GDP-B Doesn’t Cut It Either

GDP is hyped-up to be an all-important measure of economic activity. It does not measure economic activity, instead recording meaningless money-totals spent in unsound currency over a given period. A bad statistic such as GDP is wide open to official manipulation, and there is always a desire to enhance it. GDP-B, which includes an estimated consumer surplus, appears to conform with this desire. If it is successfully introduced, GDP would be substantially increased, making governments look good, and reducing their debt to GDP ratios. However, it is no more than a statistical cheat.

Gross Domestic Product-B attempts to capture the added value of things we don’t pay for, such as Facebook, WhatsApp, Google and other digital services free to the user. B stands for benefits; the benefits consumers receive from free and subsidised services. It was devised by Erik Brynjolfsson, a professor at MIT, and is a work-in-progress. He points out that according to the US Bureau of Economic Affairs, the information sector in GDP statistics has been stuck at between four and five per cent of GDP for the last twenty-five years. Yet, the importance of this mainly digital sector now dominates both work and leisure activities, benefits not recorded in GDP.

His solution is to quantify it by attempting to establish how much an average user of a free service would pay if it wasn’t free. The thinking goes that this approach allows the statistician to estimate a “consumer surplus”, defined as the difference between the consumers’ willingness to pay and the amount they actually pay. This approach obviously throws up substantial surpluses, which added to GDP would boost it significantly.

It is one thing to say how much a service is worth and another to actually pay for it. Those surveyed are told that one in two hundred will be paid the cash-value for abstaining from the digital service for a month. But surely, a reasonable person surveyed would say he is prepared to pay an artificially higher value for the service to maximise the potential payment for abstention. This potential for gaming the survey appears to be ignored.

Professor Brynjolfsson also points out that free stuff online probably reduces GDP, because we give up buying physical copy when we can obtain it for free online. There are many examples where this is undoubtedly true. Conceptually, he has a point; but it exposes confusion over the difference between a GDP money-total commonly believed to reflect an improving economy and the actual improvement to the human condition from economic progress. The latter is not measured by a money-total, but by the market’s unquantifiable but proven ability to satisfy consumers’ demands. While the impact of not buying physical newspapers and instead reading them online reduces GDP, there is no doubt that consumers prefer it. Discarding previous methods of delivering consumer satisfaction is, in fact, economic progress. Here we see evidence of economic progress while Professor Brynjolfsson regrets that GDP falls.

The consumer surplus error

Econometricians have been thinking for some time about something they call “consumer surplus”, so the concept is not new. Simply put, if a consumer is willing to pay $10 for something that costs $7, there is deemed to be a consumer surplus of $3. According to Professor Brynjolfsson, this is also the basis between a free Google service and what an average user would be prepared to pay for it.

This immediately flags up a problem with the concept. The precondition for an exchange of goods or services for money is that a buyer perceives the good or service to be worth more to him than the payment for it. Otherwise, the transaction does not take place. The supposed consumer surplus is not an additional factor to the transaction; it is the reason for it. It certainly should not be added to GDP in an apparent attempt to boost the statistic.

But is this the case with free digital services? We have established it is not an additional factor to a transaction, so logically it cannot be an additional factor in free digital services. Indeed, Professor Brynjolfsson misses the wider reasons for an internet transaction. Google acts as a marketing intermediary. In return for a user’s data, Google’s real customers in the advertising industry pay Google fees for highly targeted and accountable marketing. In effect, a barter takes place, where consumers swap their data for access to Google’s services. Access to this data allows Google to sell its marketing services to advertisers with additional analytical benefits not available using conventional media. It has nothing to do with generating a supposed consumer surplus.

In some instances, users of data services have passed on their data without it being used commercially. Facebook, for example, achieved a circulation of hundreds of millions before the company earned any income. It had the data and needed to find a way to exploit it. But in these cases, it is a mistake to think users get the service for free in the economic sense. While swapping their data for a service, they are consuming the company’s capital, which is spent on employing computer specialists and the hardware, together with all the other business expenses involved. Proponents of consumer surplus seem blind to these offsets, many of which are already included in GDP calculations.

The broader GDP fallacy

Econometricians have long been on a mission to measure things, and one way that always finds favour with the government is to unearth a method of enhancing GDP. But other than for currying official favour these attempts are useless and misleading, being frustrated by a simple fact: the economic calculations of a population over a period of time cannot be measured, let alone be turned into a statistic masquerading as a measure of an economy’s condition. This is because people choose. If they buy anything it is in preference to something else. Choice, not money-totals, is the driver of economic advancement. Choice leads to the creation of wealth and is the basis behind all exchange. Progress is the outcome of near-infinite numbers of binary choices, the result of individual judgements of relative values. Through the medium of money, individuals exchange the goods and services they provide to others in exchange for the goods and services they themselves need and desire. It is the basis of the division of labour, the most effective way a society organises itself for maximising improvement of the human condition.

