Spending vs. PSST
By Arnold Kling
Mark Thoma articulates the conventional view.
It’s useful to break down the economy into four major sectors — households, businesses, government, and the foreign sector…lower consumption growth will be a substantial drag on the economy…looking to housing to lead the recovery is likely to lead to disappointment….Business investment does not provide much hope either …As for foreign exports, which is one of our best hopes for growth in the long-run, it hard to see that sector leading the recovery since the rest of the world is having troubles too. …So there’s very little besides government that can provide the needed boost to the economy in the immediate future.
I would argue that this is like saying, “Our football team’s players are too small to win in this league. They can’t get any taller. Their bones can’t get any thicker. And they can’t add enough muscle. So what we have to do is make them fatter.”
The problem with the conventional view is that it is focused on spending, as measured by GDP. As Mark points out, this consists of spending by households, businesses, government, and the foreign sector. Everything seems to follow logically from that.
My alternative is to say that economic activity = PSST, meaning patterns of sustainable specialization and trade. GDP is one indicator that you can use to measure PSST, but it is not the best indicator.
There are many problems with using GDP as a measure of economic well-being. These are well known. They include the fact that some purchases are negative indicators–more burglar alarms, for example. GDP does not take into account positive and negative externalities. Ed Leamer points out that perhaps the most important omission in GDP is consumers’ surplus. The market gives us many goods and services at prices far lower than what we would be willing to pay for them. That is the virtue of competition.
I wonder how much consumers’ surplus is provided by government-provided goods and services. There are no market forces that lead the government to provide consumers’ surplus. In fact, there is nothing to stop the government from providing negative consumers’ surplus, in which the value of the goods and services is less than the dollar amount spent.
The focus on GDP might be justifiable if GDP were tightly related to employment. However, as we have seen, they are only loosely linked, at least in the short run.
I would like to see less emphasis on measuring economic activity as spending. I would like to see more effort put into understanding economic activity as patterns of sustainable specialization and trade.