GDP, ISEW and Other Nonsense [Part 1]

GDP does not measure welfare. It is often used as a proxy for welfare, but an economist who thinks it actually measures welfare should find another job. That GDP does not directly measure welfare is usually mentioned briefly during some economics courses. But telling this is meaningless, if the rest of the material shown implicitly assumes the opposite. GDP is used as a proxy so often that people have come to forget that it is only that – a proxy. Let's quote Wikipedia to see what GDP is:

Gross domestic product (GDP) refers to the market value of all final goods and services produced within a country in a given period.

Ironically enough this is wrong, but even if it wasn't it still wouldn't measure welfare. Let's quote something else:

GDP was first developed by Simon Kuznets for a US Congress report in 1934, who immediately said not to use it as a measure for welfare...

This is not to say that GDP is useless, but it certainly attracts more attention than it deserves, especially when quarter-to-quarter numbers are being crunched. In the short run GDP can be not only useless, but misleading. I can assure you that monetary stimulus can boost GDP in the short run, but I'd hardly recommend it. On the other hand in the long run I have no big problem with using it as a proxy.

The Wikipedia article already lists some of GDP's limitations, but we can go further than that. For example you hear quite often that consumer spending makes up over 60% of GDP. And if we simply think that GDP represents the economy, then the obvious conclusion to draw is that consumer spending is what keeps the ball rolling. Actually saving is the main source of spending in the economy, but GDP hides this fact.[1]

An economist is supposed to look at demonstrated preferences(i.e. what people actually choose) and here we have a slight problem. GDP includes government expenditures, but there are no voluntary exchange or market prices there. Does the Pentagon pay market prices? Of course not, their purchases have nothing to do with consumer preferences. The price of a F-22 is next to meaningless. This is why the first Wikipedia quote is wrong, because it says market value.

GDP also doesn't measure sustainability. And I'm not talking about the end of natural resources or any of the other green myths. I'm talking about capital consumption. E.g. U.S. GDP grew 2002-2007, but that was possible only through massive capital consumption and future impoverishment.

Obviously GDP needs to be adjusted for inflation and inflation can't be accurately measured. Though it doesn't help that governments actively calculate inflation wrong on purpose, as it's good politics(I remember this very well).

There are other flaws, but I think I've made my point. To confuse GDP with welfare is bad enough, but some ecological economists(I didn't make that name up, I swear they even have a journal called Ecological Economics) have jumped on this issue. They claim that equating GDP with welfare is stupid(and they are right) and propose an alternative(and here they are wrong). GDP has flaws and people draw false conclusions out of it; it's an easy target. But if you have something to criticize, you might as well use it as a pretext to push your own alternative idea. I'm talking about the Index of Sustainable Economic Welfare(ISEW) and the Genuine Progress Indicator(GPI) and they are both crap(they're essentially the same thing).[2]

I'm sure collecting data and calculating ISEW & GPI provides jobs and academics then get to feel important and publish their findings in journals, but seriously speaking these abominations are bad science and contribute nothing to our understanding of how the world operates.

[1] George Reisman Standing Keynesian GDP on Its Head: Saving Not Consumption as the Main Source of Spending
[2] Eric Neumayer The ISEW - Not An Index of Sustainable Economic Welfare