Neoclassical Economist Recants Key Article of Faith
by Eric Zencey
Mark this down as minor good news: in Vermont, a neoclassical economist who has long served as a media “go-to guy” for commentary on economic matters appears to have recanted a key element of the neoclassical model. He didn’t put it in those terms, and the scope of his readership is rarely larger than his (and my) home state, but still, this counts as progress.
The element of the neoclassical model that has come under critical scrutiny in the Vermont press lately is the notion that GDP — a measure of the dollar value of all goods and services produced by the economy — is a practical and useful measure of economic well-being. It’s not hard to see why GDP is being re-thought: last month tropical storm Irene dumped tropical-rainforest quantities of water on the state in just a few hours, leading to major damage from unprecedented flooding. Rivers filled their flood plains and kept rising, sweeping away roads, bridges, and houses, ruining homes, lives, farms, and communities. The publicly owned infrastructure is being put back with great speed and efficiency (and should be in good shape for the upcoming foliage season, so if you’ve planned a visit don’t think that you need to cancel). That repair work is the source of some economic confusion. The construction industry had been slumping; now workers are busy, doing productive things, getting paid. Is all this public works effort a net benefit to the economy, or not?
GDP says yes, absolutely. Common sense — and steady-state economic theory — says no.
GDP gets it wrong because it fails to take into account the ongoing benefit we derive from the services of physical wealth that’s already in place — public and private infrastructure that is paid for and in use. My car is a capital investment that provides me with transportation services; if I own it, the only aspect of its delivery of services that shows up in GDP comes from the spending I do on operating costs and maintenance. And perversely, if gas prices go up so does GDP — telling us that because there’s more spending, the economy must be delivering more economic benefit. If I make the switch to renting a car rather than owning it, the rental fee shows up as a monetary transaction and gets counted in GDP — though there’s no net increase in the quantity of services I’m getting. Those services count in GDP only if I pay for them incrementally and continually (and don’t get an equity stake in my vehicle).
The same miscounting happens with the services provided by (non-rental) housing, roads, bridges, etc.: the ongoing benefit is simply not counted. GDP is an indicator for amnesiacs. It has no memory, no room to allow that the economy has been operating for quite a while and has produced forms of durable wealth — things like buildings and bridges and roads and communications systems — that continue to be useful long after they’ve been paid for.
So, when disaster leads to major new spending, a by-the-book accounting has to say: GDP is up, so we must be better off. The downside — the loss of wealth (and the loss of services derived from that wealth) can’t show up in the books because it wasn’t counted in the first place. Disaster looks to be good for business, good for the economy, good for us; within the limits of neoclassical concepts, tools, and analysis, when we repair storm damage the result is “net positive.”
Will Vermont end up net positive in economic benefits as it repairs the damage from Irene? There are additional complexities when we ask such a question about a particular location or region, and the answer is “it depends.” The net economic effect of damage and repair for any one location depends in part on where the funding comes from — whether it is raised within or outside the economy being considered. (At the macro level, there is no “outside,” and the answer is no.) If Vermont’s repairs are paid for with money from outside the state — from the Federal government, say, through FEMA grants — disaster repair might or might not have a net positive effect in the state; it may or may not exceed the loss of wealth from the disaster. If there is a net positive effect, the surplus comes either from deficit spending by the central government, or through direct transfer of resources (through Federal taxes) from other states. If it’s a transfer, it represents loss of purchasing power and economic activity in the areas from which the money is transferred: there’s been no net gain in the system, just a shift in who benefits and who pays. If the funding comes from deficit spending, the stimulus may be just what’s needed to put people back to work, but there is still a shift: the transfer is inter-generational rather than geographic. Wealth creation that might have occurred later, benefiting a future generation, has been brought forward to benefit us.
This wouldn’t be a problem in an economic system on an infinite planet. In a world without resource constraints, deficit-financed investment can always increase the amount of production in the future, and the deficit can be repaid from that increase. Thus, on an infinite planet it would be possible for both the present and the future to benefit from our deficit spending today. But on our planet, with an economy built beyond the limits of what’s sustainable, expanding production today diminishes the wealth and well-being of people in the future. On a finite planet at maximum capacity, there’s no room to expand the economy’s ecological footprint without causing harms and losses, and economic growth today is a transfer of wealth and well-being from the future to the present.
