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On Measuring Economic Activity

Posted By Don Boudreaux On November 1, 2012 @ 6:12 pm In Data,Scientism,Seen and Unseen,State of Macro | Comments Disabled

My new correspondent – who I know only by the strange moniker “Aaron the Aaron” – points me (again without comment) to this report in the Wall Street Journal.  It’s entitled “Economists React: ‘Naive’ to Think of Sandy as Stimulus [1].”

Of course I agree.  Such thinking is indeed naive (if commonplace among men-in-the-street thinkers).

But some of the commentary in the WSJ essay (all by business-economist sorts who specialize in predicting the course of macroeconomic aggregates, such as nominal GDP) is confused, or at least potentially confusing - confusion that springs from failure to appreciate wisdom of the sort that is spelled out by Tim Worstall [2] (and, in longer form, by the late Oskar Morgenstern [3]).  (I concede that such wisdom might not be particularly relevant for whatever purposes business-economist sorts issue their predictions.)

Consider, for example, this passage:

Whatever the direct losses [from storm damage], they will not be visible in the economic indicators, which focus on the flow of new production, sales, and employment, rather than the stock of existing wealth. (They are therefore a poor measure of the impact of a natural disaster on the nation’s well-being.) Nevertheless, Sandy is likely to be visible in the monthly economic indicators. In the very short term–that is, the October 2012 data–the impact is likely to be negative, as workers are forced to stay home, capital equipment is either unusable or idled temporarily, and shops are closed. In the slightly longer term–that is, the remainder of 2012 and the first few months of 2013– the impact is likely to be positive because workers make up for lost output, capital equipment is brought back online, consumers make purchases that did not take place during the disruptions, and the rebuilding of damaged property begins. The positive longer-term effects are typically large enough to push the level of activity above the path that would have materialized without the disaster. If so, the positive longer-term impact on the growth rate of activity will exceed the negative short-term impact. …

The parenthetical remark above is key.  Higher GDP figures do not necessarily mean more prosperity for most Americans.  (Again, see Worstall.)  Therefore, even if “the positive longer-term impact on the growth rate of activity will exceed the negative short-term impact,” no one should interpret this claim as predicting that hurricane Sandy’s destruction will prove in the long-run to be an economic boon to Americans.  Our long-run standard of living might well be made lower by Sandy even though that hurricane unleashed forces that rev up the rate of measured economic activity.

Even more revealing is this passage from the WSJ report:

Property damages do not subtract from economic activity. The homes, buildings and automobiles damaged or destroyed by Hurricane Sandy were produced some time ago and were part of GDP from earlier periods. The cleanup, repair and reconstruction of these damaged properties do add to GDP, however, and will likely provide a modest boost to economic growth in 2013.

Here we have a clear confession of the fact that measuring a country’s wealth by GDP can indeed by quite misleading.  A house built, say, in 1980 and worth $1 million is destroyed by a hurricane.  Its destruction – its loss – doesn’t cause GDP to fall (although wealth has been destroyed; people are poorer as a result). Instead, the process of “cleanup, repair and reconstruction” add to GDP!  But this addition to a measured statistical aggregate misleads if it is interpreted as suggesting that hurricane Sandy promotes higher material living standards.

For these business-economist sorts, then, to write that “The cleanup, repair and reconstruction of these damaged properties do add to GDP, however, and will likely provide a modest boost to economic growth in 2013″ misleads uninformed or careless thinkers and pundits [4] - and, hence, misleads the general public - into believing that experts predict that hurricane Sandy will make our economic lives better than our economic lives would have been had Sandy instead headed harmlessly out to ocean.

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URLs in this post:

[1] Economists React: ‘Naive’ to Think of Sandy as Stimulus: http://blogs.wsj.com/economics/2012/11/01/economists-react-naive-to-think-of-sandy-as-stimulus/

[2] spelled out by Tim Worstall: http://www.forbes.com/sites/timworstall/2012/10/29/frankenstorm-sandy-will-boost-the-us-economy/

[3] by the late Oskar Morgenstern: http://www.amazon.com/Accuracy-Economic-Observations-Oskar-Morgenstern/dp/0691041512/ref=sr_1_3?s=books&ie=UTF8&qid=1351806072&sr=1-3&keywords=oskar+morgenstern

[4] uninformed or careless thinkers and pundits: http://finance.yahoo.com/blogs/the-exchange/economic-impact-hurricane-sandy-not-bad-news-150458002.html

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