GDP isn't just adding up all the nice things

People keep wanting GDP to be something it isn't.

The only thing that GDP is is a measure of the final value of goods and services that trade in markets. That's it.

There are all kinds of good things that are not in GDP.

High among those good things is the value of household production that does not trade in markets.

This is standard fodder in principles and intermediate-level coursework. If you have a two-parent household, with one working outside the home for wages and the other working inside the home, then the value of in-home production does not count toward GDP. If the one parent starts paying the other one, then GDP goes up - even though absolutely nothing has changed.

If I make a sandwich at home, the value that I add to the ingredients by my labour is not counted toward GDP. If I sell the sandwich to myself, like if I were owner-operator of sandwich shop, it would be - again, despite there still being no change in the real economy.

If I babysit the neighbour's kids at our place for free in exchange for their babysitting ours, it doesn't contribute to GDP. If I paid them, and they paid me, it would be.

This is all standard stuff.

And there are some real problems caused by this, but they have nothing to do with GDP. They have to do with tax. But we'll come back to that.

ANU's Julie Smith was on RNZ today arguing the case for including the value of breastmilk in GDP. She argues that the value of unpaid household services should be in GDP. She's right that there is a problem if we're setting GDP growth rates as a target and we're ignoring that increases in female labour force participation has been at a cost to unmeasured but valued household production. Patricia Apps made similar points in her keynote at the NZAE meetings this year.

But there's good reason for keeping GDP as it is, and just being careful about how it's used.

Let's start thinking about all of the unpriced non-market activities that go on and that could, alternatively, be provided within markets.

Parents provide a lot of services for their kids, from chauffeuring to tutoring, and from homecare to mentoring. People can hire Ubers, and tutors, and home-care workers, and life coaches. Valuing all of those services would be tricky. And it would be pointless if GDP numbers were being used in ways that they should be used.

Except, that is, when it comes to tax.

I'd raised this as question during Patricia Apps' keynote at the NZAEs. People thought I was joking as reductio, but it's a serious point - and I expect a very real distortion. Just one that's probably not worth worrying about because trying to fix it would be even worse.

The distortion is as follows.

If you have a two-income household, both earners pay income tax on their earnings. And they pay GST for the services that they have to buy-in to help around the house, if they're buying in services to help with the lost time for home production. And the workers providing those in-home services pay tax on that income.

In-home services are paid for out of after-tax income, are subject to GST, and the worker takes home an after-tax income.

That builds a substantial tax wedge encouraging the in-sourcing of a lot of services, and distorting activity and formal labour force participation. There is a substantial tax advantage to having one partner stay home and provide untaxed services rather than be out in the formal paid workforce.

I recall stories about, when top marginal tax rates here were a lot higher, econ faculty doing a lot more of their own home renovation work. The tax wedge mattered. It's the same kind of problem.

Effectively, single-earner families are tax dodgers. No GST is paid on the in-home services provided by the stay-at-home parent. No income tax is paid on the monetary transfers to the stay-at-home parent from the in-work parent.

So I'd asked Apps whether, if we wanted to be really serious about addressing the value of household production, we shouldn't be taxing single-earner families based on the value of the household services implicitly provided. I don't think she'd thought about the problem that way before.

Of course, down this path lies madness. There are plenty of services provided between couples that do also trade, one way or another, in markets - legally in New Zealand, illegally in other places. But we'd all recognise it as insane to wish to impose GST on the imputed value of those activities - or to start having Stats NZ ask couples how often they had sex, put a dollar value on it, and start adding it into the GDP statistics. It sounds nuts and all, but as sex work is now legal, every visit to a brothel counts toward GDP (and attracts GST and income tax), while tax-dodging black market activities in the bedrooms of the nation do not.

Better I think to just keep GDP as it is, and recognise its limitations for policy purposes.