Casting up GDP accounts, even when corrected this way, doesn’t begin to measure the personal and social costs of the damage — people’s loss of livelihoods and secure expectations, their loss of the personal effects that help define them and their familial and community relations, and sometimes — as when farmland is poisoned by toxins in floodwaters and herds and breeding stock are swept to their deaths — their loss of a known, satisfying way of life in a familiar landscape. When those softer, less quantifiable costs are included, it’s very hard to think that the catastrophe in Vermont had any sort of net positive benefit.
But economics as neoclassicists practice it slices off those less quantifiable aspects of well-being and looks at cold, hard cash. In those strictly monetary terms, disaster looks good for business, and more business looks good for Americans. That’s the flaw in GDP that one neoclassical economist has recanted in his latest appearance in our local media.
I interviewed this particular economist by phone in 2009, when I was putting together an op-ed piece on the shortcomings of GDP for the New York Times. When I asked the professor about the perverse way GDP tallied the results of Hurricane Katrina ($82 billion in property damage, so an $82 billion boost to GDP if all the damage were to be repaired), he defended GDP. “That figure is going to include a lot of improvements,” he said. “Those people are getting new cars, new carpets, new refrigerators.” Notice that this way of thinking gives a disciplinary seal of approval (“100% rational behavior”) to a very uneconomic, irrational exchange: you’d be crazy to pay the cost of complete destruction of your household in order to get incremental upgrades of some of the things it contains.
While it isn’t always possible to map theoretical insight directly from individual households to the larger household of planet earth, here I think we can. Because GDP doesn’t count the flow of services from existing household wealth as an economic benefit, GDP fails to treat destruction of that wealth as a cost item, and so it treats reconstruction of that household wealth as a net gain. Ditto when we look at the whole system: in the planetary household GDP fails to count ecosystem services as a benefit, and so fails to count ecosystem destruction as a cost item, and so makes continual economic growth look like a net gain. Because of our shoddy accounting, we’re destroying the ecosystems that support civilization, often to get nothing more than an incremental upgrade to the wealth we already have. At some point, we’ve got to admit that this is uneconomic, irrational: crazy.
This far the go-to economist didn’t go, at least not as he was quoted in the paper. But fixing our accounting system is a commonsense idea that subverts infinite planet thinking, and in what he did say the neoclassical economist showed that he had taken the first step on that path. He allowed that Tropical Storm Irene wasn’t an economic boon to Vermont, because “there’s a tremendous amount of wealth that’s destroyed, and that’s not a good thing.” Having recognized the existence of that already-built wealth, he should be ready to take the next (logical!) step: start measuring that wealth and start counting the services we derive from it as part of our economic benefit. That means getting beyond GDP, which focuses on the now, the moment, the instantaneous rate of change in our market-based economic activity.
Getting off of GDP and implementing an accounting system with a memory will prove to be the first step on a path to broader changes. If we take into account the services we derive from our considerable stock of built wealth, and also take into account the services we derive from our considerable-but-declining stock of natural wealth, we’re led by inexorable logic to re-evaluate the concept of economic growth. When we have a system of economic accounting that includes all costs and all benefits, it will be easier to see that much economic growth is uneconomic, because it costs more in degradation of ecosystem services and other costs than it brings in benefits. Once we get over GDP it will be easier to see that the only sane, sustainable economic doctrine is one that calls on us to live within our current solar income, a steady-state flow of matter and energy through the economy. By then this truth will have become self-evident: on a finite planet, we can’t grow the economy’s ecological footprint forever.
If, thanks to unprecedented storm damage, neoclassical economists are led to reject the valuations offered by GDP and follow their thinking to this conclusion, then unprecedented weather events like Irene may yet prove to have a net positive economic effect: they will have nudged economic theory onto the path to a sane, rational, sustainable, steady-state economy.
