This posting has been a long time in the hopper. It started long long ago when Serioso wanted to get into a jousting match with me over GDP and Government. I could see a yawning black hole of days opening before me, and basically quashed it.
But now is an O.K. time to address a couple of points on GDP and Government.
First, what is GDP?
On the one hand, it is a single well defined formula:
What is ‘Gross Domestic Product – GDP’
Gross domestic product (GDP) is the monetary value of all the finished goods and services produced within a country’s borders in a specific time period. Though GDP is usually calculated on an annual basis, it can be calculated on a quarterly basis as well. GDP includes all private and public consumption, government outlays, investments and exports minus imports that occur within a defined territory. Put simply, GDP is a broad measurement of a nation’s overall economic activity.
Gross domestic product can be calculated using the following formula:
GDP = C + G + I + NX
C is equal to all private consumption, or consumer spending, in a nation’s economy, G is the sum of government spending, I is the sum of all the country’s investment, including businesses capital expenditures and NX is the nation’s total net exports, calculated as total exports minus total imports (NX = Exports – Imports).
But as with all things Economics, the devil is in the details. Note that “Government” is part of GDP. Does it really increase our net national wealth or produce valuable goods and services to drop bombs on another country and reduce them to rubble? Is the creation of an airport near the home town of a Senator, when nobody much goes there, a net gain, or a waste?
Then there is the question of “In what currency?”. This is the classical Economics Rubber Ruler problem. The $US today is about 5 ¢ of the Gold Standard Dollar. So for any long term view of things, you must use a ‘price deflator’. But which prices? Buggy Whips and Oxen? The 1956 Chevy? The 2016 Google Autonomous Car? All are “transportation” so involved in how to deflate the transportation portion of the package. Or ought we to use € or ¥ to measure the USA? Gold? As a commodity it bounces up and down like crazy, though very long term tends to be that one ounce will buy “A Gentleman’s Suit Of Fine Clothing”. Yet even gold and silver move as mining tech moves (and as central bank fads change…). Silver, once pegged at 16 oz per oz of gold, is now closer to 50:1 (and also bounces around). So even two metals can’t properly deflate the other.
So folks “fiddle with the GDP”. Reagan had the inflation numbers (and thus the deflator) “cooked” so that inflation would be smaller and folks expectation of pay rises reduced. Now there’s an adjustment needed for pre vs post Reagan. Some folks deflate one way, some another, others do other things. Which deflator from which years? Eh?
Then there are long discussions of GDP vs NNP (Net National Product) and a dozen other ways to try to measure our “productivity” of stuff and services.
Now, even here, we have the tricky problem of how to measure $US exports properly against ?Whatever? currency imports.. Are two equivalent cars to be net zero against each other as the Ford Focus is not much different from a Datsun? Or do we let market swings of $ vs ¥ decide? If George Soros is seriously attacking the British Pound, does that make their cars “worth less”? But setting that aside, there’s a bigger issue.
Generally, that NX Net Exchange can be worked out reasonably. C Consumption is pretty clear, but subject to the Broken Window Fallacy. Tossing a rock through my own window, then paying someone to fix it, increases GDP… my real wealth not so much… Government loves to fund “make work” and “political favor” projects with high B.W.F. quotients…
Which brings us to the G part. Government. Note this is not “Government ex-bombs” or “Government ex-Graft Paid to Egypt” or “Government ex-Senator Private Airport in Nowhere”… Want to raise GDP? Easy, start a Big Fat Do Nothing Good Program… Send $5 Billion to A Middle East Dictator? GDP up $5 Billion. That this consumes wealth and destroys economic well being? Who cares… Does “Shovel Ready” ring a bell? IF I have a program spending $1 Trillion to have folks with shovels dig holes, and another $1 Trillion for another group to fill them in (WPA – Works Program) at the end of the process, GDP went up $2 Trillion, but all I have is a load of tired people and worn out shovels. NOT a gain. This fallacy comes around a LOT in Government Programs.
The Wiki starts to touch on some of the issues of GDP and different ways to calculate it. (AND still ignoring the zoo of ‘sister acronyms’ that pop up in trying to fix it… GNP, GNI, NNP, NDP, etc. etc.) I’m not going to quote them in full, just a couple of main titles and first sentences to give a flavor of it all I’ve bolded a few bits.
