Many decision makers and commentators treat gross domestic product (GDP) as if it measures the whole of the economy. They even use “the economy” and GDP interchangeably. GDP is an accounting device—and a poor measure of economic health. Household wealth is much closer to what we mean by “the economy.”
Say a new medical school graduate got a nice hospital job in 2011 paying $100,000 per year. However, she owed $150,000 in loans. Meanwhile, a retired couple had income of $50,000 in 2011 and an investment portfolio of $2 million, plus their home. If we compare 2011 income, the new doc is doing twice as well. Of course, this is ridiculous—why would anyone use one year’s worth of income to see how they’re doing?
Yet that is what we do with GDP: We take one year’s worth of production and act as if it’s the whole story or nearly the whole story. It’s just as wrong with GDP as it is with one year’s income.
Using GDP also leads to some fairly silly practices. If a house is built, it adds to GDP. If it is then torn down a year later, that also adds to GDP (because people were paid to rip it down). Unbelievably, you can just keep building and tearing down forever, and it will always add to GDP. Or the house can be sold back and forth between two rather strange real estate companies, each sale counted toward GDP.
If the government spends more than it takes in, this adds to GDP, no matter what the spending is used for and no matter how it is financed. GDP says government borrowing is always good.
Tens of millions of Americans choose imports every single day because it makes them better off. Yet every one of these decisions is said, by some, to hurt the country. Because of the way GDP is constructed, some observers imagine we should push it higher by having ordinary people not buy imports and make themselves worse off. It is a major problem that what could increase GDP, such as reduced imports, is bad for individuals.
GDP is supposed to measure the size of the nation’s economic pie. But when we see how the pie is cut up (i.e., how much individuals or households have), GDP is the wrong measure: 10 percent of households holding 30 percent of GDP doesn’t tell us anything we actually care about.
So what should we use to measure actual prosperity? National wealth. What should we use to measure improvement? Changes in the value of national wealth.
What’s the value of a house to the people who own it? What’s the value of a car, a mutual fund, and so on? It doesn’t matter how many times something has been built or torn down or bought or sold—what is its value right now? How fast is all this wealth growing? How is it distributed? Those are the right questions.
In 2012, GDP was $15.7 trillion. That’s one measurement—not a good one—of what Americans produced and earned last year. On Friday, the Federal Reserve said that at the end of 2012 combined household wealth was $70.3 trillion. This is a net figure, meaning it subtracts off a measure of debt. That’s the sum of everything we did and decided last year and every year before that. It’s a much better reflection of what our economy really is.
A lot of people have been understandably unhappy with government economic policy for a quite a while. How can we make good policy when we don’t even know what we’re trying to improve? GDP is not our economy—far from it.