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Overview
How GDP came to rule our lives—and why it needs to change
Why did the size of the U.S. economy increase by 3 percent on one day in mid-2013—or Ghana's balloon by 60 percent overnight in 2010? Why did the U.K. financial industry show its fastest expansion ever at the end of 2008—just as the world’s financial system went into meltdown? And why was Greece’s chief statistician charged with treason in 2013 for apparently doing nothing more than trying to accurately report the size of his country’s economy? The answers to all these questions lie in the way we define and measure national economies around the world: Gross Domestic Product. This entertaining and informative book tells the story of GDP, making sense of a statistic that appears constantly in the news, business, and politics, and that seems to rule our lives—but that hardly anyone actually understands.
Diane Coyle traces the history of this artificial, abstract, complex, but exceedingly important statistic from its eighteenth- and nineteenth-century precursors through its invention in the 1940s and its postwar golden age, and then through the Great Crash up to today. The reader learns why this standard measure of the size of a country’s economy was invented, how it has changed over the decades, and what its strengths and weaknesses are. The book explains why even small changes in GDP can decide elections, influence major political decisions, and determine whether countries can keep borrowing or be thrown into recession. The book ends by making the case that GDP was a good measure for the twentieth century but is increasingly inappropriate for a twenty-first-century economy driven by innovation, services, and intangible goods.
Product Details
| ISBN-13: | 9781400873630 |
|---|---|
| Publisher: | Princeton University Press |
| Publication date: | 09/22/2015 |
| Sold by: | Barnes & Noble |
| Format: | eBook |
| Pages: | 184 |
| Sales rank: | 1,002,738 |
| File size: | 2 MB |
About the Author
Read an Excerpt
GDP
A Brief But Affectionate History
By DIANE COYLE
PRINCETON UNIVERSITY PRESS
Copyright © 2014 Diane CoyleAll rights reserved.
ISBN: 978-1-4008-7363-0
CHAPTER 1
From the Eighteenth Century to the 1930s: War and Depression
Warfare is the mother of invention. Many new technologies that end up in use in civilian life have been spurred by the demands of conflict and funded by the military. Among these inventions, ranging from the Internet to Teflon, radar to programmable electronic computers, is Gross Domestic Product. GDP is one of the many inventions of World War II.
Its name sounds as though it should be self-explanatory. Product: things that are produced. Domestic: at home. Gross: nothing deducted, the opposite of net (conversely, a cereal packet will give "net weight," meaning the contents alone, not including the packaging). GDP is just one figure in a full set of accounts for the economy, the national income accounts. We will get to the detail later. To make sense of the idea of GDP, first a brief history of the development of national statistics will help.
The Early Days of National Accounting
It was an earlier war that prompted the first systematic attempts to measure the whole of the economy. In 1665, a British scientist and official, William Petty, produced estimates of the income and expenditure, population, land, and other assets of England and Wales, with the aim of assessing the country's resources to fight a conflict and finance it through taxes (it was the now little-known Second Anglo-Dutch War, which lasted from 1664 to 1667). Petty wanted to prove not only that the country could bear a higher burden of taxes but also that it was capable of taking on its powerful neighbors, Holland and France. There was no need for it to win more land or increase the size of the population to ensure victory, because the available land and capital and labor could be used to better effect. This was a significant economic insight. Also significant was Petty's introduction of the tool of double-entry bookkeeping to keep records for the nation as a whole. Another early set of estimates, by Charles Davenant in 1695, had the title An Essay upon the Ways and Means of Supplying the War, making his aim perfectly clear. The word statistics has the same origin as state, and originally referred to the collection of figures concerning the state, specifically taxes. It proved to be a major advantage for England to have consolidated national income statistics, enabling calculations about the scope for increased output and tax revenues, when its larger and seemingly more powerful neighbor France lacked such information. Not until 1781 did the French king have similar strategically important economic and financial data, when the finance minister Jacques Necker delivered a famous compte rendu au roi, or report to the king, on the strength of the French economy. It enabled the king to raise new loans but did not, of course, help him avert the French Revolution in 1789.
