Janan Ganesh, an often original if not iconoclastic columnist, asked why bad governments such as populist ones don’t seem to undermine economic growth, at least in the short run (“Why Hasn’t Populism Done More Economic Harm,” Financial Times, January 23, 2024). This provides us with a good opportunity to review what GDP numbers cannot prove.
For seven or eight decades, it has been known to economists (at least to those who studied the issue) that, if GDP might help those who get more of it, it does not measure “social welfare” (sometimes called “aggregate utility”). There is much welfare-economics theory behind the reasons for this, but they can be intuitively rendered in a few more or less equivalent ways, or at least that’s what I will attempt to do. (The basic theory can be found in Paul A. Samuelson’s “Evaluation of Real National Income [Oxford Economic Papers, 1950] and Francis M. Bator’s “The Simple Analytics of Welfare Maximization” [American Economic Review March 1957].) Consider different descriptions of what happens after the government forces the economy to move on the production possibility frontier (PPF) by authoritatively deciding that more of something and less than something else will be produced:
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Some consumers and possibly some workers and owners of capital are harmed. In economic jargon, the move is not a Pareto improvement. Since some gain and others lose, there is no social-scientific (economic) way to tell if “social welfare” has increased or decreased, whatever the GDP figures show. There is typically no practical way, nor even (as shown in the Samuelson article cited above) theoretical formulas, to compensate those who are harmed. Ultimately, the cause lies in the impossibility of interpersonal comparisons of utility. (Of course, if everyone gets a higher real income with nothing else changed, we would know that everyone’s utility, or individual welfare, has increased, and thus “social welfare” too.)
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Prices, which serve to add apples and oranges to make up GDP, lose their previous correspondence with consumer valuations.
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It is not consumer sovereignty that determines what will be produced in the economy, but government rulers or some majority. Imagine, for example, that real GDP grows at 10% and that all the growth accrues to the king, all other individuals being impoverished: “the economy” has improved, but there is no scientific way to establish that welfare has increased.
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The free interaction between demanders and suppliers is prevented from determining what “economic growth” is made of or what it is used for. To see this in a slightly different way, imagine that as the year 2023 progressed, the state continuously seized all its subjects’ incomes over subsistence level and invested the proceeds in a portfolio mirroring the S&P 500. Given that the latter increased by 24% during the year and assuming that the government invested the money as it seized it regularly (linearly) during the year, the investment portfolio would have yielded a return of 12%. Even if the government paid this gain back to its subjects, it makes no sense to say that “the economy” grew at 12%.
To summarize: If, and to the extent that, producers are not at liberty to make money by producing what consumers demand on free markets (what is called consumer sovereignty), the configuration of the number of units of goods and services produced and their prices (GDP is the name of this configuration) is basically meaningless; or, if you will, it represents what the rulers want to be produced at prices that represent the trade-offs they make.
In economic jargon, a government-dictated increase in GDP does not signal a Pareto improvement, that is, an increase in the welfare of some individuals without a decrease in the welfare of anybody else. Most economists, however, would view as Pareto improvements the production or financing of “public goods” wanted by everybody but not excludable to non-payers (such as territorial defense), as well as the reduction of “externalities.”
Thus, if a ruler’s dirigiste policies result in the production of, say, more steel and less wheat, an increase in GDP does not imply that the economy has grown in the sense of increasing the value of consumption as evaluated by the consumers themselves. It is only in the longer run and mainly negatively that the evolution of GDP (per capita) can lead to some conclusion: if it plunges or stagnates (as it did in Argentina for long periods), we may, especially if other indicators confirm the trend, consider that as a refutation of the ruler’s beneficial contribution to economic efficiency.
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Featured image: Busts of Juan and Evita Peron covered with snow.
READER COMMENTS
Kevin Corcoran
Feb 2 2024 at 11:18am
This reminded me of one of my favorite zingers I ever read from Paul Samuelson. Some years ago, I managed to acquire multiple volumes of economics papers and commentary published by the AEA throughout the early to mid 1950s. In A Survey of Contemporary Economics, Volume II, there is a paper by Kenneth Boulding describing the state of welfare economics. Samuelson is one of a few economists offering comment on that paper, where he says “There is no necessary connection with cardinal measurable utility of the individual, or with the addibility of the independent utilities of different individuals into some grand national total,” and says the very idea is a confusion only taken seriously by “a few utilitarians, drunk on poorly understood post-Newtonian mathematical moonshine.”
