The ABCs of GDP

Is gross domestic product a worthy estimate of our worth?


How should we gauge our well-being? One economist suggests opening the mouths of residents and inspecting their teeth. A less equine measure is the value of all that we produce on our soil, when we’re ready to use it. That’s gross domestic product (GDP).

Consider a simple economy – a soccer stadium that sells only tickets and doners. For a match, that stadium sells 10,000 tickets at 500 tenge apiece as well as 1,000 doners for famished fans at 150 tenge apiece. The value of the economy is 500T*10,000 + 150T*1,000 = 5.15 million tenge.

In general, GDP is the annual market value of final goods and services produced in the nation. In a year that was typical of its golden period, 2004, GDP in Kazakhstan was 5.5 trillion tenge, .3% of GDP in the United States. Kazakhstan’s economy grows more slowly now. Adjusted for inflation, GDP in 2012 was only a fifth higher than in 2008. This lackluster performance was mainly due to a 3% drop in GDP in 2009, in the wake of a bank crisis.

A “final good” is a good at the point of use. For example, you can drive an automobile right off the dealer’s lot. The steel that goes into the car is not a final good but an input, the value of which is reflected in automobile’s price. Suppose that $8,000 of steel is used to produce an SUV that sells for $15,000. Then we will count only the $15,000 vehicle towards GDP. We won’t separately count the $8,000 of steel, since it is part of the $15,000.

We’ll use market value to avoid messy subjective judgments about what other people do. Maybe cigarettes are a form of assisted suicide, but we won’t supplant the smoker’s acuity with our own. If he paid 450 tenge for a pack of coffin nails, then we will assume that the pack was worth at least 450 tenge.

GDP includes foreign-owned enterprises. When foreigners help us produce more, they contribute to our well-being. China is an owner of some oil wells and pipelines in Kazakhstan. Despite its involvement, we will credit the full market value of this oil extraction and transport to Kazakhstan’s GDP.

Before the Nineties, economists calculated the value of what Kazakhstanis produced, whether here or abroad. That’s gross national product. For Kazakhstan, GNP includes operations in Kyrgyzstan that Kazakhstanis own, and it excludes oil operations here that are undertaken by only the Chinese.

If we worry about jobs, then GDP would seem the more accurate measure of our well-being. If instead we focus on income, then let’s try GNP. For a nation like Tajikistan, which sends a large share of its workers to Russia, GNP exceeds GDP.

Calculating GDP raises conundrums worthy of the hoariest philosopher. It should count just what we produce for the final user. But it includes what Almaty spends on its police force. Is police protection a final product or an input? You go to Ramstore because you trust the cops to keep your car from getting lifted. There, you spend 1,500 tenge on a trunkload of bread. If policing is just an input into your purchase, then we shouldn’t count, in GDP, the salary of the officer who patrols Furmanov Street while you’re shopping. Ramstore paid taxes for that protection and presumably passed on the cost to you (or to its owners).

Indeed, suppose that Ramstore can avoid paying its taxes and can contract with private guards. Its costs of production won’t change, since it now pays to the rent-a-cops what it had paid in taxes. The police services are just as valuable as before. Yet GDP will drop by the amount of public spending on the police that Ramstore now avoids.

Vagueness and vagaries

In some ways, GDP underestimates how much that we produce. A woman marries her gardener, who now labors for love. Her garden is still beauteous, but GDP will fall.

Also, GDP won’t account immediately for improvements of goods when competition among firms restrains the price. Half a million tenge buy a more powerful computer now than before, but GDP won’t reflect that until the number of sales rises.

In other ways, GDP overestimates our quality of life. Runoff from construction sites of one to five acres is a leading cause of water pollution. The sales value of the site is part of GDP, but the full costs of the pollution are not. Your drinking water may taste funny, and so you would value it less. But the price that you pay for the water remains the same. You may pick up an intestinal disease over the weekend from drinking the water. You are worse off, but GDP will rise by the value of the medical services that you procured.

The amount that we spend on clothing does enter GDP, but an American economist early in the 20th century, Thorstein Veblen, thought the money wasted. As he saw it, people buy clothes just to demonstrate how little that they must work. The rich wear top hats and coattails to show that they no longer need to dig ditches. The corset was a “mutilation” that sapped the woman’s vitality and “[rendered] her permanently and obviously unfit for work.” Clothes have no redeeming social value.

Does leisure suit?

GDP’s largest underestimate of the value of our product arises from its failure to account for what we do after punching out from work. You may enjoy writing haikus at home. But since you never sell them, they don’t boost GDP. In the recession of 2009, the number of workdays per employee in Kazakhstan fell more than 5% as compared to 2001. This reduced income but increased leisure, which is worth something even when it’s forced.

The American economist Robert Eisner estimated that unpaid labor at home would raise US GDP by a third. This includes cooking, wringing out dirty underwear, and looking after the tykes – as well as “connubial bliss,” which, valued on the market, would count as illegal activity except in places like Nevada.

Unpaid labor services are massive. In the US, married couples report spending almost as much time on housework as upon paid work. Households actually purchase more durable goods – presumably for household production – than firms do. GDP models typically ignore household production, but those that include it do a better job of explaining our economy. For example, in a recovery, households buy more goods for consumption. The usual model has trouble explaining why, because it assumes that people spend at a given rate over time; supposedly, they don’t buy many more goods during a recovery. In fact, however, people work more during booms, so they conserve leisure time by buying dishwashers. A model that includes household production will predict correctly that people spend more in recoveries, writes Jeffrey Wrase.