I’m asking myself again and again why economics is still sticking to GDP as a proxy to well-being, while it is so clear that this is insane thinking. What you are describing here is not even a question of the “pre-analytic vision” of the economy being a sub-system of the ecosystem (or the other way around, as neoclassics think) – except for the notion about deficit-spending. All the other arguments outlined here should be acceptable even within the neoclassical pre-analytic vision…
I am sort of astonished that proper credit is not being given here. What you’ve described in the early part of this article was described first by Frederic Bastiat in the 19th century as the ‘Broken Window’ fallacy, or ‘What is seen and what is not seen’ and is often referred to by adherents to the Austrian school of economics, who have assailed this fallacy – which is regularly by both the Keynesians and Monetarists – for decades. Henry Hazlitt singled it out for analysis in his classic ‘Economics in One Lesson.’ Thus, there is a considerable pedigree involved for this simple economic truth.
Of course, there are more basic problems with GDP, as Chris Martenson has discussed at length in his ‘Crash Course’ series, in the chapter titled ‘Fuzzy Numbers’ – the notion of hedonics renders this statistic fraudulent.
Finally, GDP – despite the ‘P’ – is calculated as a measure of consumption, not production.
So there are numerous reasons for why GDP is fatally flawed – but it is precisely those reasons which point to why it is so widely used. Because it serves the purposes of those who wish to manipulate our perception of reality. In this sense, GDP is not an economic concept as much as a political one.
It is also worth noting that neither the Keynesians NOR the ‘neoclassical’ school are at all interested in a ‘free market’ – as Bastiat was and as the Austrians are. That is one of the most wide-spread myths in economics today. One simple test to understand if some economic school is pro-free market is to ask if they believe in a free market in currency, or in a centrally planned currency regime. Keynesians and Monetarists are both of favor of the latter.
A Lincoln was once asked: if you call the tail of a dog a leg, how many legs does a dog have? To which he answered: 4 – calling it a leg doesn’t make it a leg. Same goes for the free market. No mainstream economic school for well over a century in this nation has been in favor of a free market, which basically boils down to being in favor of voluntary transactions instead of coercive ones.
I haven’t been able to figure out yet where steady state economics stands on this question, but the article above implies a tendency to see things more like the Austrian school than the two mainstream schools.
Thanks for the thoughtful comments. Yes, GDP is definitely a path OUT of the neoclassical vision–it doesn’t even make sense within that vision, and if you start measuring the actual, delivered well-being of the economy, you can hardly be a neoclassicist anymore. (My belief: steady-state and ecological economics lead us toward reintegration of political studies and economics into a coherent discipline of political economy, from which Economics misguidedly calved off a little more than a century ago.)
Oz, your point that the commitment to GDP may be more a matter of political forces than economic theory is a good one. (And yet–just a few years ago it was hard to get a neoclassical economist to agree “The GDP is fatally flawed as a measure of well-being and ought to be abandoned for that purpose.” Have enough economists come around so that the major blockage now against adoption of better indicators is political rather than economic-theoretical?) And yes–The Broken Window Fallacy is what we’re talking about here; I could have given the provenance, but didn’t. Another part of your comment reminds me of this truism/slogan: “There is no such thing as a free market.” Markets are always structured by policy. Similarly, we’ve always and everywhere exerted social (political) control over the use of capital. (If you own a factory, you’re not allowed to maximize profits by locking workers inside and working them to death; though that has, in fact, been tried….) The argument isn’t and should be about whether to have free markets or not, or whether to have social control of capital (“socialism”) or not. We’re all in agreement about that: social control and intervention are necessary. The only questions that remain are “how much social control, and for what purposes?” It seems to me that preservation of civilization through preservation of ecosystem services, which requires limiting ourselves to a steady, sustainable throughput of matter-and-energy in the economy, is a worthy goal. If we fail to achieve that goal, we will need more and more public control of markets and capital to stave off collapse by attempting to manage our culture’s increasingly unmanageable ecological footprint. In a book I’ve got coming out next year (“The Other Road to Serfdom”) I carry this argument into the Austrian camp by pointing out: since economic growth on a finite planet leads to a need for resource regimes to control our ecological impact (protocols and accords divvying up fish and water and controlling carbon exhaust and etc.), the supposedly free-market system run on infinite planet principles leads to centralized planning. If planning is the road to serfdom, then free markets are, under infinite planet principles, simply the other road to serfdom.