Therefore the money-total is irrelevant. GDP is the money-total which, if perfected, is nothing more than the sum-total of recorded and qualifying transactions over a past period, normally annual or annualised. It assumes a make-believe world which does not change, neither progressing nor advancing. It tells us nothing more because it is just a sterile number, wrongly promoted above its usefulness. It has become a statistic that deceives both its compilers and users. For a government its only real use is as a yardstick for maximising taxation. Increase GDP and you make the burden of tax appear less. Governments have an obsession with appearances and tax-raising.

From a catallactic standpoint the economic uselessness of GDP as a measure of the economic condition can easily be demonstrated by comparing the conditions of an economy that uses sound money, which cannot be manipulated by the state, with the conditions of an economy where the circulating medium is an unbacked fiat currency issued by the state. Let us first assume an economy uses sound money, which cannot be tampered with by central banks and by commercial banks expanding money and credit out of thin air. Consumer choices are made within the confines of a fixed quantity of money in circulation.

Circulating money merely facilitates the exchange between all goods and services. In other words, the labourer labours so he can put food on his family table, clothe his family, take them to the seaside, and buy the conveniences of life as he and his kin so choose. The money he earns from his labour is the means by which he turns his labour into the goods and services he and his family need and desire. Putting to one side for the moment changes in the level of physical cash, total supply and demand for goods and services, together with changed in the factors of their production, must balance each other.

No more money is required for the economy of this sound-money society to “deliver the goods”.  In our example, credit is provided from genuine savings at an originary interest rate set by the time-preferences of an economising society.

The role of trade balances in sound money

Imported goods are matched by exports, and any difference will be minor, because the credit required to bridge any difference will be provided in sound money, in practice confined to self-liquidating trade finance.

Changes in the levels of physical cash were briefly mentioned above. In our sound-money example these balances will include both cash and cash deposited for safe-keeping in depository banks which do not lend it out. In the absence of fractional reserve banking (the source of credit expansion), physical and deposit money are personal spending liquidity, not to be confused with savings.

Together, changes in spending liquidity fuel minor imbalances in the balance of trade. A trade deficit is part and parcel of the export of money, the consequence of a general reduction of the quantity in circulation. The result is a fall in prices, reflecting an increase in the remaining money’s purchasing power.

The conditions that lead to a temporary deficit in the balance of trade in one jurisdiction are balanced in other jurisdictions by conditions that lead to corresponding surpluses. A trade surplus is part and parcel of an increase in the quantity of circulating money, reducing its purchasing power and therefore increasing prices. These higher prices tend to reduce the factors that lead to an export surplus. Money-flows are an important factor in setting a common purchasing power of sound money in all economies where it freely circulates, and in establishing the quantity of money a society needs. The relatively minor differences in trade balances in a sound-money economy will always lead to a price arbitrage, equilibrating prices between different trading centres.

For these reasons variations in a trade balance are trivial in an economy using sound money as the medium of exchange. Furthermore, it is a basic condition for a society that makes free choices, where all individuals can choose to spend the fruits of their labour as they please, using the money of their choice.

By exercising choice, consumers in aggregate will disadvantage some producers and favour others. Therefore, some producers will earn less and some more, but the total value of all transactions (the GDP) over the course of a year must be the same as the previous year, because without any change in the quantity of circulating money, there can be no change in the total proceeds of everyone’s labour.

Admittedly, this is an idealised theoretical analysis, which ignores factors always present. Those who are unemployed or otherwise unable to contribute production to society have to be provided for by others, either charitably or through state welfare. However, the conditions are the same, so long as their needs are met fully from the surpluses of others. It also ignores the non-productive role of the state. Here again, so long as the state balances its finances (which tends to be the case when the option of inflationary financing is not available) our sound money conditions apply.

We are led inexorably to a conclusion: the money required by a society is set by itself through trade. Furthermore, its increase obviously relates to the rate of increase of the population. If there is no population increase, then sound money in circulation need not increase at all unless society desires it. The concept of measuring economic progress by GDP then flies out of the window, because it cannot capture the improvements in economic conditions that go with sound money and is wholly irrelevant.

The above is an approximation of the monetary conditions that existed before the First World War, when much of the world was on a gold standard. No one can possibly claim that in Britain from the Napoleonic War to the First World War there was minimal progress, because this is what GDP over these decades would have indicated to today’s historians.

