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Thoughts from the Frontline

Time to Put a New Economic Tool in the Box

July 26, 2014

[E]conomists are at this moment called upon to say how to extricate the free world from the serious threat of accelerating inflation which, it must be admitted, has been brought about by policies which the majority of economists recommended and even urged governments to pursue. We have indeed at the moment little cause for pride: as a profession we have made a mess of things.

It seems to me that this failure of the economists to guide policy more successfully is closely connected with their propensity to imitate as closely as possible the procedures of the brilliantly successful physical sciences – an attempt which in our field may lead to outright error. It is an approach which has come to be described as the “scientistic” attitude – an attitude which, as I defined it some thirty years ago, “is decidedly unscientific in the true sense of the word, since it involves a mechanical and uncritical application of habits of thought to fields different from those in which they have been formed.

– Friedrich Hayek, from the introduction to his Nobel Prize acceptance speech in 1974

Last week we took a deep dive into how the concept of GDP (gross domestic product) came about. We looked at some of the controversies surrounding GDP statistics that we use to measure the growth of the economy, and we noted that the GDP tool seems designed to reflect and serve an economic theory (Keynesianism) that prefers to focus on the demand side of economic activity. If your measurement of the growth of…

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July 28, 1:12 p.m.

Although useful for analysis of economy internals the aggregate C + I + G in GDP already subsumed what is called intermediary investments (II) in Gross Output (GO). As Mauldlin correctly observed there’s double count, thus the qualification “Gross”, there’s no netting here, no elimination of what was already counted and accounted for.

It must be noted (in the Steve Hanke’s text, linked, quoted and sanctioned by Maudlin) nonetheless the fallacious nature of contrasting the result of division from different bases (fallacy of division) and the comparison of properties of things supposed to represent the same reality but that are of fundamental different nature (fallacy of equivocation if I remember well).

Fallacies expressed boldly in paragraphs like this:

“Contrary to what the standard textbooks have taught us and what the pundits repeat ad nauseam, consumption is not the big elephant in the room.The elephant is business expenditures.”

To be clear, to say that, measured by Gross Product, now consumption it’s only about half the of economy as measured by GDP, and presumedly that gives a new knowledge of relative importance of consumption, is the same thing as to compare C/(Y + 1.4x) and C/Y saying that since C/(Y + 1.4x) is less than C/Y, an obvious fact, it gives you a new insight of the real participation of C in the Economy.

No, it doesn’t. With GDP as base you are comparing consumption with total production, with GO as base you are comparing consumption with a measure of total transaction that recursively includes a multiple of what is included in consumption. There’s for sure new insights to be gained in GO measure in many details of economy internals and in many useful facts for description, but no new insights in the role of C. The magnitude of C as a drive of the Economy is not altered whatsoever and so the assessment of the importance of C (and G and I) to guide economy policy is not bettered in any way.

Ironically the advocacy of a new measure of economy as something that will better the policy (“Time to Put a New Economic Tool in the Box”) is antithetical with everything that Hayek defended all his life. Just imagine what new distortion in the complex economy structure that a fundamentally flawed reason of uncritically transfer the procedures of the nature sciences to social sciences, that Hayek regarded sarcastically as “scientistic”, with yet new measures, and so illusions of new controls and dials,  will entice by intervention of fiscal and monetary authorities. Just Imagine! New Taxes, new suppression of market signals, new macro prudence policies, etc ad nauseam. Beware the dials!

One cannot fight the marxist inspired left embedding in one’s own thinkings and frame one’s own reasons, like it was an imperative
categorical, the very methods,terms and frames they use. If you do that you already concede the most and you only dispute the least.
A conservative policy have to be assertive in his own terms. 

So is appropriate to close with a yet another quote from the classic F. A. Hayek “Pretence of Knowledge” Nobel address.

“The conflict between what in its present mood the public expects science to achieve in satisfaction of popular hopes and what is really in its power is a serious matter because, even if the true scientists should all recognize the limitations of what they can do in the field of human affairs, so long as the public expects more there will always be some who will pretend, and perhaps honestly believe, that they can do more to meet popular demands than is really in their power. It is often difficult enough for the expert, and certainly in many instances impossible for the layman, to distinguish between legitimate and illegitimate claims advanced in the name of science…

If we are to safeguard the reputation of science, and to prevent the arrogation of knowledge based on a superficial similarity of procedure with that of the physical sciences, much effort will have to be directed toward debunking such arrogations, some of which have by now become the vested interests of established university departments. “

July 28, 1:09 p.m.

Analysis is fataly flawed.

You must deduct from a country GO or GDP, the Foreign Owned Company profits that are removed from the economy and expatriated to offshore Parent Companies.

These profits no longer contribute to the economy, it is a cash outflow from the economy, for the benefit of the GDP of the Parent Company.

In a country like NZ, we lose 8% of GDP to Foreign Owners.

Asset Sales of the countries infrastructure Assets, Govt COntracts awarded to Foreign Owned Co’s, are decimating our economy.

NZ is now a PONZI scheme, borrowing $60 Billion from overseas banks in the last 5 years, to “create” a surplus.

Until our children have to pay the Debt back.

but what with, we no longer own the major Companies in NZ, so we have no profit or retained earnings to fall back on.

