Picture this: The U.S. government finally sells the Postal Service. As with other functions moved from the government to the private sector, the privatized post office does what the government did for about half the cost. So, with prices correspondingly lower, people spend roughly half as much as before on mail–which frees them to spend the difference on other desirable things. Because the Postal Service costs over $40 billion a year, the saving is $20 billion. By any reasonable measure, the average person in the U.S. is better off. In fact, the per capita increase in well-being is approximately $20 billion divided by 260 million citizens, or about $80 apiece.

But how does this change show up in gross domestic product? It doesn’t. The government’s contribution to GDP is measured not by how much value it creates but by how much it costs. So the $40 billion spent by the Postal Service counted as a $40 billion contribution to GDP. Cutting that in half through privatization may shift $20 billion from public to private hands but still adds up–under the conventions of national income accounting–to the same $40 billion. So the net effect on GDP of a $20 billion increase in economic well-being is precisely $0.00.

Obviously this is absurd. Indeed, “gross domestic product is not a good measure of a nation’s overall well-being” is what we economics professors tell our students every time we teach a macroeconomics course. (Macroeconomics is the study of employment, inflation, GDP, and economic growth.) But too many macroeconomists promptly forget that basic fact and judge an economy’s performance almost solely by the growth of its GDP.

This is from my article, “The Case for Small Government,” Fortune, June 26, 1995. I wrote it as a critical response to an earlier Fortune article by Paul Krugman.

Another excerpt:

Krugman asserted that any politician who claims he can raise the economy’s growth rate “by as much as three-tenths of a percentage point is naive–or worse.” Maybe, but that doesn’t mean a politician can’t add three-tenths of a percentage point to the growth rate of economic well-being.

Then I went through and showed how it could be done.

Why post this now? Because the point about GDP not being a good measure of economic well-being becomes even stronger when so many valuable services are given away on the Internet. That’s the point of an excellent article in the New Yorker, “Gross Domestic Freebie,” by James Surowiecki. Excellent, that is, until the last paragraph.

One great excerpt from Surowiecki:

New technologies have always driven out old ones, but it used to be that they would enter the market economy, and thus boost G.D.P.–as when the internal-combustion engine replaced the horse. Digitization is distinctive because much of the value it creates for consumers never becomes part of the economy that G.D.P. measures. That makes the gap between what’s actually happening in the economy and what the statistics are measuring wider than ever before.

I also covered some of the same ground in “GDP Fetishism.”

HT to Jeff Hummel.