The Power of a Single Number

The Power of a Single Number

There is something fascinating about John Maynard Keynes that makes him the guy at the right time in the right place, most of the times. As in explaining business cycles and government intervention, his role is crucial for understanding why and how we calculate GDP as we do today. Though he did not invent anything, in this case.

GDP – which stands for Gross Domestic Product – was the result of political contingencies and economic necessities (wars and crises). However, if it were not for World War II, the reception and implementation of GDP would have probably been way slower. After all, the incentive came from governments that needed estimations to plan for the war.

William Petty: (forgotten) "Father of GDP"

History of GDP is about 300 years older than Keynes and starts with an Englishman that you probably have never heard of. The guy is William Petty (1623-1687), who was a government advisor for the British government during the economic period called "mercantilism." Petty gathered data across the whole country in order to compare the wealth of England with France and Holland and show that despite wars and revolutions, it was on a par with its two enemies. His estimation also had a political implication. "If we increase taxes," he said, "we can finance a stronger military power and go to war against France and win."

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Petty’s revolutionary methodology (which he called "Political Arithmetick") was soon dismissed, both because his data were pretty inaccurate and – more importantly – because the father of economics, Adam Smith, completely dismissed the helpfulness of these figures; "I have no great faith in political arithmetick" he wrote in the Wealth of Nations.

Colin Clark: at the wrong time in the right place

It took 200 years before the necessity of gathering these figures reappeared. The incentive came from the Great Depression (1929). The British government did not know what was happening economically and appointed, for the first time in history, a committee of experts that had to advise the Labour government. Colin Clark (1905-1989) was among them, but he soon resigned when he realized that the government wouldn't rely on his statistics and advice.

Keynes, who was professor at Cambridge at that time, was aware of the accuracy of Clark’s measurements and his methods of data gathering, and secured him a position as a lecturer in statistics there. Clark was also able to show that it was possible from the data to gain an idea of how consumption, saving patterns, the size of the local population, and other macroeconomic indicators developed.

But the world was not ready and mainstream economists such as Keynes and Lionel Robbins found these calculations meaningless.

World War II: Keynes's success

The turning point occurred with the outbreak of WWII. Based on the experience of WWI, economists and government officials understood that they needed data and war plans if they wanted to win a war that was not expected to be short.

At that time, Keynes was the prominent economist in UK and was extremely trusted by the government for the major roles as advisor he covered during the interwar period. More importantly, his theories envisioned a new role for the government as active agent in the economy rather than a marginalized one.

Keynes realized that continuous up-to-date data about the state and economy were crucial to plan for the war.

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Keynes's estimations departed from Clark’s in that his definition of national income included government expenditure further than private consumption and investment.

World War II: Simon Kuznets and the New Deal

At the same time, on the opposite side of the ocean, the US was grappling with the Great Depression and World War II, too.

The guy studying economic growth in the US at that time was Simon Kuznets. Kuznets was a member of NBER (National Bureau of Economic Research) and was tasked with national income accounting from 1929 to 1934. The estimations on economic growth that resulted from his study were disastrous. As a result of the Great Depression, the entire activity of the economy from the income side had fallen by half. Politicians were eager to use this figure as justification for the New Deal, and the view that progress could be measured using national income soon became commonplace.

Keynes vs. Kuznets: The role of the State in GDP

At the beginning, the Kuznets method used by the Department of Commerce was independent of Keynesian theory. Kuznets placed the focus on national income paid out – that is, private households’ disposable income. The state featured only inasmuch as it made transfer payments. From this perspective, an increase in armaments production registered as a decline in national income. Instead, by including government spending, the Keynesian method equated the State with consumers.

It was OPACS (Office of Price Administration and Civilian Supply) that had a vested interest in implementing Keynesianism. The authority relied on estimates of private consumption, private and public investment, and government spending. In this way, increased spending on armaments would be recorded as an increase in GDP.