Throughout the eighteenth century a number of successive statistical pioneers built on these first British attempts, although each was measuring slightly different things. The concept of "national income" may seem clear enough, but measuring it in practice means choosing what to include and exclude, which is surprisingly fuzzy. Unlike in our own time, there was no standardization, no commonly agreed definition; and what was measured was not at all like modern GDP. What these early national accounts had in common was the general idea that the national income depended on how much was available to spend now and how much remained for increasing the national stock of assets.
This framework evolved over the decades. Later authors emphasized different aspects of the economy. Some — among them the novelist and pamphleteer Daniel Defoe — thought that the key to the nation's prosperity was increasing trade, both overseas and within the country. At another time, the debate in coffeehouses and pamphlets centered firmly on the national debt, the figures for which the government published frequently between the late seventeenth and late eighteenth centuries. Once again, financing warfare was the motivation.
Then came a substantial intellectual innovation. In The Wealth of Nations (published 1776), Adam Smith introduced the distinction between "productive" and "unproductive" labor. An anonymous author had written in 1746, "What I mean by National Income is, all the whole body of our People get or receive from Land, Trade, Arts, Manufactures, Labour, or any other way whatsoever; and by Annual Expence I mean, the whole that they spend or consume." Yet in Adam Smith's definition thirty years later, the "whole body of our People" did not count. Only those involved in the making of physical commodities, agriculture and industry, would count toward national income. The provision of more services was a cost to the national economy, in his view. A servant was a cost to his employer, and did not create anything. Importantly, money spent on warfare or the interest on government debt was also being used unproductively. The nation's wealth was its stock of physical assets less the national debt. National income was what derived from the national wealth. According to Benjamin Mitra-Kahn, "The Wealth of Nations introduced a new idea of the economy, and through the effort of Adam Smith's students and admirers, it was adopted almost instantly."
In Smith's own words:
There is one sort of labour which adds to the value of the subject upon which it is bestowed: There is another which has no such effect. The former, as it produces a value, may be called productive; the latter, unproductive labour. Thus the labour of a manufacturer adds, generally, to the value of the materials which he works upon, that of his own maintenance, and of his master's profit. The labour of a menial servant, on the contrary, adds to the value of nothing.... A man grows rich by employing a multitude of manufacturers: He grows poor, by maintaining a multitude of menial servants.
The idea of a distinction between productive and unproductive activity, adopted by Adam Smith, dominated economic debate and measurement until the late nineteenth century. Karl Marx echoed it, and it remained the basis for measuring the centrally planned economies until the collapse of communism after 1989. For example, the Soviet Union's economic statistics counted material output and largely ignored service activities; yet by the late 1980s, these accounted for about two-thirds of GDP in the Western capitalist economies, so it was a large omission.
Still, this way of thinking about the national economy in terms of material production was generally adopted in the nineteenth century, until it too was overturned. Then the new generation of "neoclassical" economists (in contrast to "classical" economists such as Adam Smith) discarded the distinction between productive and unproductive activities. Alfred Marshall, as titanic a figure as Smith in the history of economic thought, said firmly: "Wealth consists of material wealth and personal or non-material wealth." Services were to be included in the definition of national income. The work done in the late nineteenth and early twentieth century to measure the economy in the wake of Marshall's decree in his 1890 book Principles of Economics has been described as a "first phase" of national income accounting.
The Birth of Modern National Accounts
This quick dip into the early history of national income accounts and the forerunners of GDP shows that the definition of "national income" was not precise or fixed. How it was interpreted depended on the intellectual climate and on the political or military needs of the moment, and so the definition changed over time. Some economists have concluded that the pre-twentieth-century measurement of the economy was not all that serious. Angus Maddison, who spearheaded the extraordinary achievement of constructing GDP statistics for the world dating back to ad1000, wrote, "Economic growth was much slower before the 19th century and therefore seemed irrelevant or uninteresting." He added, a bit sniffily: "Although there was a proliferation of national income estimates, there was little improvement in their quality or comparability. They provided little help for serious analysis of economic growth, and there were significant differences in their coverage and methodology." The early work was certainly not consistent over the years, nor consistent with our modern definitions. But the opposite interpretation seems likely: from the nineteenth century, people were starting to reconsider how to measure the economy precisely because it was starting to grow, thanks to the Industrial Revolution and the dawn of capitalism.
