The boss hires his worthless unemployed nephew for a summer job.  Does that raise GDP or lower it? To keep things simple think of this as ex nihilo hiring: if not for this hire, the person wouldn’t have been hired otherwise and if the boss doesn’t hire the worthless nephew nobody else is going to get the job.

As we saw last week, the answer to whether the worthless hire boosts GDP turns on whether the boss works for the government or for the private sector.  Let’s take a new look at why.  We usually measure GDP as total spending (by consumers, businesses, governments, foreigners) but it might be clearer if we remember that GDP is also total income: Every dollar spent goes to somebody either as wages or as business profits.  Omitting details (e.g., “wages” includes salaries and bonuses, “profits” are often paid out as interest to the bank), we can sum it up this way:

GDP = Wages + Profits
But here’s the thing: Government doesn’t make a profit.
That’s not a punchline: That’s the reason government hiring of the unemployed boosts GDP by definition while private hiring of the unemployed does not.  When the private sector boss hires his worthless unemployed nephew, the nation’s total wage bill rises by, say, \$100K, but the nation’s total profits also fall by the same \$100K: The firm’s decision to hire the worthless worker is the firm’s decision to take an equal cut in profits.
But when the government hires the same worthless unemployed nephew, the nation’s total wage bill rises by \$100K and then…that’s it!  Government doesn’t report profits–at least in the GDP figures–so government doesn’t record any – to balance out the +.  A GAO audit might report wasteful hiring but it won’t show up in GDP.
Official GDP statistics assume the value of a government worker is what she costs. Official GDP statistics assume the value of a private worker is what she produces.  That’s the reason worthless government workers have a bigger boost to GDP than worthless private workers.
And there’s another lesson to draw from this: If we measured the value of the private sector the same way we measure the value of the public sector–by looking just at wages–then the private sector would look more stable than it currently does.  In the private sector, total wages are vastly more stable over the business cycle than total profits.  When the average firm loses sales during a slump profits take the biggest percentage hit, not wages. Profits are—as a matter of arithmetic, leaving causation aside–a volatility multiplier.  Image a GDP figure that was missing this:

It would be great to measure how much reported GDP volatility would fall if we calculated the whole thing the same way we calculate the government part of GDP.  A task for another day…..
[I thank Patrick and Alex for spurring me to think about GDP in income terms.]