The horizon is not so far as we can see, but as far as we can imagine

The Chimerical Growth of GDP and Privatization

Modern economies are often measured in terms of Gross Domestic Product (GDP). Look up the definition of GDP and you’ll come up with something like this: a country’s GDP is the total value of all finished goods and services in a country in a year plus exports, minus imports.

Consider this, if a parent takes care of their children, is that included in GDP?

No, it isn’t.

What if the children are taken care of by a nanny or day care worker?

Then yes, it is part of GDP.

Either way the work gets done, the children are taken care of. But if they are looked after by someone who is paid for it, it’s considered economic activity and if not done for money, it isn’t considered economic activity. Studies show, and our own common sense tells us, that as a rule, children cared for by their own parents, especially when young, turn out better: healthier, less likely to commit crime later on, brighter, and so on. So, increasing GDP by paying to have children cared for reduces well being while increasing the size of the economy.

More money being spent, and more GDP, is not always good. Another commonly used example is that if a hurricane devastates a city, the rebuilding will increase economic activity, and GDP. This doesn’t mean we want hurricanes to wipe out cities. Keeping someone in prison costs more than sending them to university, that doesn’t, or at least shouldn’t, mean we prefer locking young men up to sending them to prison.

In the developing world GDP is often increased by moving from subsistence farming, which is to say, people growing their own food, to cash crop farming. Moving to cash crops, for various reasons, tends to push people off the land. They no longer grow their own food and now have to buy it. GDP increases because cash crops are sold for money, mostly to foreigners, and sometimes because a whole bunch of people now have to buy their food rather than growing most of it.

The theory behind this is that with the foreign currency earned by selling cash crops, the country can modernize, the displaced subsistence farmers will find jobs, and buy food. In practice, in many countries, the farmers have wound up in vast urban slums without jobs, food has to be imported from overseas, and what the UN euphemistically calls “food insecurity” spreads. There is a larger economy as measured by GDP, but more people are hungry, more people can’t support themselves, and malnutrition stunts the intelligence and growth of the generations to come.

Ironically, because there are only so many cash crops, and western “development experts” spent decades telling multiple countries to grow the same few crops, the price of the the crops often crashed. The end result of that was that countries wound up with trade deficits, and had trouble affording imported foods. (The IMF will then tell the government to stop subsidizing food. The result is predictable.) So you have the spectacle of Egypt, for millennia the breadbasket of the world, needing to import food, nor is it the only country which went from feeding itself to having to buy food. (check timing on this)

GDP is up, measurable economic activity is up, but much of the population is worse off, though certainly some people get rich.

Another way GDP and the money economy increased is through privatization. Imagine a road is sold to a private company. The people, in the form of the government, get a one time infusion of cash. The company receives an asset – the road, whose value comes from the ability to charge people to drive on it.

This increases the money economy in three ways:

  •  An asset can be borrowed against. The value of assets in the economy has just increased, and new capital can be raised by the owners of the road to do whatever they want with. This could be productive, investing in their business, or it could be used to pay the executives more money, or it could be used to buy back shares in an already existing company, raising share prices and increasing executive bonuses based on share price.
  • If not already a public company, the company can sell itself either to other private investors, or by issuing shares to the public. If they raise more money doing that than they spent buying the road, then they have a surplus which they can use to pay themselves or invest in some fashion. They could buy another company, invest in the business itself, branch out (perhaps putting up stores on the road), and so on. Once those shares are issued, people who own them have an asset, and they too can borrow against that asset, often for many times what the shares are worth.
  • The fees used to drive on the road. The road is an end product, this is GDP. The economy has increased in size.

All of this may sound good, but the price is obvious: people have to pay to drive on the road. While it’s strictly true that the public road was paid for, through taxes, that’s very different from having to pay a private company to drive a road. Because it is no longer free in daily practice, the road will be used less. Drivers will have to decide if the cost of driving on this particular road is worth it.

This will reduce economic activity. Say you were thinking of going out to eat. The cost is no longer gas+meal cost, it is now gas+meal cost+toll or perhaps the cost of taking roads which go to the same place, but less quickly. For some people, the cost will now be higher than the benefit. The restaurant loses a sale. So do other businesses.

By selling the road we have pumped up the economy in the short term, and created more assets which can be borrowed against (which is good if the money is used productively, but not if it isn’t) and we have given some specific people a way to make a profit in the future. But we have also reduced the benefits of the road for everyone else.

There are other types of privatization. Perhaps the government directly provides garbage pickup, using its own employees. Perhaps road repair, or police, or cooking food for troops, or car insurance, or the railways, or airports, or power generation, or clean safe water, or sewage removal and treatment, or parks.

Privatization can be good, there are services and goods which are better produced by markets, but widespread privatization is often a way of artificially pumping the private asset base of the economy. It looks good, it produces increased GDP and GDP per capita, but it often actually reduces welfare.

Privatization, then, often produces money and the chimera of economic growth, but not the happiness, sense of purpose and access to healthy levels of necessities which are supposed to be the purpose of growth and money.

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  1. If I pay you $10 to mow my grass and you pay me $10 to mow your grass we have contributed $20 to GDP, whereas if each of us mowed our own grass we would contribute nothing to GDP. The $20 we contributed to GDP is meaningless because no more grass was mowed and neither of us has any more money than we started with, but the GDP is increased by twice what either of us spent.

    Growth is created by an increase in consumer spending, so let’s each pay the other $40 for mowing grass. Now we are contributing $80 to GDP, a 400% increase. There is no increase in the amount of grass mowed. There is no increase in income because I spent $40 in order to make $40; my income was zero before, and it is still zero, as is yours. But Paul Krugman is deliriously happy because the national debt is now smaller as a percentage of GDP.

  2. CMike

    There’s also the question of whether leisure has value. [LINK] [LINK]

  3. wendyedavis

    Many good observations here, Ian. But aren’t Wall Street transactions also a large percentage of GDP now, and aren’t debts counted as money now, or perhaps they always were? Bonds issued by the Fed, for instance, sold to Wall Street for zero, parked at the Fed to accrue interest?

    But no, the financialization of America is not reaping good results. Well, except for the Ruling Class, of course.

    I remember that sometime in the past, Joseph Stiglitz was attempting to help France’s Sarkozy to construct a new way to reckon GDP, and it *may* have been within that project that he was said to be working on a ‘Happiness Index’.

    @ Bill H: hilarious second paragraph!

  4. Ian Welsh

    Debts always were, yes, and Wall Street’s proportion of profits is up to, iirc, 40% of the US economy (wall street meaning financial industry). The question is proportion.

  5. Jonathan

    Bill H, isn’t that an example of economic rent? The portion of a price over and above what a seller would freely accept in an exchange?

  6. “GDP is up, measurable economic activity is up, but much of the population is worse off, though certainly some people get rich”

    Exactly. The market indicators are not always reflective of the realities in society. Who cares if the DOW hit a new high if its effects aren’t “trickled down” to the rest of the economy?

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