Because GDP doesn’t value housework, it may overestimate the output gain due to women taking jobs. But it may also overestimate the drop in the amount produced per worker – “productivity” – because the share of inexperienced workers of the labor force has increased. Even had the new workers been experienced, productivity would have dropped anyway, because more workers now shared the same number of machines. But suppose that we account for the woman’s productivity at home. She chose the factory over the kitchen, so she must have judged that the value of what she did would rise, notes Eisner. The flocking of women to the labor market may increase productivity, even though the surge in workers will increase competition for jobs and thus cut market wages for a while.

Although GDP may underestimate the size of our economy, increases in GDP generally benefit people. They live longer, go to school longer, and are more likely to read in nations with higher GDP per person. The figures on infant deaths tell the story. In the West, about six babies die out of every 1,000 live births. In the least developed countries, 100 babies die, note Robert Frank and Ben Bernanke (who now heads the central bank of the US). Also, in the poorest countries, children are less likely to go to school, perhaps in part because they could work on the farm instead and earn income for the family. GDP increases now, at the expense of foregone later gains in GDP that would have stemmed from education. The obsession with GDP of political leaders in the Third World is myopic. –Leon Taylor, tayloralmaty@gmail.com


Good reading

Robert Eisner. Extended accounts for national income and product. Journal of Economic Literature. Pages 1611-1684. December 1988.

Robert Eisner. The misunderstood economy: What counts and how to count itT. Harvard Business Press. 1995.

Robert H. Frank and Ben S. Bernanke. Principles of macroeconomics. McGraw-Hill. 2008.

Thorstein Veblen. The theory of the leisure class. Various editions. 1899.


References

Statistical Agency of Kazakhstan. Real monetary income. www.stat.kz

Statistical Agency of Kazakhstan. Use of labor time as of November 2010. www.stat.kz

Jeffrey M. Wrase. The interplay between home production and business activity. Business Review. Pages 23-29. The second quarter of 2001. Federal Reserve Bank of Philadelphia. www.phil.frb.org

The big push

How will history judge Kazakhstan’s industrial policy?


The government of Kazakhstan has made industrialization its top economic priority for the next few years, hoping to rev up economic growth and to create jobs for all, reports Kursiv’. Political leaders claim that only industrialization can vault Kazakhstan into the ranks of the top 30 nations. Turkmenistan’s president has also said that he wishes to industrialize. How likely, in Central Asia, is success?

History may provide a clue. In his cogent survey, Global economic history: A very short introduction, Robert Allen of Oxford University suggests this: While careful (or lucky?) planning may ignite economic growth, it cannot ignore the resource – workers, machines, or land – that the nation holds in relative abundance.

Consider Japan of the late 19th century. In the West, the ratio of capital to labor was unusually high, because workers were relatively few. This scarcity drove up the value of another worker and consequently wages. To hold down costs, Western firms innovated ways to produce that relied more on capital than on labor. Their production of silk used metal machines powered by a steam engine. But in Japan, the ratio of capital to labor was low. The relative abundance of workers reduced their wages, rendering labor-intensive methods of production the cheapest. To reel silk, firms used wooden machines powered by men who turned cranks.

Labor scarcity played a key role in the West’s Industrial Revolution. By 1820, Europeans were rich in part because their high wages had expanded demand for their own products. Manufacturers sought to satisfy the new demand by substituting cheap capital – buildings and machines -- for expensive labor. This raised the capital-labor ratio and consequently wages, creating a virtuous circle. Karl Marx had thundered that increasing reliance on capital would destroy jobs, but in reality the ascent of wages raised the worker’s standard of living over the long run in the West. “The countries that were richest in 1820 have grown the most,” Allen writes. This may not surprise you, since richer nations have more wealth for financing expansions of economic capacity.

Standard model, sluggish performance

Early in the 20th century, economists, observing the economic growth of the United States and Western Europe, recommended to poorer nations the “standard model” – “railways, tariffs, banks and schools,” as Allen puts it. Tsarist Russia illustrates the pitfalls and opportunities of this approach. Russia built rail links to the rest of Europe and raised tariffs (import taxes) on pig iron to encourage domestic production of it. Also, education expanded: By World War I, almost half of Russia’s adults could read.

Yet the nation still depended on the West for stimuli to growth. Rather than adapt Western technology (knowhow) to its own peculiar mix of inputs, Russia simply imported it, by permitting foreigners to build plants of their own design on its soil. “Tsarist economic growth was mainly an agricultural boom, souped-up with some tariff-induced industrialization.” The nation still had far more workers than could be employed, so wages remained at rock-bottom. Any gains from industrialization went to the owners of firms and land. Add a world war, stir vigorously, and you have 1917.

In the wake of World War II, the need to quickly rebuild European and Asian economies led to tinkering with the standard model. “Big Push” industrialization, as Allen calls it, emphasized timing. “The only way large countries have been able to grow so fast is by constructing all of the elements of an advanced economy – steel mills, power plants, vehicle factories, cities, and so on – simultaneously.” The glaring example of the Big Push, Stalin’s Soviet Union, demonstrated its limits. Markets lack time to adjust to consumer wants, so a dictator must impose his own preferences (and will be none too shy).

Kazakhstan seems to have embarked upon a variant of the Big Push, and the impact on the transition to markets remains to be seen. The only verity is that consumers will not have the last word but may have the last laugh. -- Leon Taylor, tayloralmaty@gmail.com


Good reading

Robert C. Allen. Global economic history: A very short introduction. Oxford University Press. 2011.


References

Aleksandr Constantinov. Razgovor nachyctotu. Kursiv’. Page 1. January 24, 2013.

Catherine A. Fitzpatrick. Turkmenistan: President concedes need to industrialize. Eurasianet.org. January 10, 2012.