Pierre Lemieux
Feb 2 2024 at 11:39am
Kevin: I never read this article but I like the envolée littéraire by Samuelson. Boulding (an interesting economist whom I need to revisit) was not saying the contrary, was he?
Kevin Corcoran
Feb 2 2024 at 12:14pm
Oh no, Samuelson’s commentary was expressing broad agreement with Boulding and offering a few supporting comments of his own. But if you’re curious to check it out, I did some quick Googling and found this list of Boulding’s published work, including that 1952 paper, and the listing for that paper had another link leading to what appears to be a full version of the book online! The internet remains undefeated.
David Henderson
Feb 2 2024 at 1:09pm
Ken Boulding was great.
Craig
Feb 2 2024 at 12:07pm
“In economic jargon, a government-dictated increase in GDP does not signal a Pareto improvement”
Indeed, the socialist 5 year plans might target ‘steel’ or ‘concrete’ or whatever and after 5 years maybe they could point to an increase of these items. Ultimately if command is to produce things people don’t actually want, what’s the point. It becomes a stat in the book. Even if we look at the US during WW2, GDP went up, but the American people still were suffering economic privation in the form of ration cards etc (and naturally the deaths caused by war), but of course there were B-17s which, even though needed for the war effort, still aren’t things people would want in ordinary times.
I have often commented at having to pay $.56 off each dollar I earned at all levels of government while in NJ, but indeed that represented the government making the majority of economic decisions of what to do with my income. TJCA + a move to FL and I can point to things like houses in TN instead of tax dollars going to monstrous ships like the aircraft carrier Gerald Ford, a $20bn investment in power projection to make sure we can bomb the Houthi in Yemen.
Ahmed Fares
Feb 2 2024 at 3:30pm
The same argument was made as regards globalization.
On Trade, Angry Voters Have a Point
Pierre Lemieux
Feb 3 2024 at 12:40am
Ahmed: The same argument (if correct) can be made about everything, including of course internal trade and my trade with my butcher or with the company that sells prepared meals. The argument for trade has nothing to do with short-term GDP but with long-term opportunities and the possibilities of more welfare for virtually all individuals. Imagine how the world would be if the Industrial Revolution had not happened.* Trade is the opposite of command. It is central to human progress and, in Adam Smith’s or Jim Buchanan’s analytical tradition, is the basis of economics. Buchanan wrote (James M. Buchanan and Richard A. Musgrave, Public Finance and Public Choice: Two Contrasting Visions of the State [MIT Press, 1999]):
*One book to read about trade and progress is the delicious little book of John Hicks, A Theory of Economic History. He said that he wished it were for this book that the Nobel Committee had awarded him his Nobel prize in economics.
Jose Pablo
Feb 3 2024 at 5:01pm
In this regard (3% grow of the pie, the redistribution of the size of the slices and so on) how is “globalization” different from “open trade between Miami and Tampa”?
Richard W Fulmer
Feb 6 2024 at 1:28pm
How can trade be good for the country over all without also being good for the individual citizens of that country? Global trade isn’t carried on between countries; it’s carried out between individuals. Those individuals have decided that their lives are improved by trading with others – sometimes others living in different countries. By what calculus does Mr. Autor determine that they are mistaken and are making themselves worse off by their actions?
Far more people are hurt by innovation. Should we compensate those people as well or limit improvements in technology and industrial processes as some wish to limit trade?
To what extent should angry voters determine how others should live or how they should be allowed to dispose of their property?
Jim Glass
Feb 2 2024 at 5:53pm
Every textbook I ever had, when introducing GDP, flatly said right there “GDP is not a measure of welfare”.
Let’s see, looking now at my Gordon textbook from too many decades ago, yup, right there.
Craig
Feb 3 2024 at 4:27pm
It does make me wonder what the R2 of a correlation between per capita GDP and life expectancy might be?
Jose Pablo
Feb 3 2024 at 5:11pm
which makes me wonder what the R2 of a correlation between life expectancy and happiness might be?
It seems to me like a great tradeoff living less years but, for instance, having a clearly stablished right to have whatever sexual preference you could have or to give a finger to any and every authority or to not being robbed by the government on a daily basis or to not having to suffer periodically the unbearable exercise of stupidity that election campaigns are …
Craig
Feb 3 2024 at 6:57pm
I think the late comedian George Burns quipped that one could live to be 100 if one gave up everything one would want to be 100 for, which, given his cigar consumption and longevity is somewhat ironic.
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