don’t know. Not well enough to be able to predict them, anyhow.

And you’ll read that Person X predicted the last recession, with the implication that  Person X really knows everything there is to know about recessions and economics, so you should always listen to Person X.

I don’t buy that. I don’t put much stock in people who claim to have “predicted” such and such economic event. For one thing, if you predict a recession enough times, you’re going to be right eventually. People predict recessions all the time – a “the sky is falling” financial crisis book comes out roughly every 3.9 minutes. Eventually there’s always a crisis, and the authors claim to have predicted it. Only they’ll conveniently forget about the 27 false alarms they had before they finally got it right.

Part of the problem is that economies are just too complicated for people to be able to predict much about them very accurately. Far too many unpredictably things affect economies. Weather. Revolutions. Politics. Elections. Wars. Politicians. Dictators. Terrorism. The individual choices and decisions of 7+ billion consumers. There’s just no way to take all those things into account and come up with useful and reliable predictions.

Yes, we can forecast, but it’s basically trying to quantify chaos theory. The best anyone can do is maybe come up with probabilities of certain outcomes. And even those will be iffy.

About the only prognosticator I give much credence to is Warren Buffett. And even he admits that he makes mistakes.

So the next time someone tells you that you have to believe what Person X says because he/she predicted Y, ignore it. If someone manages to predict three recessions in a row without any false alarms, they’ll have my attention.

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So what is a recession, anyhow?

The textbook rule-of-thumb definition is two or more consecutive quarters of negative real GDP growth. In other words, whenever an economy shrinks for 6 months.

In truth, it’s more complicated than that, as reality often is. For reasons that are still imperfectly understood, economies tend to move in an up-and-down cycle. They grow for about 2 to 10 years, and then shrink for about 6 to 24 months. The periods of growth are called expansions, and the periods of shrinkage are called recessions.

The two-quarters-of-negative-real-growth rule usually is close enough for government work. But not always. What if an economy shrinks substantially one quarter, grows 0.1 percent the next, and then shrinks some more the next? By the rule of thumb, there’s been no recession, but that’s cold comfort to the people who lost their jobs. And that sort of thing does happen.

To sort this stuff out, the U.S. National Bureau of Economic Research (NBER) actually has a committee of some of the best brains in macroeconomics. In true economist fashion, it’s creatively called the Business Cycle Dating Committee. They meet whenever they see the need to pore over reams of data and decide when the most recent business cycle began and ended. In the process, they’re deciding when the expansion and recession were.

So here’s the actual NBER definition:

 A recession is a period between a peak and a trough, and an expansion is a period between a trough and a peak. During a recession, a significant decline in economic activity spreads across the economy and can last from a few months to more than a year. Similarly, during an expansion, economic activity rises substantially, spreads across the economy, and usually lasts for several years.

So a recession is “a significant decline in economic activity spreads across the economy and can last from a few months to more than a year”. In other words, an econquake.

As a public service, I’m including the NBER’s dates of all U.S. business cycles since 1854.

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One of the few things economists are absolutely certain about is that business cycles happen. We don’t know exactly why, and we can’t predict them all that well. But they do. Over and over people have claimed that we’ve beaten the business cycle, that there won’t be any more recessions. And over and over, they’ve been proven wrong.

If someone tells you that there’s no more business cycle, they’re trying to sell you something.

Yeah, yeah, economists are dismal scientists. We’re always predicting gloom and doom. But unfortunately we’re always right about that. Eventually, anyhow.

So when I read that Australia hasn’t had a recession in 21 years, I was suspicious. That was something I had to check out.

So I looked at the data. And sure enough, it’s true. By the textbook definition, Australia hasn’t had a recession since 1991. They’re not even having one now. The U.S. had recessions from March to November 2001, and from December 2007 through June 2009. But Australia’s economy kept growing, if somewhat more slowly.

So how did Australia avoid the Great Recession and the recession(s) before? What’s Australia’s secret? Have they found that Holy Economic Grail, the key to overcoming the business cycle?

That I seriously doubt. But answer that “how” question will probably decades to answer; economists are still debating the Great Depression, and that was 80 years ago.

And in true dismal scientist fashion, I’d like to point out Australia did have at least two slowdowns during those 21 years. They just weren’t severe enough to amount to “negative growth”.

Either way, it bears looking into. I’ll try and give it a shot in a future post.

Economics Area 51: The Great Labor Statistics Conspiracy

The number of jobs in the U.S. increased by 873,000 jobs in September, and the unemployment rate decreased from 8.1 percent to 7.8 percent.

Coming as it does right before an election, this news has been met with skepticism on the part of those who don’t want the economy to improve. Among these of course is Fox.

An article on Fox’s website implies not so subtly that something fishy is going on. According to Fox, former Congressional Budget Office director Doug Holtz-Eakin said “This must be an anomaly. It is out of line with any of the other data.” Holtz-Eakin noted the household survey is smaller, suggesting it is not as reliable. He called estimate of 873,000 new jobs “implausible.”

Never mind that the economy created 847,000 new jobs just this past January. Or that the economy lost 1,100,000 jobs in January 2009.

I have the utmost respect for the Congressional Budget Office. That said, I might point out that Holtz-Eakin was chief economic policy adviser for John McCain’s 2008 presidential campaign and is now head of the conservative American Action Forum.

As a labor economist, I’m in a position to have an opinion on the jobs numbers. I’ve spent many, many hours poring over the detailed survey data that the Bureau of Labor Statistics produces. Just one month of Current Population Survey data is a 150 megabyte text file.

I’m not saying it would be impossible to falsify something. I suppose nearly anything is possible. But the data is so detailed and complex that it would probably take 873,000 workers just to do it.

And thousands of economics and business researchers scrutinize this data. Dissertations and journal articles rise and fall on it. To alter that data in a way that would fool the thousands of  (often critical) researchers who look at this data in detail would be an incredibly difficult task. It would require so many people to be in on it that it would pretty much be impossible to hide.

It’s a lot like open source software. The whole process is all so transparent that it’s nearly impossible to pull something.

Admittedly, a lot of the new jobs were part-time, and we’d much rather have them be full-time. But part-time is better than none at all. No one’s hoping the economy will pick up more than I am, but, as I’ve pointed out in earlier posts, the Great Recession of 2008-2009 was unprecedented in scale and scope in the post-War period. It’s taking time to recover. But it could have been worse – much worse. If you doubt that, I refer you to the 1930s.

I’ll confess that I haven’t yet dug into the details of the September 2012 labor numbers the way I have with some of the earlier data. But I will. And when I do, if I find anything odd or out of the ordinary, I’ll be the first to point it out.

As an economist, I require – nay, crave – accurate labor data above all else. If there’s the slightest chance I’m not getting it, you’ll be hearing from me loud and clear.