GDP vs. EE Round 2: Papola's Socks

The sage and puissant Russ Roberts and his accomplice John Papola recently appeared on Stossel discussing "austerity" (a heartbreakingly awful term) and the role of fiscal policy. I don't know how to embed the video, but this link is here. Keen-eyed observers will identify an error made by Mr. Papola when discussing measured prosperity. He says that he could sell his sock to Stossel, who could just turn around and sell it back to him, lather, rinse, repeat and that counts as prosperity to the state accountancy.

While technically wrong, Papola hits on (or at least hints at) an ecstatic truth squirreled away in how GDP is actually reckoned.

You may have already read some of my comments on the shortcomings of GDP here. Recall that the kernel of my argument is that welfare economists use GDP as a metric for prosperity and that the negative sign on imports implies that goods purchased from foreigners make Americans worse off. This is patently and obviously false. What Papola's comment reveals is interesting for the virtue of being factually incorrect.

The error is not obvious to the casual observer, so let me remind you how GDP is approximated.

Y = C+I+G+(X-M)

Output (Y) is the sum of private consumption (C), investment (I), government expenditure (G) and net exports (X-M).

I've already griped about the last term, so let's now gripe about the key differences between the first and the third. To wit, it's only the purchase of final, new goods that count in C. Flea markets need not apply, neither do intermediate goods like bulk paper sold by a mill to a printing press. John's socks got counted as part of GDP when he bought them from Brooks Brothers, but no subsequent sales count towards our official prosperity measure.

Unless of course they're bought by Uncle Sam. All 'G' counts. Every joint strike fighter, every pension check, [edit] every Congressional toilet seat, every button on every uniform paid for out of the Treasury gets added up and rolled into GDP, but nada, zilch, zero, bupkis from the high school kid getting her first used VW from the local dealership.

Curious that, eh? I think most folks would agree that secondary market sales are indeed welfare-enhancing, particularly if they help encode structural changes that reduce recycling costs. Yet the great productive strides made possible by Craigslist and the like are studiously ignored by national income accounting, while any and all government spending plugs right straight into the identity.

How about that.