Why You Can’t Trust GDP Figures

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Manuel Valls, the prime minister of France, says the risk of terrorism will hang over the country for many years.

Whether this is prophecy or wishful thinking, we don’t know.

But it seems at odds with the recent promise to ‘annihilate’ ISIS made by French president François Hollande.

But the fight against terrorism is full of contradictions and paradoxes.

In Fredericksburg, Virginia, for example, plans to expand the local mosque were met with a torrent of objections…

‘Muslims are evil’

All of Christendom — or at least that part of it in central Virginia — was horrified.

Some of the protesters shouted, to Muslims who had celebrated Thanksgiving in their midst for as many as 20 years, that ‘Muslims are evil!

Others urged listeners to ‘look at history…the Muslims have always been our enemies.’

This sentiment is so widely shared — not just by rednecks and yahoos in remote and benighted precincts of the Republic, but also by some of its leading historians, presidential candidates, and state governors — that we thought we should give it more consideration.

We looked at history…

Civilized people have lived in Fredericksburg for 400 years. The first settlers may have been menaced by the local tribes of ‘Native Americans.’

And then the British posed a threat — in the American Revolution and again in the War of 1812. But the only real enemy attacked 50 years later, from the other side of the Potomac.

The history posted on the town website offers this account:

On December 11, 1862, the Union Army of the Potomac, after bombarding the town with artillery fire, crossed the Rappahannock River and landed at the foot of Hawke Street.

The Union Army charged into town and ransacked homes and businesses searching for Confederate soldiers.

Caroline Street became a stronghold for the Confederates and thus received the brunt of the battle which extended south to William Street. Several churches and dwellings, including Federal Hill at 501 Hanover Street, were used as makeshift military hospitals, and the basement of the town hall served as a refuge for slaves during the battle.

By nightfall, the Confederate Army retreated to Marye’s Heights to the south of the town. Two days later, on December 13, a second assault was mounted at Marye’s Heights.

Confederate soldiers were strategically placed behind a stone wall along the Sunken Road. The battle resulted in significant casualties for the Union Army. The entire Battle of Fredericksburg resulted in 12,653 Union casualties and 4,201 Confederate casualties.’

Memo to the people of Fredericksburg: you may want to keep an eye on the Muslims. But don’t turn your back on those Yankees!

As yesterday was Thanksgiving, and time was short when writing this, here is a piece from the archives on another subject entirely…

Replacing capital with cleverness

WhatsApp, the popular phone messaging service acquired by Facebook for $22 billion, has ‘a greater market value than Sony,’ writes our favourite humbug, Larry Summers, ‘with next to no capital investment required to achieve it.’

Summers continues:

Ponder that it used to require tens of millions of dollars to start a significant new venture. Today, they can be seeded with hundreds of thousands of dollars. This means reduced demand for investment, with consequences for equilibrium level of interest rates.

This passage from Summers gives us a sense of foreboding. If these companies require little input…might they also produce little real output?

Or possibly a type of output that cannot be easily monetised?

Summers is talking about the way the new Internet-based companies replace capital with cleverness.

They take out heavily capitalized intermediaries with cheap apps.

Newspapers, for example, require huge inputs. But their lucrative want-ads slipped away from them, thanks to the cleverness of eBay.com and Monster.com.

And think of all the capital it took to research, write, and publish the Encyclopaedia Britannica. Then, in a trice, it was dead weight…replaced by Internet-based, and user-written, encyclopaedia Wikipedia.

These new companies are more efficient. But do they produce new wealth? Or do they simply destroy old wealth?

About 10 years ago, I was sitting in the lounge at Orly Airport, in Paris, waiting for a plane. With me was my son Edward, then about 14 years old.

A group of people watched a news report on a TV set above the bar when all of a sudden, for no apparent reason, the channel switched to a soccer game.

Who changed the station?’ a man asked. The passengers all looked at each other.

After a minute or two the channel suddenly switched again — this time to a children’s program. Again, the passengers looked at each other. None had touched the TV.

Then I noticed Edward giggling. Putting two and two together, I suspected that he had a remote control for the TV. But he did not. All he had was his cellphone. But somehow he was using it to change the station.

This was technology. Not the kind of technology I’d grown accustomed to but the intangible ‘new technology’ of the Information Age that exists only as lines of programing code somewhere out in the ether.

Was it adding to GDP? To output? To the stuff that gives money value and helps to make good on the claims made in anticipation of it?

A promising idea

People are now used to hiring an Uber car or renting a place to stay via Airbnb. We use Bitcoin, Netflix, and Facebook routinely.

These may be valuable ‘services.’ But what kind of value do they add to the economy?

There is chatter, in Internet-land, about the economy ‘dematerialising’ or ‘demonetising.’ Perhaps there is a new kind of value, unconnected to ‘stuff’?

This seemed like such a promising idea, I asked technology analyst Jeff Brown, to explore it for us. Here’s what he wrote back:

At the core of the issue, is how we as a society define ‘economic well-being.’

Historically, to your point, that has been done by measuring increases in output… more specifically in GDP. But improvements in technology do not directly correlate to increases in GDP. In fact, they often have the opposite effect of reducing cost, demonetizing products and services, and thus lowering GDP and hindering GDP growth.

Technological progress does improve economic well-being. This is precisely what GDP is not capturing and why GDP is useless as a measure of economic well-being.

A simple example is being able to use FaceTime or Skype for video conferences. This is hugely valuable, but it costs nothing. So, it doesn’t increase GDP.

This kind of service was not available at any price in previous decades; there is no way to compare to previous GDP statistics. The breadth and depth of services are also not captured in official GDP data.’

Missing trillions

In other words, GDP is a dinosaur…

It misses out on trillions of dollars of economic activity. Here are four studies Jeff dug up that shed some light on just how much may be getting left out.

  1. A study by MIT professors Erik Brynjolfsson and JooHee Oh estimated that accounting for IT-related intangible assets would increase capital assets by more than $2 trillion in the US alone.
  2. Economist Robert Gordon says official GDP numbers miss the value of new goods and services by 40 basis points of growth every year. [A basis point is one-one hundredth of a percent.]
  3. Hal Varian, chief economist at Google, valued the time savings gained from Internet search technology at about $500 per adult worker per year.
  4. Brynjolfsson and JooHee also estimated that the Internet creates about $2,600 of value per user every year, which would increase GDP by 30 basis points a year.

In the approximately 20 years since the dawn of the Internet, average annual GDP growth is about 4%. Based on the numbers above, perhaps it should be as much as 40 — 70 basis points higher.

We’re not convinced. But we’re keeping an open mind.

Regards,

Bill Bonner,

For The Daily Reckoning, Australia

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Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
Bill Bonner

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