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A new study by Dutch economic magazine Economisch Statistische Berichten (ESB) into GDP questions its use as a measurement for the “well-being” of a nation’s citizens. It concludes that:

“At the beginning [1820] of the examined period, until 1870, the correlations of GDP per capita and the dimensions are not that strong. (…) After the ‘coupling’ around 1870, well-being and GDP per capita develop more or less along similar lines, but in the second half of the 20th century, a new ‘decoupling’ takes place. (…) After 1980 a reversed form of ‘decoupling’ occured: Countries had a certain or even strong economic growth, yet well-being lagged behind on growth. The strong growth of economic inequality through globalisation is probably the most important cause.”

Is the divergence between GDP and well-being caused by inequality through globalization? Well, perhaps, but let’s not factor out Western Europe’s eroding social cohesion and increasing proximity to legislative power.

But the very concept of GDP itself, once hailed as the stat to rule them all, isn’t without its flaws either. A project sponsored by the Netherlands Environmental Assessment Agency (PBL) is seeking new definitions to see if a correlation between GDP and well-being could still be found. The question is whether that is possible at all in the first place.

Short History of GDP

GDP is based on the economic output by consumers, companies, and government. Simon Kuznets, one of its originators, wanted it to understand general welfare and not merely measure economic output. Kuznets initially excluded, amongst other things, government spending. GDP without government spending showed this spending had a negative effect on GDP. This is the case because increased government spending diverts private means to public goals, e.g. through increased taxation.

On this basis, Alexander Cartwright shows that following this outcome the definition of GDP was changed in order to fit in government spending:

“Hence national income, from its inception, was created and defined with political motives; that is to serve an interventionist, Keynesian ideology. Since the definition of ‘nationale income’ (…) is determined based on the intellectual climate of the time along with the political and military needs of the moment. (…) Kuznets lost and wartime Realpolitik won, giving birth to a practical tool that upholds an economic and political legacy to this day.”

This means GDP has been transformed into a political, rather than an economic measurement.

Three difficulties with GDP

There are some real-world difficulties with GDP as well. According to economist Frank Shostak, economists have to overcome three hurdles if they want to solve their problems with GDP. The first is that GDP lobs together different categories of products, which makes it impossible to properly calculate the aggregate value of different products. The second hurdle is that the economic output of individuals is seen as consumption. This is assumed to be the driving force of the economy, rather than capital/wealth creation.

The third hurdle is government spending as a metric. Shostak notes that

“if a government embarks on the building of a pyramid, which adds absolutely nothing to the well-being (emphasis added) of individuals, the GDP framework will regard this as economic growth. In reality, however, the building of the pyramid will divert real funding from wealth-generating activities, thereby stifling the production of wealth.”

A driver for economic inequality and well-being

American economist George Reisman notes in his monograph Wrong Theory/Destructive Program two important problems. Government-sponsored credit fuels economic inequality while government spending disrupts private wealth creation. Reisman underscores “the role of government-sponsored credit expansion” in non-productive assets, and “flooding into stock and real estate markets” since the fall of Bretton Woods in the late 70s. This drives up stock and real estate prices. Those who already own these assets will benefit almost exclusively. These people already belong, disproportionally, to the richer segments of society. Thus, government policy spurs on economic inequality.

The birth of the extreme growth of government-sponsored credit is directly correlated to the end of the Bretton Woods agreement. Since then, governments worldwide are able to print their way to financial wealth. As you know by now, this is not seen as a problem for GDP, since government spending is seen as economic growth.

Following Reisman however, spending ensures growing inequality and rising prices which mostly benefit an already privileged section of the nation. It is not hard to imagine why in such a world GDP continues to outpace well-being.

Well-being and government spending in ESB Data

The aforementioned critiques show GDP and well-being correlate roughly till the 1980s. From that mark onwards GDP outpaces well-being. The question then becomes whether GDP can be a measure for well-being at all, without further broadening its definition.

The increase in GDP for the European nations coincided roughly with the switch to fiat currencies, and in the US with the expansion of welfare programs to combat the Great Depression. This allowed governments to inflate their budgets and increase spending. Thus, GDP strongly outpaces well-being. This suggests Kuznets is correct in leaving out government spending.

Why you should care

Until economists come to grips that economies are not based on government spending, welfare programs, and consumerism they will continue to search for reasons to tell you the economy is doing great, or fine. As Kuznets realized, there is a distinction between private wealth creation and public spending. This distinction is vital, because without it the impact of government spending goes unmeasured. Would we return to what Kusnetz intended GDP to be, government spending would be excluded and show its real impact on civil society.

Then, once again GDP would show that the diversion of private means into public hands is detrimental to economic growth and flourishing individuals. More importantly, you no longer need to tell yourself you are doing well, because ‘the economy’ is doing well.