One of the reasons the global financial crisis took the world by surprise may be that our measurement system failed. That is, market participants and government officials were not focused on the right set of statistical indicators, claims a report from a panel of top economists led by Nobel Prize winners Joseph Stiglitz and Amartya Sen.
One of the main culprits, according to the research, which was commissioned by President Nicolas Sarkozy of France, is that the classic and widely referenced gross domestic product metric is no longer a good measure of general well-being — and, in fact, has not been for some time
Simply put, the GDP is a measure of economic performance that represents the value of all the goods and services in an economy based on prices being charged. But there has long been discussion of the metric’s alleged deficiencies; namely, that it does not take into account factors such as disparity in the distribution of wealth, depletion of natural resources, underground economies, and the quality of goods and services.
Stiglitz, Sen, and their colleagues say that such deficiencies helped portray the U.S. economy, and to a larger extent the global economy, as being in better shape than it actually was before the credit crisis hit. “In a performance-oriented society, what you measure affects what you do. If you have the wrong measures, you can wind up doing the wrong thing,” asserted Stiglitz at a seminar last Friday sponsored by law firm Labaton Sucharow.
A key problem, according to Stiglitz, was that faux profits were factored into GDP calculations. He noted that, for example, 41% of all corporate profits in 2007 were generated in the financial sector and tied to debt. In other words, the gains were “borrowed from the future,” he said.
As a result, the massive subprime-related losses that financial institutions booked in 2008 wiped out not only the profits from 2007 but also those from the preceding five years. “They were not really profits, but we recorded them as fantastic years,” asserted Stiglitz.
Further, during the bubble-based run-up to the economic crisis, prices of output or capital were much higher than they should have been — 30% or more higher in the case of real estate. So the value of all goods and services being used to calculate the GDP “overestimated output,” he concluded.
The GDP also fell short as a measure of sustainable growth, because the U.S. consumption boom between 2003 and 2007 was based on debt, and borrowing to generate consumption is unsustainable, added Stiglitz.
Another fundamental measuring mistake relates to household income. Adjusted for inflation, median household income in 2008 fell to $50,303, which was 4% below its 2000 level and continued a downward trend that had been accelerating for some time. That’s “a striking statistic,” said Stiglitz, because the GDP per capita for the same period climbed from $33,700 in 2000 to $38,100 in 2008 (adjusted for inflation).
The counterintuitive trend is explained by the increasing financial inequality within American society, which allows the two measures to go in absolutely different directions. The implication, according to Stiglitz, is that most citizens’ standard of living goes down while the GDP goes up.