Afternoon roundup

The afternoon's worthies on the closing of a week's worth of browser tabs:

• Hamish Rutherford explains why, despite Keith Ng's insistence that any mildly clever move in a Google Search that gets you something that somebody didn't want you to see is indeed a hack, the inappropriate use of the term kinda matters. Keith now recommends we use the term cyberbadtouch instead of hack - I like it. 


• Environmental monitoring and reporting at a few of our Councils could stand improvement.


• Is there any good reason that the RMA makes it hard to put up new wind farms? When oh When will have a fit-for-purpose RMA?


• The Irish Central Bank's recruitment process for its next Governor cost €70,236. I wonder whether their headhunter talked to any senior economists around town.


• Great piece from Damien Grant at NBR on the coming regulation of the insolvency industry. I'd be using it in my Public Choice class were I still in that world. A snippet:

  ...the Ministry of Economic Development proposed, in 2010, a simple bill allowing the Ministry to ban those who were acting dishonestly from being liquidators.
  
  The industry body at the time, known as INSOL, sought a far more intrusive regulatory model. It has succeeded.
  
  Parliament has adopted a ‘co-regulatory’ regime, where the coercive power of the state is delegated to approved industry bodies who will issue licences to those who want to be insolvency practitioners.
  
  This is a terrible result. In a field with 50 active firms dominated by a handful of large players, the industry will set its own guidelines, decide who can and cannot practice and will investigate complaints against themselves.

• Tom Chivers has a very nice piece reminding everyone of the risks of replacing GDP with dodgy metrics.


• I completely fail to understand a public health establishment that spends all its time campaigning to ban anything with sugar in it while it seems there's zero consequence for ignoring doctor's quarantine advice and flying from Auckland to Christchurch, round-trip, while infectious with the measles. Could the New Zealand airlines at least ban this clown from their flights in future?

Afternoon roundup

Today's closing of the browser tabs brings a greater share of stupid New Zealand policy than I'd like.

• The SuperGold Card scheme was always stupid. Why? It's badly targeted. If you want to alleviate poverty, give money to poor people. Giving free transport to old people doesn't make a lot of sense. And as Duncan Greive over at the Spinoff points out, there's a big subsidy to rich retired (or just old and still working) people who live up on Waiheke Island - and who can get a free 23km ferry ride any time after 9am. Greive shows that this is just under $2m of the $28m government travel subsidy provided to old people. One upshot from Andrew Leigh's visit to New Zealand earlier this month: where Australia's government tries to give money mostly to poor people, New Zealand's government tries to give money mostly to old people. 
• Biddy Fraser-Davies is a hero. It takes a hero to fight MPI, year after year, to be able to make cheese despite MPI's regulatory efforts. It shouldn't take a hero to do this, and yet here we are. .
• The Public Health People are trying to ban schools from getting special alcohol licenses for school events. It's not like anybody's giving booze to kids. Sometimes there'll be parent events and fundraisers at which they want to be able to serve wine. It's harmless. But the nannies just can't help themselves. At least they've not been as successful as they'd like.

And one bit of news from outside of New Zealand: dictators lie about their GDP figures. And we can tell by the night sky. 

I study the manipulation of GDP statistics in weak and non-democracies. I show that the elasticity of official GDP figures to nighttime lights is systematically larger in more authoritarian regimes. This autocracy gradient in the night-lights elasticity of GDP cannot be explained by differences in a wide range of factors that may affect the mapping of night lights to GDP, such as economic structure, statistical capacity, rates of urbanization or electrification. The gradient is larger when there is a stronger incentive to exaggerate economic performance (years of low growth, before elections or after becoming ineligible for foreign aid) and is only present for GDP sub-components that rely on government information and have low third-party verification. The results indicate that yearly GDP growth rates are inflated by a factor of between 1.15 and 1.3 in the most authoritarian regimes. Correcting for manipulation substantially changes our understanding of comparative economic performance at the turn of the XXI century.