This approach mirrors the OECD definition given above.
Estimate the gross value of domestic output out of the many various economic activities;
Determine the intermediate consumption, i.e., the cost of material, supplies and services used to produce final goods or services.
Deduct intermediate consumption from gross value to obtain the gross value added.
Gross value added = gross value of output – value of intermediate consumption.
The second way of estimating GDP is to use “the sum of primary incomes distributed by resident producer units”.
If GDP is calculated this way it is sometimes called gross domestic income (GDI), or GDP (I). GDI should provide the same amount as the expenditure method described later. (By definition, GDI = GDP. In practice, however, measurement errors will make the two figures slightly off when reported by national statistical agencies.)
This method measures GDP by adding incomes that firms pay households for factors of production they hire – wages for labour, interest for capital, rent for land and profits for entrepreneurship.
These five income components sum to net domestic income at factor cost.
Two adjustments must be made to get GDP:
Indirect taxes minus subsidies are added to get from factor cost to market prices.
Depreciation (or capital consumption allowance) is added to get from net domestic product to gross domestic product.
Total income can be subdivided according to various schemes, leading to various formulae for GDP measured by the income approach. A common one is:
GDP = compensation of employees + gross operating surplus + gross mixed income + taxes less subsidies on production and imports
GDP = COE + GOS + GMI + TP & M – SP & M
The third way to estimate GDP is to calculate the sum of the final uses of goods and services (all uses except intermediate consumption) measured in purchasers’ prices.
In economics, most things produced are produced for sale and then sold. Therefore, measuring the total expenditure of money used to buy things is a way of measuring production. This is known as the expenditure method of calculating GDP. Note that if you knit yourself a sweater, it is production but does not get counted as GDP because it is never sold. Sweater-knitting is a small part of the economy, but if one counts some major activities such as child-rearing (generally unpaid) as production, GDP ceases to be an accurate indicator of production. Similarly, if there is a long term shift from non-market provision of services (for example cooking, cleaning, child rearing, do-it yourself repairs) to market provision of services, then this trend toward increased market provision of services may mask a dramatic decrease in actual domestic production, resulting in overly optimistic and inflated reported GDP. This is particularly a problem for economies which have shifted from production economies to service economies.
Components of GDP by expenditure
U.S. GDP computed on the expenditure basis.
GDP (Y) is the sum of consumption (C), investment (I), government spending (G) and net exports (X – M).
Y = C + I + G + (X − M)
And that is just the Wiki. Once you get into The Literature, there’s even more “stuff” done to / with GDP trying to find The One True Number. IMHO, it doesn’t exist. But Serioso had another idea.
So here’s that email that’s been festering in my “moderation” queue for way too long (over a year):
Originally from this thread:
2015/03/04 at 3:05 am
Which GDP, you ask. It really doesn’t matter, so long as you use the same dollars for tax receipts and national product. Use constant dollars or use current dollars, the result is the same if you use the same type of dollar in numerator and denominator. That’s one of the advantages of using ratios.
I never said anything negative about the Laffer curve, and I never proposed to “toss [it] out.” Indeed, reading the reference you provided, I see that Laffer himself believes we are on the productive (low tax rate) side of the curve, far from the point of maximum tax revenue.
The fact remains that income tax revenues declined as a percentage of GDP after the Reagan tax rate cut. A change of one in 8 or 9 is far from trivial. And the fact that GDP does not include voluntary work (etc.) is irrelevant when looking at a large change in a small time period.
The question, I suppose, is whether you can explain the decrease. Or, if not explain it, see it.
Essentially doesn’t care at all about how GDP is figured, what adjustments and all might be in it, how cooked the deflators are, that it does not reflect real wealth creation, etc. etc. Just divide it and things are fine…
His position is, roughly, we have lots of room for more taxes to be sucked out of the economy, so let’s get to taxing and spending!
My position is, roughly, we are on the ragged edge of collapse due to too much taxing and spending and the peak of the Laffer Curve is likely behind us. I’ve had several postings with data supportive of that POV, so you can find that backing matter if you look under the economics tags.
Most importantly, I think “GDP Ex-Government” is the most important for illustrating why more tax and spend is a Very Bad Idea.
Found A Good Example GDP -ExG
So after some looking, I found this very clear example of why GDP Ex-G is what matters.