At this point we must traduce the back-calculations of GDP for these years. There is no data upon which to base these calculations, because data collection of GNP and GDP only commenced in the 1930s, and even then, imperfectly. Consequently, all earlier statistical estimates are baloney, and must be disregarded. Instead, catallactic analysis provides us with a far better understanding of the relationship between economic expansion and exchange ratios under a gold standard.

A catallactic approach tells us that under a gold standard it was arbitrage which adjusted price levels into an approximate conformity, as described above. Furthermore, traders were suspicious of any variation in the policies of note and coin issuers from sound money, thus imposing monetary discipline on governments tempted to issue unbacked currency. Consequently, general price levels between different nations showed a high degree of accord.

However, general price levels were affected by variations in gold mine output. Monetary gold in global circulation increased, particularly following the Californian gold rush in 1848, and South African discoveries after the late-1880s. This led to a tendency for prices of goods and services to rise as the extra gold went into circulation. Offsetting this was the rapid development of industrial production along with growing populations, which led to a counter-tendency for prices to fall. It so happened that the combination of these forces resulted in a general price stability for almost a century following the Napoleonic Wars.

Post-Keynesian economic beliefs are inconsistent with this sound money outcome. They defy the facts. Ignorance of economics, and particularly of the theories of exchange result in misunderstandings of the role and limitations of statistics such as GDP.

GDP growth only reflects the additional fiat money in the economy

Now let us assume an economy is based on unbacked fiat currency, and that an expansion in the quantity of currency and bank credit takes place. Obviously, this expansion in the money quantity is spent into the economy and is an addition to the money that previously circulated. If GDP recorded all economic activities, then the additional money simply adds to GDP as it is spent into circulation. Putting to one side any temporary distortions introduced by this extra spending, it is clear GDP increases precisely by the amount of extra money introduced.

This is being deliberately simplistic to establish an axiom. In reality, statisticians exclude important categories of spending, notably money directed at financial activities and investment speculation. This is designed to focus the GDP statistic on the consumption of physical goods and services only. But if a consumer spends the fruits of his or her labour on acquiring something not in the GDP statistic, for example payments in cash, it is not recorded.

The most significant exclusion by far is money and credit expanded into purely financial and investment activities, where the only contribution to GDP is from the personal earnings and consumption of the individuals who provide financial services. The exclusion of financial and unrecorded cash payments creates a disparity between changes in the quantity of money and credit and matching changes in GDP. It provides an explanation for why it is that monetary expansion drives up asset prices while an increase in the general level of prices in the components of GDP can appear relatively subdued, though this relationship changes over the course of the credit cycle.

The mistaken concept of inflation-adjusting GDP

Since they are aware that the purchasing power of a fiat currency has a tendency to decline over time, econometricians attempt to adjust GDP to take account of it. They reason that a true comparison between GDPs over successive years can only be made if price inflation is taken into account. In the process they pile error upon error.

As shown above, GDP is simply a money total which has no further meaning. If it increases all it tells us is that the total money and credit spent in the part of the economy included in GDP has risen. Because it means nothing more, no further adjustment to GDP is appropriate. The inflation of a GDP number lies in the quantity of money introduced into the GDP statistics, not in the price effects.

If GDP was not just a money-total, adjusting prices by an honest estimate of monetary inflation might have some rationale. Instead, it has become the basis for inflation-adjusted payments, principally by governments. As a result, statistical methods have developed to reduce measures of inflation and therefore the cost to the state of inflation adjustments, and to supress evidence of price inflation. So, not only is the application of inflation-adjusting to GDP not theoretically justifiable, but in the hands of government statisticians it has becomes doubly meaningless.

Conclusion

GDP is of little use to practical economists. The only justification for it perhaps is so that the proportion of total transactions allocated to the private sector can be compared with those for which a government is directly responsible. If we know, for example, that a government is responsible for 40% of GDP, we will know the extent of the burden it imposes on the productive private sector. The French government imposes upon its productive sector to the tune of 56% of total GDP. Take the government out, and you get a truer figure of GDP at only $1.22 trillion equivalent. Government debt stands at $2.71 trillion, so the implied government debt burden on the productive private sector is 220% of its GDP.

Looked at this way, a country like France is in deep debt trouble. Instead, econometricians, thee devisers and champions of GDP, would rather we take France’s debt to total GDP ratio to be 97%. This is inconsistent with a proper estimation of loan risk.

It is hardly surprising that GDP is not used truthfully, but instead as a massive obfuscating cover-up of the role played by the state. This is why the state looks favourably at attempts to rig GDP by academics at institutions such as MIT.

We must therefore dismiss Professor Brynjolfsson’s GDP-B as nonsense and disregard both it and GDP entirely.

Alasdair Macleod

HEAD OF RESEARCH• GOLDMONEY

 Twitter: @MacleodFinance

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