You can now imagine how the story ended. The US government implemented the Keynesian method to calculate GDP as it gave the government room for expanding armaments without being blamed for a reduction in GDP. Keynes won.

Why GDP after WWII?

After the war, government spending on armaments would end, so why is GDP still necessary if we don’t need to plan anymore?

Well… since during the war, government spending was responsible for almost half of the gross national product, the issue then became how to keep the same levels of GDP?

In the postwar era, the goal shifted to create enough jobs and, after years of low consumer and investment spending, stimulate domestic demand and private investment to make full employment possible.

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The idea then was that data on gross national product provided the state with an indispensable basis for decision-making and should, therefore, be conducted by government bodies on a permanent basis.

... Continental Europe (?)

It seems like we’re missing a relevant actor… What about countries in Europe? How is it possible that Germany with the Bismarkian welfare state and heavy bureaucracy had not implemented some measure of GDP yet?

This actually had never happened with the accuracy that did in the UK and US.

GDP became a relevant measure in continental Europe only after WWII, when countries were forced to do so by the US. It was first introduced in West Germany and spread across Europe under the framework of the Marshall Plan. The US wanted to make sure that West Germany implemented the right policies with the right outcomes. Following the Bretton Woods Conference (1944), GDP was officially adopted as measure of international (economic) harmonization.

Though accepted with some skepticism, it soon emerged that the statistics could be used as a basis for tax estimates, the budget, and medium-term financial planning.

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In France, politicians saw the benefits of those numbers for planning the reconstruction of the country and finding the way back to international standing. The French considered the national accounts to be "accounts of power."

My Take Today

Why GDP is better than measurements of happiness (GNH)

It’s interesting how GDP, which was initially seen as a positive measure associated with progress and wealth, soon became questioned. Not only did Schumpeter criticize capitalism and envision the end of economic growth, but movements claiming a reduction in GDP spread across Europe.

They were mostly Neo-Malthusians concerned with the increase in population, the depletion of natural resources, and pollution – something which resembles today's FFF (Friday For Future) & co. One of the most popular movements – the Club of Rome – published a report in 1972 titled “The Limits to Growth,” which used computer models to analyze the impact of population growth, resource depletion, and pollution on the world's economy and environment. The report concluded in a highly Malthusian mood: “if current trends continued, the world would face an environmental and societal collapse within the next few decades.” Sounds familiar?

In 2007 a movement called “Beyond GDP” was formed across Europe. Growth in GDP has been then associated with pollution, lack of happiness, and inequal distribution of wealth, among others. In Italy this idea has been adopted on steroids. Politicians were advocating the so-called “happy de-growth” (decrescita felice). Alternative measures started to be searched to assess “progress.”

In my view, the eagerness to look "beyond GDP" and embrace alternative metrics is quite dangerous. Here’s why:

  1. The “objectivity” of GDP makes the government accountable. Other metrics, meh. Although alternative measurements like Bhutan's Gross National Happiness Index (GNH) may initially appear more "holistic," they can eventually serve as a pretext for increased government interference in our lives. GDP focuses on ensuring economic growth and minimal interference with our private lives. Conversely, by using the GNH, the role of the government is easy to become more vague, ambiguous, and as a result more intrusive. In general, the more limited the scope of the government, the easier to check it. If we expect the government to be in charge of our happiness, life-work balance, psychology, and numerous other aspects, it will encroach even further into what should be considered "private." Many individuals already expect the government to find suitable employment, provide income, and even address their "mental health" concerns. It is rather citizens' responsibility, and not of the government, to take care about their own idea of happiness.
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According to Adam Smith the goal of the government was to ensure “peace and plenty,” something that everyone can straightforwardly measure. Peace: you are involved in no wars. Plenty: GDP is growing.
  1. Giving up on GDP will likely reflect a society that has given up economically. A society that has nothing to offer but economic decline. A perpetual decline. A society whose focus is on the redistribution of the economic pie instead of recipies to get the pie bigger.