The Point of Economic Activity and Other Useful Criteria
April 16th, 2009Posted by: Roger Pielke, Jr.
A letter in today’s FT from John Hay says some thoughtful things about economic activity and GDP. The letter is in response to an FT editorial critical of plans in the UK (and elsewhere) to encourage new auto purchases via an incentive to scrap older cars:
So if breaking a window (or car) encourages money to move faster, it will increase GDP, or economic activity. But GDP fails to capture either wealth (the shopkeeper’s savings) or the point of economic activity – the satisfaction of human needs. The usual way we measure those things, GDP, is actually the sum of all the costs of satisfying those needs that were satisfied in a year. As such, GDP cannot distinguish between avoidable or wasteful costs and those that are unavoidable.
For the same reason, making tax law more complex would create work for accountants and hence raise GDP. But by wastefully consuming resources and labour, it would reduce society’s ability to satisfy other needs.
Economic progress is about finding ever cheaper solutions to problems – such as moving a load from A to B – so that more resources can be devoted to new problems, like finding a cure for cancer. Output, conventionally measured, is more a symptom of this process than a cause.
While people will debate legitimately what constitutes avoidable or wasteful costs (e.g., auto manufacturers will welcome policies to scrap older cars, others may not), the notion of finding cheaper solutions to problems seems to be a far more politically tractable basis for collective political action than resolving debates over what constitutes the worth of investment, even if people debate the notion of “cheaper.”
This straightforward criterion for evaluating an action calls to mind Sarewitz and Nelson on criteria for technological fixes, and probably is a version of their number one:
I. The technology must largely embody the cause–effect relationship connecting problem to solution.
II. The effects of the technological fix must be assessable using relatively unambiguous or uncontroversial criteria.
III. Research and development is most likely to contribute decisively to solving a social problem when it focuses on improving a standardized technical core that already exists.
Cheaper, cause-effect, building on what we know. These criteria are just about the opposite of the dominant approach to climate policy:
Make energy cost more.
Address emissions indirectly (while mostly ignoring adaptation).
Design a massive new and untested derivatives market.
At some point the differences between common sense and reality will have to be reconciled. The political process will inevitably make this happen, but it could take a while.
April 16th, 2009 at 5:30 am
Roger, you seem to fallen right back into the broken window fallacy. “While people will debate legitimately what constitutes avoidable or wasteful costs (e.g., auto manufacturers will welcome policies to scrap older cars, others may not)”
Everyone recognizes that the glazier (or auto manufacturer) welcomes the broken window (govt subsidy). Bastiat was trying to get everyone to recognize that society as a whole was worse off.
Destroying a working automobile does not make society better off. It makes society poorer.
Remember the idiots who said that Hurricane Andrew was good for the Florida economy? Algore also defended the govt regs on refrigerant change on the grounds that forcing businesses to scrap all their working A/C systems and buy new ones was good for the economy. By that same type thinking, one would argue that a flood which wiped out New York would also be good for the economy.
Keynes fell for the same fallacy.
Currently in Washington we have people claiming that all that matters is govt spending and the object of the spending doesn’t matter. They assert that waste, fraud, etc. make no difference to the economy, only the amount spent. Of course, the recipients of the largesse are always happy to get it and willing to debate whether it constitutes waste.
The keys are productivity and wealth. Increasing productivity improves the standard of living. Destroying property makes us poorer and reduces our ability to be productive. Even Christina Romer, the Chair of President Obama’s Council of Economic Advisers, did a study a few years ago which showed that tax cuts are far better for improving the economy than govt spending. Individuals do a much better job of allocating resources productively. That shouldn’t be a surprise. That transactions freely entered into produce greater utility than transactions coerced by govt should be obvious to anyone.
If someone went to the parking lot where you work and played demolition derby, I don’t think your co-workers would have much sympathy for the argument that the demolition was good for the economy. And even if the govt made someone else (i.e. taxpayers) pay for the damage, the negative impact to the economy as a whole would be the same.
April 16th, 2009 at 10:11 am
Roger:
“Cheaper”!
The problems are: “For whom?” and “When?”
It’s very difficult to make such estimates for a global population – and for that population, at various times in the future. But that’s just what’s required!
A decision to accept business as usual until 2100, is quite like junking a new car to stimulate the auto industry; it only looks at a ’small’ piece of the problem.
You – and those you criticize – and almost all of us usually make this same ‘mistake’.
April 16th, 2009 at 10:19 am
Sometimes the answers aren’t simple. The idea that individuals will always allocate investment better than government is not true. Sometimes it is. It depends on what you are talking about. Individuals will not invest in very expensive and long-term projects which can greatly improve the productivity of economic activity in general. This is why government takes responsibility for most major infrastructure. But government isn’t so good at choosing the next best internet thing.
Nor do investors (whether or not they are the government) need to be perfect. Government subsidies for the transcontinental railroad are often held out as an example of a project that worked well, and yet that was fraught with corruption.
However, in the case of cap and trade, I agree that this is not the right strategy. Far too complex and for too unlikely to get it right. That’s why straightforward carbon taxes are gaining favor with even some who in the past would have lauded something that uses market processes.
The issue is how we are to deal with a negative externality. This is not something where individual decision can provide a solution that I can see.
April 16th, 2009 at 10:59 am
And of course, ‘price’ involves the way currencies are valued as well as the values that are perceived to be associated with uncertain risks – and these vary wildly from culture to culture, place to place, and over time. But global ‘averages’ are what need to be used in making global assessments.
April 16th, 2009 at 12:16 pm
Yes it’s true that the single number for GDP is a poor measurement of something as complex as a superpower economy. The reduction of complex systems to a single dimension measurement is a common human (ok mostly male) error. It allows us the illusion of understanding something only vaguely seen.
Obama’s problem is that he has no experienced central economy planners on his staff. If he really wants to micromanage the economy he needs to hire some of the many experienced, and un-employed, central planners in Russia. What could go wrong?