The Myth of GDP

We might be getting poorer while we imagine we’re getting richer.

One well-known number cited frequently to characterize the strength of the U.S. economy is GDP, or gross domestic product. In 2011, the country’s inflation-adjusted per-capita GDP was $48,282. In 2001, it was $45,046. Since those figures differ by 7.2 percent, we tend to believe that this period saw a net 7.2-percent increase in our economy’s ability to generate wealth.

Not so fast, says Tyler Cowen. His book, The Great Stagnation, argues that GDP is not that precise. Moreover, a GDP figure of today is not directly comparable to a GDP figure of years past, because the makeup of the number has changed. We look at this number as though it is made up of goods-producing activities to the same extent that it ever has been, and that’s a mistake.
The problem is the difference between value and expenditure, Mr. Cowen says. Economic value is what we believe we’re measuring, but GDP is actually tabulated from dollars spent. Where physical goods are produced and sold, that’s okay—price is an indicator of value. A car or an industrial valve is sold because it’s wanted at that price. But other sorts of spending are not like that.
Take health care. Money spent here is much less an indicator of value, because considerable health care spending is for treatments that do not prove effective. In Mr. Cowen’s words, “Some health care works and some doesn’t.” 
The same could be said of education. Much of the spending in this area leads to improvements in knowledge, skill or employment prospects, but much of it does not. This is the nature of the endeavor.
Then there is government. Because public monies are spent on behalf of citizens who do not necessarily want the purchase, value creation is often absent. Government might spend $1 million on an urgent public need or it might spend the same amount on a boondoggle. Either way, GDP logs this as $1 million of value. Thus, as a measure of wealth creation, GDP is overstated.
Of course, this padding within GDP has always been there. The difference today is that the three sectors cited here—health care, education and government—are now among the strongest growing sectors in terms of their share of GDP. Mr. Cowen says these sectors combined comprise more than 25 percent of GDP, meaning a fourth of the total now comes from activities for which a sizeable share of spending only masquerades as value. Given that the amount of GDP overstatement is potentially large while GDP growth lately has been small, we might currently be getting poorer while we think we’re getting richer. 
The lesson in this goes beyond just viewing GDP skeptically. Another lesson I see is this: As an economic activity, manufacturing is inherently superior. That’s not too strong of a word. Health care, education and government are needed—I wouldn’t want to lose any of them. But the role of these sectors is to support those creating wealth. To expect these sectors to create wealth themselves is to leave them buckling under a burden they can’t carry. The most reliable way to transform economic effort into value is to produce tangible goods that people want. If we’re not doing this, then the wealth we think we have is suspect.