The definitions we use now date back to two seismic events in modern history, the Great Depression of the 1930s and World War II (1939–1945).
Following the publication of Alfred Marshall's Principles of Economics, a number of researchers had already set about new efforts to improve the collection of statistics and the measurement of national income. In the United Kingdom, the most successful was due to Colin Clark, who throughout the 1920s and 1930s calculated national income and expenditure, for the first time on a quarterly rather than an annual basis, and with a new degree of care and thoroughness. For example, he provided detailed splits of production and expenditure into different categories and published thorough accounts of the government's finances, too. He discussed how to adjust the figures for inflation, and also the distribution of income among different categories of people. Clark was appointed in 1930 to provide statistics to the newly created National Economic Advisory Council, the first body ever created by the British government to provide formal economic advice. The experience of the Depression created this demand for statistics that might help the government figure out how to bring to an end the unprecedented economic slump.
Across the Atlantic, in the United States, Simon Kuznets had a similar motivation. The government of Franklin Delano Roosevelt wanted a clearer picture of the state of an economy trapped in a seemingly endless depression. The National Bureau of Economic Research was requested to provide estimates of national income. Kuznets, who later won the Nobel Memorial Prize in Economic Science for this work, took on the task of developing Clark's methods and applying them to the U.S. economy. He was a meticulous collector and assembler of data, paying careful attention to the circumstances in which different statistics were gathered, and what their flaws might therefore be. His first report, submitted to Congress in January 1934, showed that America's national income had been halved between 1929 and 1932. Even in those depressed times the report was a bestseller, at twenty cents a copy, and the first print run of forty-five hundred copies quickly sold out. President Roosevelt cited the figures in announcing the new Recovery Program and used updated figures (running up to 1937) to send a supplemental budget to Congress in 1938. As one survey of the history of national accounting points out, having national income estimates for the whole economy made a huge difference to the scope for policy. President Herbert Hoover had made do with the incomplete picture painted by industrial statistics such as share price indexes and freight car loadings. This information was less compelling, as a call to action, than an authoritative figure showing the halving of the whole of national economic output in the space of just a few years.
Kuznets, however, specifically saw his task as working out how to measure national economic welfare rather than just output. He wrote:
It would be of great value to have national income estimates that would remove from the total the elements which, from the standpoint of a more enlightened social philosophy than that of an acquisitive society represent disservice rather than service. Such estimates would subtract from the present national income totals all expenses on armament, most of the outlays on advertising, a great many of the expenses involved in financial and speculative activities, and what is perhaps most important, the outlays that have been made necessary in order to overcome difficulties that are, properly speaking, costs implicit in our economic civilization. All the gigantic outlays in our urban civilization, subways, expensive housing, etc., which in our usual estimates we include at the value of the net product they yield on the market, do not really represent net services to the individuals comprising the nation but are, from their viewpoint, an evil necessary in order to be able to make a living.
These observations prefigure some of the criticisms made of GDP in our own time: GDP definitely does not attempt to measure welfare or well-being (a subject picked up again in chapters 5 and 6).
With this aim, in fact, Kuznets was out of tune with his times. Welfare was a peacetime luxury. This passage was written in 1937, when his first set of accounts was presented to Congress. Before long, the president would want a way of measuring the economy that did indicate its total capacity to produce but did not show additional government expenditure on armaments as reducing the nation's output. The trouble with the prewar definitions of national income was precisely that as constructed they would show the economy shrinking if private output available for consumption declined, even if the government spending required for the war effort was expanding output elsewhere in the economy. The Office of Price Administration and Civilian Supply, established in 1941, found that its recommendation to increase government expenditure in the subsequent year was rejected on this basis. Changing the definition of national income to the concept of GDP, rather than something more like Kuznets's original proposal, overcame this hurdle.
