Wednesday, June 5, 2013

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.

7 comments:

  1. As a counterpoint... isn't the expected resale value already imputed into the 'new' purchase price? Hence why Alchian argues that used textbook sales don't hurt textbook publishers.

    That said, what about businesses that specialize in selling used goods? My guess is that Goodwill and St. Vincent show up in GDP numbers, although in those cases they're earnings are from their role as middleman reducing the cost of search in a secondary market (which flea markets do as well...)

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    1. Under static conditions, yes, Alchian's point holds. I'd retort that when there's a long enough time lag, technology may outstrip price imputation. The Kenner and Beanie Baby noise cancels, sure, but P2P sales enabled by the Internet are a tidal improvement not captured anywhere.

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  2. Or used cars. Used car sales count toward GDP, though as a service not as the good itself. If Papola sells his sock in a secondary market, his profit does reflect real wealth created - the service of making the sock available. So, at least in theory, his trading with Stossel might rightfully count in GDP.

    Obligatory note: GDP still sucks for all the reasons you say.

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    1. I'm curious what the accounting would look like for this. Presumably, the COGS wouldn't be part of the accounting here, but rather the labor share of the sale, or the commission or something? I've never done any of the nitty gritty ledger-scribbling for this stuff, but if what you write is true, it implies that GDP figures are even noisier than I thought. Comparative growth economics could suffer from horrendous measurement error.

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    2. I am not 100% certain, but that's at least how HBP talk about it in The Economic Way of Thinking.

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  3. To clarify, G includes only government purchases of goods and services. Social security & welfare payments (cash and non-cash alike), business subsidies (direct and indirect) are transfer payments and do not count in G. Roughly speaking, all government spending is about 35% of GDP, whereas G is about 20% of GDP.

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    1. Edited to include correction. Thank you.

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Do you have suggestions on where we could find more examples of this phenomenon?