November 15, 2005

A Good Thing

It's taken me a while, though I hadn't forgotten. Here's a first follow up to my Inefficiency Boost piece about voltage stabilizers and questioning GDP.

Also, a comment on that previous piece pointed to a related Jug Suraiya article which I think is worth reading.

***

In Tamil Nadu, there's a town that may be the hosiery capital of the world. Millions of pieces of underwear come out of Tirupur every year. It's a good bet that whatever you're wearing as you read this probably did so. Tirupur's hosiery factories are profitable successes, small jewels in India's economy.

But the transformation of Tirupur into this hosiery machine over the last couple of decades has had a downside. Its water sources are either hopelessly polluted by the hosiery factories or have dried up altogether, unable to keep up with the demand. For some years, Tirupur has had to truck in water for its residents, at a substantial cost.

You guessed it: paying that cost adds to India's GDP. Someday, someone may have to pay to clean up the pollution. (Or may already be doing so). You guessed it again: that transaction will also add to the GDP.

You might say, it's not just Tirupur's production that contributes to our GDP, but its pollution as well, and twice. First, when it happens and has consequences; second, when money must be spent to clean up. You might say, Tirupur has robbed from its future to pay for its present success. But even that theft is considered a gain for the economy.

What's perverse about the GDP is not just that it counts every transaction of money as a gain. It is also that it counts only transactions of money. It is also that it ignores the environmental and social costs society must inevitably pay for depleting natural resources or ignoring social issues. The way it goes is almost conventional wisdom by now: the more we use up -- or ruin -- our natural resources, the more the GDP rises.

There must be something wrong with a measure in which depleting your capital counts as current income, in which disaster is seen as gain.

But that's the GDP for you.

Yet the GDP been so closely identified for so long with a country's economic advance that people think of it as written in stone, an unquestioned standard. In reality, it is little more than a relic of an earlier era, when compulsions hardly relevant today drove its definition.

The Gross Domestic Product is actually an avatar of the old Gross National Product, and both are oddly perverse measures. To understand why, consider the origins of the GNP.

In 1932, the US Commerce Department gave a bright young economist, Simon Kuznets, the task of devising a way to account for how well the economy was doing. The Department had no real way to monitor the performance of the economy, which was a problem in those Depression years. This is not the space, and I'm hardly the person, to explain Kuznets's approach in minute detail. But it's enough to understand that he focused squarely on production and spending, important in the shuddering economy of the time. Kuznets's work was the foundation for what became the GNP and later the GDP.

And then WWII came along. Plunged into fighting on two major fronts, the US looked at GNP as the primary way to keep track of its economy. As the country's wartime factories pumped out planes, tanks and guns, Kuznets's system helped locate and make use of unused production capacity. Famously, this huge engine of production not only prepared a nation for war, but also brought the US charging out from the Depression like an express train.

And the GNP played a crucial, if usually overlooked, role in winning WWII. Lacking an accounting system such as Kuznets had devised, Hitler had set far lower production targets for Nazi Germany. The US entry into battle, by itself, meant that German production would be overwhelmed inexorably; thus, that the Allies would win the war.

This close identification of GNP with pure production, married to victory in the war, set a course for economic policy for the next half-century. Because the war had been won, because US industrial output had been a major factor in that triumph, and because GNP measured that output, the craze for production became the peacetime model too. Production was a Good Thing.

And while during the war, the military was the great consumer, in peacetime it was ordinary citizens who consumed the products factories were churning out. So production was more than a Good Thing, it was Progress itself. Therefore the GNP, that measure of production, became a measure of progress too. That was the mantra, the conventional wisdom.

It took many years, but eventually people began questioning that mantra.

***

In a future piece or possibly two -- and I hope it won't take me as long to get to them -- I'll take this further.

8 comments:

Vikrum said...

Dilip,

I did not know about the history of the GNP/GDP calculation, and enjoyed learning from your post.

I agree with you that the GDP is, without a doubt, an incomplete measure of an economy. It gives us some information but not nearly enough to accurately assess a country from an economic perspective.

Abi said...

Thanks, Dilip, for the second part of the series.

I just wanted to mention this blog called Environmental Economics, that tackles some of the issues that you mentioned. But you are right: GDP's supremacy in economics is legendary.

The real problem with the environmental damage is not just the need for correcting for it later (with some money that the current GDP has 'borrowed'), the damage may not be correctable at all. What if our current path puts the environment on an irreversible trajectory? Isn't that one of the fears behind the warning about global warming?