I do like this bit from the conclusion. Is GDP too 'hard' a measure as proxy for how well things are going? Looks like things go the other way:

These results provide additional justification for the use of innovative and ‘harder’ measures of economic performance, such as nighttime lights, in the study of economic development.

Broad-based growth?

Here's Shamubeel Eaqub:

If everyone is better off, the sum total has to increase. But the total also grows if a few are much better off. Increasingly, it's the latter kind of economic growth New Zealand has experienced.

Further, broad economic measures by definition aggregate individual experiences. But can mask significant underlying differences across regions, ethnicities or family background.

Our economy has grown significantly over the last three decades, but some measures of income and wealth distribution show compelling evidence that trickle down has not worked.

Income inequality, as published by the Ministry of Social Development, has not improved since the early 1990s after a significant worsening in the 1980s.

The reader might be forgiven for drawing the inference that incomes at the bottom haven't risen much since the early 1990s.

Here's Brian Perry's most recent statistics. I highlighted the relevant row.

Over the 20 years from 1994 to 2014, real household income for the bottom ten percent increased 44%.* For the 30th through 80th percentiles, it increased around 53%. And it increased 64% at the top. Incomes went up across the board.

If we take the period from 1982 through to 2014, incomes at the bottom rose by less; they dropped during the the late 1980s. But we still have real income growth ranging from 15% at the bottom to 64% at the top. Real income growth for the equivalised household at the fiftieth percentile is 28%.

After housing costs is far less pretty a picture, with real decline in the bottom decile. There are real problems caused by excessively expensive housing, which need to be addressed through appropriate changes to zoning and to council incentives to let more housing be built.

If we're looking at household incomes though:

• There was decline almost across the board from the late 80s through early 90s. Pain was concentrated in the bottom four deciles, which saw substantial real declines in equivalised household income. There were tiny gains at the very top. None of this is a problem of "growth benefiting the rich", rather, it's a story of the costs of substantial economic restructuring.
• Income growth since 1994 has been stronger and broadly shared. Incomes at the bottom are up 44% on where they were in 1994; incomes at the top are up 64% on where they were in 1994.  

It's hard to see evidence in there of New Zealand's having increasingly experienced growth that only benefits the top. If we look at the most recent years there available, 2011 through 2014, incomes at the bottom are up 8% while incomes were flat for the 95th percentile. 

I agree with Shamubeel that GDP is hardly a general measure of good stuff. We noted a few of the problems with GDP in our Case for Economic Growth two years ago. But we also noted that rather a lot of good stuff does correlate with GDP.

It's good to have lots of different measures of good stuff. But it's better to properly price in things like negative environmental externalities than to throw out GDP and give up on economic growth. New Zealand has really rather poor overall economic growth figures. Stronger growth from solving some of the barriers to productivity growth lets us afford all kinds of good things, including better environmental amenities.

* Here and elsewhere, though, always be sceptical of the numbers for earnings in the bottom decile.

GDP isn't everything...

...but it sure does correlate with a whole big bucket of good stuff. Here's Will Wilkinson from a couple of years ago. And, a few relevant GapMinder links:

• Life Expectancy
• Child Mortality
• Age at first marriage

My former colleague Les Oxley presented at the Transit of Venus Conference:

Measuring the success of our nation by Gross Domestic Product is a dated and senseless exercise according to speakers, Oxley said.

He said it was time to do away with GDP as it was "not fit for purpose".

"It is not a good single measure of success. GDP is only good for what it was built for: financing World War Two," he said.

Of course GDP isn't a good single measure of success. Things like earthquakes can bump GDP up during reconstruction, but at horrible cost to wealth and life. Broad voluntary shifts from labour to leisure would show up as drops in GDP even if people were happier. A good single measure of success would be some GDP+, incorporating a bunch of other good stuff along with GDP; it would be pretty hard to get agreement on the relative item weightings.

But surely abandoning GDP goes a bit too far.