Eric, thanks for the thoughtful answer – much to chew on here. I hope locking workers inside is NOT one of the themes we see revisited in the years to come, but in a sense, we already have, as the cybersphere can be seen as the new factory, and everyone with a corporate mandated issued Android or iPhone can be said to be virtually chained to their desk to one degree or another!
Yeah bit of a stretch…;-)
Oh – and I love the name of your upcoming book. I’m going to have to go visit the Mises site just so I can observe the virtual steam coming out of their virtual ears! :)
Seriously, I’ve tried to have that argument with those folks, and many if not most hold to the Julian Simon viewpoint – aka magical thinking – that there are literally no finite limits in sight, either in terms of resources OR in terms the the biosphere’s ability to absorb pollution. I honestly don’t know how you can debate with people this far removed from reality.
In regard to this statement:
“The only questions that remain are “how much social control, and for what purposes?” ”
I would add a third, which I believe will determine whether the first two can be answered effectively or not: what is/are the mechanism/s by which social control is to be deployed?
I suspect many millions of people believed that they were voting for some specific forms of social control related to our ecological predicament (another others) when they elected the 2008 version of the candidate for hope/change. Didn’t turn out that way, though. I’ve been around long enough to know, it never really does.
I’m convinced that a top down political system like we have will generally prove inferior to a more bottom up civil society mechanism, or a set of some such mechanisms, in terms of actually representing the ‘will of the people’. Perhaps it would like like what Murray Bookchin called ‘libertarian municipalism’ – which embodies the principle of subsidiarity (undertaking political actions at the most local level feasible) and whereby the majority of political decision making power rests with neighborhood and community assembles.
After all, the problem with top down, far removed centralized planning is pretty evident when we look around the world today (and that was my point in my last comment – that ‘free markets’ didn’t get us to where we are, conventional wisdom aside). What we want, or so it seems to me, is social control directed not by some unaccountable, far off central government which is profoundly susceptible to corrupting influences, but directed via face to face local democratic entities. There are challenges either way, but it seems to me we know what ti expect from the top down approach – after all, that’s what’s given us something like 200 international treaties intended to stop overfishing, none of which have done a bit of good. I wonder what sort of innovative solutions civil society might dream up to address this ‘tragedy of the commons’?
Hey, I can dream, can’t I? :)
In regard to GDP – I do not think it is so much that so many economists have come ’round to the notion that it’s ill suited as a measure of well being as it is the problem that Jacques Ellul discussed decades ago in ‘The Political Illusion’, of ‘politicization’: “the act of suffusing everything with politics and dragging it into the political arena.” There was a time, in the not too distant past, when all things economic were not by definition the political footballs they are today, where economic events and such are almost immediately politicized. There was probably a time when academic economists could have kicked around the idea of replacing GDP with, say, the Genuine Progress Indicator. But that time is long past, IMO.
Thought provoking article, indeed!
Here at the Organisation for Economic Co-operation and Development (OECD) we have been examining how to move beyond GDP to measure societal well-being. Our first workable prototype, Your Better Life Index, was launched in May and can be found at http://www.oecdbetterlifeindex.org. The Index covers 11 topics currently and will include indicators on gender equality and income inequality in the next version. While the Index is limited to those countries whose data is available, robust and reliable, we are currently trying to secure enough data to add more countries, such as Brazil, the Russian Federation, Indonesia, China, and South Africa in the near future. We welcome your thoughts!
PS. We’ve featured your article on our website’s homepage.