There was a heated debate between Kuznets and other economists, especially Milton Gilbert of the Commerce Department, about the right approach. The discussions were highly technical but the underlying issue was profound: what was the meaning of economic growth and why were statisticians measuring it? Gilbert and his colleagues were clear that the aim was to have a measurement that was useful to the government in running its fiscal policy. As one of the pioneers of GDP put it, rather blandly: "It will be convenient if the incomings and outgoings of public authorities in the provision and organization of common services such as defence, justice, education and public health are thought of as consolidated in the consumption box, being in fact nothing more than agency activities for the body of consumers as a whole." An official U.S. history of the national income accounts describes it this way:
Before GNP [Gross National Product] was made available, projected defense expenditures were sometimes erroneously subtracted from projected national income, producing a residual that was interpreted as the amount of production left for non-war goods and services.... The assessment was overly grim because national income fell short of the total market value of goods and services produced, of which defense spending was a component....
By including all government purchases as part of national products, the GNP statistics established the role of national government in the economy as that of an ultimate consumer, that is as a purchase of goods and services for final use.
The first American GNP statistics were published in 1942, distinguishing between the types of expenditure, including by government, and permitted economists to see the economy's potential for war production. "The inclusion of business taxes and depreciation [in GNP measured at market prices] resulted in a production measure that was more appropriate for analysis of the war program's burden on the economy." Kuznets was highly skeptical: "He argued that Commerce's method tautologically ensured that fiscal spending would increase measured economic growth regardless of whether it actually benefited individuals' economic welfare." In the policy tussle in Washington, Kuznets lost and wartime real-politik won.
This decision was a turning point in the measurement of national income, and it meant that GNP (or later GDP) would be a concept strikingly different from the way the economy had been thought about from the dawn of modern industrial growth in the early eighteenth century until the early twentieth century. For two centuries, "the economy" was the private sector. Government played a small role in economic life, and featured mainly because it looked to raise taxes to pay for wars. Its role expanded steadily over the centuries, however. In Victorian times this began to extend to the provision of other services, those we take for granted now such as roads and water as well as the historic government roles of defense and justice. By the time the wartime economists developed the modern concept of GDP, government was already a far greater presence than it had been. Subtracting defense spending from the older conception of national income would have wrongly given the impression that the war effort was going to involve a huge sacrifice in private consumer spending. There is, of course, a world of difference between a monarch extracting tax revenues to wage war and a democratic government pooling citizens' incomes to provide services and social security. One aspect of this democratic transition was the switch to conceiving of government as adding to national income rather than subtracting from it. However, the importance of wartime necessity in shaping the definition should not be underestimated. The pattern of growth before and after 1945 would have looked very different if government spending had been disregarded as before in the definition of total economic activity.
(Continues...)
Excerpted from GDP by DIANE COYLE. Copyright © 2014 Diane Coyle. Excerpted by permission of PRINCETON UNIVERSITY PRESS.
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Table of Contents
Note on the Paperback Edition viiIntroduction 1
ONE From the Eighteenth Century to the 1930s: War and Depression 7
TWO 1945 to 1975: The Golden Age 43
THREE The Legacy of the 1970s: A Crisis of Capitalism 61
FOUR 1995 to 2005: The New Paradigm 79
FIVE Our Times: The Great Crash 95
SIX The Future: Twenty-first-Century GDP 123
Acknowledgments 147
Notes 149
Index 161
What People are Saying About This
"Diane Coyle renders GDP accessible and introduces a much-needed historical perspective to the discourse of what we measure and why. A must-read for those interested in the far-reaching impact of GDP on the global economy, just as we seek ways to go beyond it."—Angel Gurría, secretary-general of the Organisation for Economic Co-operation and Development"Countries are judged by their success in producing GDP. But what is it and where do those numbers reported on television come from? Diane Coyle makes GDP come to life—we see its strengths and its fallibilities, and we learn to understand and respect both."—Mervyn King, governor of the Bank of England, 2003-2013"This is an engaging and witty but also profoundly important book. Diane Coyle clearly and elegantly explains the fundamental difficulties of GDP—and how this headline figure is liable to radical change by apparently simple changes in method. She also provides a nice treatment of alternative proposals such as happiness surveys."—Harold James, author of Making the European Monetary Union"GDP: A Brief But Affectionate History is a fascinating 140-page book that I cannot recommend highly enough. This is simply the best book on GDP that I've ever seen."—John Mauldin"Well written, interesting, and useful, this book will appeal to many readers. I learned a lot from it."—Robert Hahn, University of Oxford