Anonymous said...

Dilip,

I think you are needlessly injecting an ideology to GDP. GDP is simply ther broadest possible measure of current economic activity. Nothing more, nothing less. It is agnostic on whether that activity is "good" or "bad." It is agnostic on whether that activity is sustainable in the long-run or not. It says nothign about the environment.
No single measure can capture all that goes in well-being, just as there is no one single meaure that would measure a human being's health. It is ridiculuous to say that the temperature reading does not measure cholestoral or sugar or pressure. It is equally ridiculous to say that a temperature reading has acquired dominance. No serious economist will tell you that GDP is all that we need to know, the rest be damned.
In analyzing corporate balance sheets, nobody says that profits are all that matter. People analyze a whole host of ratios and indicators to judge the financial health and to project the sustainability of returns. It is the same with GDP.
If your critique is that GDP growth should not be the sole objective of public policy, i agree. In any case, public policy should be targeting growrth at all. Growth will automatically result from good policies. However, the obverse is not true. That is why we need to track mutliple indicators, icnlduing those for the environment, public health, etc.
Destructive incidents like hurricanes and wars do boost GDP. But everyone who uses GDP meaningfully knows that understands that economic well-being has not improved. Nevertheless, it is undeniable that there is a real increase in economic activity involved in rebuiliding. That increased activity means increased incoems for a lot of people. Unlike is subsistence societies, modern capitalistic societies have gone far beyond where we can meaningfully define need as opposed to want. In a subsistence farming society, a storm that destroys homes is an unmitigated disaster. Even if all material were free, the people have to put in extra work to rebuild. There is no silver lining. In a modern cash-based economy people work for money. Aside from the fact that accumulation of money in and of itself is an end (as opposed to taking care of your basic needs), having a job and working usefully is an important contirbutor to self-worth. In a subsistence society, if fruits fell off the tree and people did not have have to work for their needs, they would be very happy. That is not the case in modern economies.
There is another important thing to keep in mind. Modern economies are characterised by almost perpetual labor slack, which means that there are always some people looking for work. This problem becomes acute during recessions or depressions. Which is why you have food for work and other government employment programs. Natural calamities reduce labor slack and effectively act as redistributive mechanisms (the insurance companies and their stockholders are usually the losers). Redistributive mechanisms engineeered by politicial process usually do not work because the wealthy will take their capital elsewhere. But redistribution engendered by natural calamity will have no such undesirable effect. Of course, in places like India, where natural calamities wreck havoc among the have nots and insurance is not widespread, this analysis does not apply.
Sorry to take up so much of your space.

Neela said...

Anonymous, well said!

Dilip, a very nice recounting of the origins of GDP. But I agree with anonymous when s/he says that no self-respecting economist (or educated layperson) would use only GDP to measure growth or progress, just as no self-resepcting doctor would use just the pulse rate to measure your overall health. Anon, apologies for stealing your analogy, but its a good one.

n!

Dilip D'Souza said...

Thx, Vik. Your last sentence is the point I'm making about GDP.

Abi, I agree with you about the "real problem with environmental damage", but the irreversibility of some environmental damage is not, by itself, a problem with GDP. The argument is that GDP should take it into account (as a loss, presumably).

Anonymous, no apologies necessary. The idea is to generate this discussion, so I'm glad for your inputs. I will try to address them soon.

Moon Rays said...

A part of the comment on my blog
Dilip D'Souza goofs up on the very basics of how GDP is measured. For example if Tirupur is facing water shortages and therefore has to buy it from tankers, it will reduce and not increase the GDP. Why? Go back to the basics, GDP measures (among other things) real private consumption, not the price you pay to get it. So if water is costlier than the past, and the wages haven't kept up, this means that people have lesser money left to spend on other things. Hence real consumption of other items goes down and the GDP along with it.The environmentalist's critique of GDP, which is actually a critique of the industrial economy as a whole, is that when the people consume natural resources they consume the future, because in future we have to spend more to get things back to order in future. D'Souza adds some bit of his own expertise to this argument and says "even that theft is considered a gain for the economy". Again, if you go back to the basics you will realise how ridiculous this argument is, as is the argument that inefficient power supply boosts economy by way of higher voltage stabilizer sales. More voltage stabilizers essentially means less money for neccessary consumption and investments and therefore the same GDP and lower GDP growth. It is indeed funny to see how D'souza pulls in a valid environmental arguments against GDP and then puts in wrong anecdotes to back it up.

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