Dr William J McKibbin
Sunday, December 29, 2013
US 10-year Moving Average GDP Growth Ex-Government Spending (1958-2013)
The chart below depicts US economic growth as measured by GDP excluding government spending on a 10-year moving average basis since 1958. Note that GDP growth ex-government spending has been trending downwards since 1982, and that economic growth excluding government spending is now hitting historic lows.
I didn’t see in his posting if this was ‘real $’, ‘constant $’, deflated, whatever… I’m going to assume some kind of deflator used given the long time period. (You can see how just saying GDP is a very slippery slope of assumptions…)
Note that as of now, real?GDP-exGovt is about 2% growth (well, really as of 2013 and a 10 year average… so likely even less now) and about equal to our Inflation Target by The Fed. Now we also know that the inflation numbers are cooked (ex-anything_that_goes_up_fast…), so I think a more careful analysis might well find we are at about Zero Real GDP Growth ex-government, which is about what the Average Joe and Jane has been experiencing.
Raise Taxes and Spend more, will rapidly suck that last 2% (that might be inflation-fictional anyway) out of the non-Govt economy and put us in the Greek Puerto Rico Spain Toilet right quick (as they say in Texas).
And that, in a nutshell (though a big one, I admit ;-) is why “which GDP” and even which parts of GDP and how you fiddle with GDP and … why that matters. And why we can’t take a 2% bigger tax bite going into the G part of that equation and leaving the part that makes real economic growth and real wealth creation.
Dr. McKibben sums it up nicely:
The US is in desperate need of greater private sector growth now. The public sector should yield accordingly to private sector priorities in order to accommodate this necessary structural change in the US economy. The government cuts I envision will require a determined reassessment of both US social welfare and defense budget needs sooner rather than later.
I think that generalizes to the EU and UK as well.
A Sidebar On Stupid
IMHO, the core problem is The Incredible Power Of Stupid.
Stupid people are often stupid and usually know it. Very Smart people often do very stupid things, and don’t know it. I’d rather have more structurally slow folks who have learned to be careful, and fewer Very Bright Idiots Acting Stupid.
THE genius of The Private Economy and competition in capitalism is that businesses can and do fail. We limit the size and scope of Stupid and rapidly prune Bad Ideas. Not so in Government. In Government, Stupid can, and does, run rampant for generations. Just look at Common Core as the most recent clear example. It is a lousy way to teach. (Spouse and I both have teaching credentials and have run classrooms, we know this business). Prior to Common Core and the Federal Department of Education, schools were run locally, and generally well. I got a great education then. Now? It’s horrid. And nearly nothing can stop it as it gets worse. Despite some Presidential Candidates saying they will kill off the Fed Dept of Education, I’ll believe it when I see it. Departments rarely go away, and when they do, someone else usually picks up what they were doing and just the name changes…
Believe it or not, “Stupidity Studies” is a part of Economics:
Carlo M. Cipolla (August 15, 1922 – September 5, 2000) was an Italian economic historian. He was born in Pavia, where he got his academic degree in 1944.
As a young man, Cipolla wanted to teach history and philosophy in an Italian high school, and therefore enrolled at the political science faculty at Pavia University. While a student there, thanks to professor Franco Borlandi, a specialist in Medieval economic history, he discovered his passion for economic history. Subsequently he studied at the Sorbonne and the London School of Economics.
Cipolla obtained his first teaching post in economic history in Catania at the age of 27. This was to be the first stop in a long academic career in Italy (Venice, Turin, Pavia, Scuola Normale Superiore di Pisa and Fiesole) and abroad. In 1953 Cipolla left for the United States as a Fulbright fellow and in 1957 became a visiting professor at the University of California, Berkeley. Two years later he obtained a full professorship.
Cipolla produced two tongue-in-cheek essays on economics, circulated (in English) among friends in 1973 and 1976, then published in 1988 (in Italian) under the title Allegro ma non troppo (“Forward, but not too fast”, “Happy but not too much”, from the musical, “Quickly, but not too quick”).
The first essay, The role of spices (and black pepper in particular) in Medieval Economic Development, traces the curious correlation between spice import and population expansion in the late Middle Ages, postulating a causation due to a supposed aphrodisiac effect of black pepper.