Because GDP serves the interests of those in charge, our rational arguments against aren’t likely to dethrone it. But the varied efforts to create new indicators of an economy able to increase human, species, and planetary wellbeing have great value, I think, from French president Sarkozy to the government of China, admissions continue that measuring growth alone is not getting them to their ecological and other goals. Interesting that Simon Kuznets, a main developer of GDP as an economic indicator, was never happy with it, and, after a couple of decades had gone on to using other indicators. But GDP was measuring what the “Growers” wanted. I appreciate the work on the Genuine Progress Indicator by Clifford Cobb, Jonathan Rowe, Ted Halstead, and Herman Daly. Also that the Calvert-Henderson Quality of Life Indicators by Hazel Henderson and the Calvert Group is guiding some investing for the Calvert Group. The U.N.’s use of the Human Development Index, developed at the insistence of Mabub ul Haq, the Pakistani economist, is another plus. As these different indicators are used in at least some sectors of the economy, they show their merit even as they are further improved. Are they not heralds of the new ways of measurement that will become more widely used once the religious devotion to GDP wanes through unbelief?
Lee, thanks for the roundup of the various indicators – had not heard of the one by the Calvert Group previously. In regard to this statement:
“Are they not heralds of the new ways of measurement that will become more widely used once the religious devotion to GDP wanes through unbelief?”
Would that it were so. The dominant industrial, economic and socio-political systems, built upon the notion that growth-is-good comprise the framework in which that religion you cite operates. That framework will need to be dismantled, and this process is likely to be messy and take considerable time. That is, I don’t see everyone conveniently losing faith at once!
I wonder if it would make sense to attempt to introduce some of these more sensible well-being indicators at a more local level? If municipalities, for example – cities, towns, perhaps counties -began using such indicators side by side with current GDP-type models, a bottom-up approach might help to undermine the top-down ideology over time.
Which of these indicators might be most suitable for local or regional use, I wonder?
Can we have full employment without taxing our limited natural resource capital to the breaking point with exponential economic growth and production?
E.F. Schumacher appeared to have come to the same conclusions as the steady-state economists in his astonishing book, ” A Guide for The Perplexed” 1977.
Chapter Two, Levels of Being, from A Guide for the Perplexed by E.F.Schumacher, “Our task is to look at the world and see it whole.”
“We see what our ancestors have always seen: a great Chain of Being which seems to divide naturally into four sections–four “kingdoms,” as they used to be called: mineral, plant, animal, and human. This “was, in fact, until not much more than a century ago, probably the most widely familiar conception of the general scheme of things, of the constitutive pattern of the universe.” The Chain of Being can be seen as extending downward from the Highest to the lowest, or it can be seen as extending upward from the lowest to the Highest. The ancient view begins with the Divine and sees the downward Chain of Being as moving an ever-increasing distance from the Center, with a progressive loss of qualities. The modern view, largely influenced by the doctrine of evolution, tends to start with inanimate matter and to consider man the last link of the chain, as having evolved the widest range of useful qualities. For our purposes here, the direction of looking–upward or downward–is unimportant, and, in line with modern habits of thought, we shall start at the lowest level, the mineral kingdom, and consider the successive gain of qualities or powers as we move to the higher levels.
No one has any difficulty recognizing the astonishing and mysterious difference between a living plant and one that has died and has thus fallen to the lowest Level of Being, inanimate matter. What is this power that has been lost? We call it “life.” Scientists tell us that we must not talk of a “life force” because no such force has ever been found to exist. Yet the difference between alive and dead exists. We could call it “x” to indicate something that is there to be noticed and studied but that cannot be explained. If we call the mineral level “m,” we can call the plant level m+x. This factor x is obviously worthy of our closest attention, particularly since we are able to destroy it, although it is completely outside our ability to create it. Even if somebody could provide us with a recipe, a set of instructions, for creating life out of lifeless matter, the mysterious character of x would remain, and we would never cease to marvel that something that could do nothing is now able to extract nourishment from its environment, grow, and reproduce itself, “true to form,” as it were. There is nothing in the laws, concepts, and formulae of physics and chemistry to explain or even to describe such powers. X is something quite new and additional, and the more deeply we contemplate it, the clearer it becomes that we are faced here with what might be called an ontological discontinuity or, more simply, a jump in the Level of Being. “
Has anyone read “Human Scale”, by Kirkpatrick Sale, written back in the 80s?