Saturday, July 09, 2011

Problems with GDP

How much would the 'Bridge to Nowhere' have improved our economy if it had been built? How much has building thousands (or tens of thousands, as the case may be) of empty office buildings improved China's economy over the last decade? If you said it wouldn't have helped at all, I agree with you. People who believe that this DOES help the economy fall into the Keynesian fallacy (also known as the broken window fallacy) of digging holes and filling them up to generate economic activity. Every government expenditure is (eventually) paid by some kind of tax on people. This results in less money to be spent on actually productive activities.

GDP is calculated by adding consumer spending, government spending, investments and exports and then subtracting imports:


Government spending, on ANYTHING, by definition increases GDP.

The issue is that increasing GDP is used as a proxy for the economic health of the country. If GDP goes up, GREAT NEWS! If GDP goes down, it leads to recessions. However, if the government pays people to destroy their cars, for example, GDP - again, by definition - increases while the country's economic health is in fact harmed.