The second essay, The Basic Laws of Human Stupidity, explores the controversial subject of stupidity. Stupid people are seen as a group, more powerful by far than major organizations such as the Mafia and the industrial complex, which without regulations, leaders or manifesto nonetheless manages to operate to great effect and with incredible coordination.
These are Cipolla’s five fundamental laws of stupidity:
1. Always and inevitably everyone underestimates the number of stupid individuals in circulation.
2. The probability that a certain person (will) be stupid is independent of any other characteristic of that person.
3. A stupid person is a person who causes losses to another person or to a group of persons while himself deriving no gain and even possibly incurring losses.
4. Non-stupid people always underestimate the damaging power of stupid individuals. In particular non-stupid people constantly forget that at all times and places and under any circumstances to deal and/or associate with stupid people always turns out to be a costly mistake.
5. A stupid person is the most dangerous type of person.
Corollary: a stupid person is more dangerous than a pillager.
As is evident from the third law, Cipolla identifies two factors to consider when exploring human behaviour:
Benefits and losses that an individual causes to him or herself.
Benefits and losses that an individual causes to others.
By creating a graph with the first factor on the x-axis and the second on the y-axis, we obtain four groups of people, with an additional category either existing in its own right or drawn from the members of each previous category whose position with respect to both axes is least extreme:
Intelligent people (top right), who contribute to society and who leverage their contributions into reciprocal benefits
Naive people (top left), who contribute to society but are taken advantage of by it (and especially by the “bandit” [q.v.] sector of it); note, however, that extreme altruists and pacifists may willingly and consciously (rather than “naive[ly]”) accept a place in this category for moral or ethical reasons
Bandits (bottom right), who pursue their own self-interest even when doing so poses a net detriment to societal welfare
Stupid people (bottom left), whose efforts are counterproductive to both their and others’ interests
Helpless/ineffectual people (center)
Cipolla further refines his definition of “bandits” and “naive people” by noting that members of these groups can either add to or detract from the general welfare, depending on the relative gains (or losses) that they cause themselves and society. A bandit may enrich himself more or less than he impoverishes society, and a naive person may enrich society more or less than he impoverishes himself and/or allows himself to be impoverished. Graphically, this idea is represented by a line of slope -1, which bisects the second and fourth quadrants and intersects the y-axis at the origin. The naive people to the left of this line are thus “semi-stupid” because their conduct creates/allows a net drain of societal welfare; some bandits may fit this description as well, although many bandits such as sociopaths, psychopaths, and non-pathological “jerks” and amoralists may act with full knowledge of the net negative consequences to a society that they neither identify with nor care about.
To the right side, productivity for self, to the left, loss.
To the top, productivity for others, to the bottom, loss.
The classical “maker vs taker” expanded a bit. Upper right are the intelligent Makers who increase real wealth for all. To the upper left, those who are not yet able, such as children or others who take more than they make, but not from malice or stupidity. To the bottom right, the classical Villains of the left. Rapacious bankers, industrialists shitting on your land to increase their wealth, etc.
But what is most interesting is that classical view ignores the bottom left. What Cipolla shows, is that they are more damaging than the bandits. They impoverish both others AND themselves. When Greenpeace shuts down a coal plant in England, their lights go out too…
Now my corollary to Cipolla is simply this:
Government is dominated by Stupid.
Folks don’t get fired. It never “goes out of business” for doing something stupid. The folks running it get there via a Liars Popularity Contest, not any actual wealth building skill or economic understanding. The Stupid, it grows…
Private Enterprise is naturally self pruning. While it has some “bandits”, it has more “intelligent” wealth creators. At core, it is an enforced meritocracy, (though sometimes takes a lot longer than expected to manifest… look at Yahoo…)
IMHO, that explains much of the current Global Malaise.
Globally, Government has consumed the Real Economy productive capacity / growth. The “fix” they propose is Yet More Government Spending… which will increase GDP, but not improve the economy. So The Stupid keep doing that, and drive us ever further into debt and stagflation.
The only real answer is to reduce the size of Government, and with it the Power Of Stupid and move all of us, collectively, from lower left to upper right as the Stupid have less control of resources and economic direction while the competitive space prunes for the Intelligent to run private enterprises.
Bandits? Yes, there will always be Bandits. That’s what anti-trust and fraud laws are for…
So there you have it. And why I could not fit it into a snappy reply a year ago in an off topic discussion.