Update: Les advises by email:

The context was a discussion of sustainability and wellbeing where I had said that if these were the things you were interested in then using GDP alone was not fit for purpose.  I then explained that the original purpose of GDP was to measure a country's output and that this was used in WW2 in part to make a case for the need to  finance the war efforts.  I did say that the original purpose for which GDP was created remains valid, but not as the single and only measure if the debate is broader (i.e.,measures of wellbeing).  I (and Gareth Morgan) then said that GDP might best be considered a constraint not a goal in its own right and setting the goal of catching up to Australian GDP was basically futile unless the NZers were prepared to consider other options to increase GDP, like mining, etc.

I'd go farther and say that, even with mining, I'd be pessimistic about catching Australian per capita GDP. Agglomeration seems likely to work against it. I agree with Les that GDP by itself is a poor measure of wellbeing. It's hard for me to think of a better single one though.

Natural Disasters and GDP for National Income Accounting Nerds (UPDATED)

The broken windows falacy has been well addressed following our recent quakes, but there is an interesting technical issue with the measurement of GDP following a disaster, brought to my attention by a graduate of ours (and a former colleague of mine at the Bank of Canada), James Yetman.  

By way of background, consider how the contribution of a lottery to GDP should be measured. From total revenue, one needs to subtract off not only expenditure by the lottery seller on intermediate goods (such as the cost of the paper lottery tickets are printed on), but the payout on prizes. In effect, a lottery provides a valuable service (it would seem, from revealed preference) for transferring money from some ticket buyers to others. It is the commission earned on this transfer that constitutes the lottery seller’s revenue from which one subtracts expenditure on intermediate goods to calculate the contribution to GDP.

Now imagine that a country runs a really large lottery in which the prize jackpots if it is not won. And imagine that the probability of any particular lottery having a winner is so low that in most years the jackpot is never won. In this case, in most years, the lottery would be appear to be making a large contribution to GDP (high ticket revenue with no prize disbursement subtracted off), and then in years when the jackpot was won, would appear to be making a large negative contribution. The lottery market, however, is providing the same lottery services each year. In this example, the appropriate way to measure GDP would be subtract off the expected level of prize payment from revenue each year, not the realised payments.

Now consider the insurance market. Just as with a lottery, one should measure the revenue in the insurance industry as the difference between income received (premium payments plus interest on accumulated investments) and payouts in claims. But there is a lottery component to insurance. In the year of a really large natural disaster, payouts on claims will be unusually high, so in normal years, the difference between income received and claim payments will need to be higher to cover this contingency. Just as with the lottery example, the true contribution of insurance to GDP (the production of peace-of-mind), does not fluctuate in this way. Apparently after 9/11, the way the contribution of insurance services to GDP is measured was changed in the U.S. to subtract off expected claim payments rather than realised payments. I have no idea what the definition is in New Zealand. Can anyone with a background in official statistics enlighten me?

UPDATE: James Yetman has emailed me a reply he got from Statistics New Zealand about this. The upshot:

Premium income is used as the indicator for insurance in quarterly GDP, which affected directly by changes in insurance claims. Premium income may rise as prices rise in the longer term, but unless more people actually take out insurance it won't affect GDP in constant prices.

Annual GDP in current prices is a bit trickier. We get the output of this industry by deriving a service charge that represents the service the insurance industry offers policyholders. This starts with a service charge ratio, which measures the proportion of premiums that aren't used in paying claims (with a few other adjustments for supplementary income and reinsurance). The service charge ratio is averaged over five years to smooth out volatility and then multiplied by the premiums received for the year (again with extra adjustments I won't detail here), to give the service charge/output of the insurance industry.

A big rise in claims could potentially pull down the service charge ratio significantly, even with the five year average, though it would likely be offset by reinsurance claims by NZ insurers. So the final impact would depend on the difference between insurance claims and reinsurance claims. It's also possible that we would intervene here if we didn't think the service charge ratio was realistic, as the service charge is intended to be based on the 'normal losses' you mentioned (as the insurance industry calculates its premiums based on probabilities over the long term).