Remove Foreign Owned Co profits from GDP.

This changes our GDP growth from + 3% and is in fact - minus 5%.

All these countries that have sold Assets to Foreigners are now running with negative real growth.

THis is why wealth is going one way, upwards, to so few of the priveleged countries that have bought everyone out through Globalisation.

End Foreign Ownership of Countries assets. Its killing our economy.


July 28, 7:39 a.m.

Anthony C. Urick
The only valid determination of how the economy is doing is growth in national wealth per capita.  That is (Total Economic Assets less Total Public and Private Debt) divided by the total population.  When this increases, everything is fine and all you need to consider is whether the distribution among the population is proper.  This formula also allows one to avoid recommending truly idiotic government programs.  Two obvious ones come to mind:
1.  Cash for Clunkers:  you shouldn’t destroy perfectly good assets in an attempt to encourage production.
2.  The 1930’s programs that burned crops in an attempt to increase the selling prices of agricultural production.  Again, you are destroying perfectly good assets and thereby reducing wealth per capita.

July 28, 6:50 a.m.

It would be interesting to know how many readers think this might - however inadvertently - be a first step towards a value-added tax… the GO numbers should soon enough look like new money just waiting to be scooped up by government.

Randall Zindler

July 28, 5:30 a.m.

I believe it was 2001 when the province of British Columbia cut taxes and mandated a 1/3 cut in all government regulations over the following few years. Don’t know if there has been a study on the effects, but given Mauldin’s comments on regulations it could be interesting.

July 27, 11:19 p.m.

The unemployment “tool” needs sharpening.  The reason unemployment is down is because so many have given up trying to find a decent paying job.  The American middle class trajectory is down.  I’ve moved from engineering to tutoring math at a local university.  I now make 1/8 of what I used to.  I train young people and middle-aged unemployed to be productive in fields for which there is declining demand.  My 66 years on the planet have taught me that production increase isn’t worth much if no one’s buying.  I’d drown my sorrows, but I can’t afford to drink. 
The effect of business regulations is radically less than the effect of Chinese labor cost being about 1/5 of American labor cost. 
The GOOD NEWS is that the county property assessor’s office downgraded the value of my house from $181,414 to $135,205.  This should reduce my property tax by about $570 per year. 
In addition to calculus I also tutor business math and economics.  One of my economics students had his mom move in with him because she lost her job.  His daughter never did leave home, because she can’t get a job.  He is unemployed and living off student loans. 
Stop in on your way to the unemployment student aid office, I can help you compute the slope of the American Middle Class GDP curve.  Do you know what the sign is for this slope?  Very good!  Now if we take the second derivative of that curve it will give us the rate of change of the slope?  Can you tell me what sign it is?  Excellent!  That’s enough math for now, let us move to economics and learn various theories for why that “light of the end of the tunnel” may actually be a freight train headed straight at you.

Tom Brennan

July 27, 4:39 p.m.

If your business was inefficient, wouldn’t that increase II and thus GO?
Is it sufficient to assume that market forces _must_ drive out inefficiencies?

Dallas Kennedy

July 27, 4:09 p.m.

This is a terrific article, and everyone who’s read it should go on to read Diane Coyle’s new book on GDP. As John wrote in another piece, her book provides the deeper background to where GO came from.

An aggregate can measure any number of things, including total final demand, total output, or total expenditure. And none of these aggregates are direct measures of individual welfare or productivity.

Contrary to a common misconception, the choice of GDP doesn’t lead anyone to being a Keynesian. The GDP is simply a *definition*. What Keynes postulated was more, a *theory*, that there were stable and simple relationships among various macroeconomic aggregates. By the 1970s and 80s, it was clear that there was something fatally wrong with this theory. The *definition* remains.

Similarly, the money equation (MV = PT) is simply a *definition* of money velocity (V). The simplest version of monetarism is a *theory* about V, namely, that it’s constant. It isn’t. The simplest version of monetarism is wrong. The definition stands.

Perhaps people can postulate and prove or disprove some simple and stable macroeconomic relationships with such alternative aggregates other than GDP.

Craig Cheatum

July 27, 1:21 p.m.

It seems like there are two other tools needed to understand how we compare with other countries.  First is Net Domestic Product (GDP minus New Debt), since all the primary factors can be misleading otherwise.  Second is the Current Account (Exports minus Imports), which is the only way to measure the quality of economic activity on the world stage.

Craig Cheatum

July 27, 11:28 a.m.

Just a few reasons why Keynes “won” vs the supply siders in the 20th and 21st century.

Customer demand generates sales.

When sales decrease or remain flat and productivity can’t make up the difference gross margins, operating income and net income correspondingly decrease or remain flat.

To make up the difference employers cut back on nonessentials, may invest less, purchase less inventory and at minimum postpone hiring or begin laying off.

If conditions persist, employers layoff personnel.

Conclusion: Demand either capital investment, exports, or consumer spending is king. Supply reacts to increases in demand.

If you disagree with this syllogism and narrative, then why does China have more auto plants than the the US.

I will accept the argument that innovations and mutation of the innovations will create its own demand if successfully implemented, e.g., cotton gin, railroad, telephone, automobile, airplane, radio, TV, internet, iPhone, etc. These however, are rare game changers.

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