Blog author: jcarter
by on Thursday, June 13, 2013

Among the most significant economic challenges in America today is getting Americans to understand what an economy is.

measure-economyWhen the Latin term oeconomia was first used in the 1500s it meant “household management.” A few centuries later, the term political economy was used in reference to the economies of states or polities. It wasn’t until the modern era, though, that “economy” became to refer primarily to the production and distribution of national income and wealth and lost almost all connection to the household.

Because of that shift, we often see a confusion of terms and concepts. Take, for instance, the opening sentence of this recent news report:

The U.S. economy grew at a modest 2.4 percent annual rate from January through March, slightly slower than initially estimated.

The problem with this is that “U.S. economy” is conflated with gross domestic product (GDP) — the market value of all officially recognized final goods and services produced within a country in a given period of time. While GDP can potentially be an important economic indicator, it is not a true measure of the nation’s economy (aka political economy).

Derek Scissors provide a superb explanation for why a better measurement is one that gauges the original economy:

Many decision makers and commentators treat gross domestic product (GDP) as if it measures the whole of the economy. They even use “the economy” and GDP interchangeably. GDP is an accounting device—and a poor measure of economic health. Household wealth is much closer to what we mean by “the economy.”

Say a new medical school graduate got a nice hospital job in 2011 paying $100,000 per year. However, she owed $150,000 in loans. Meanwhile, a retired couple had income of $50,000 in 2011 and an investment portfolio of $2 million, plus their home. If we compare 2011 income, the new doc is doing twice as well. Of course, this is ridiculous—why would anyone use one year’s worth of income to see how they’re doing?

Yet that is what we do with GDP: We take one year’s worth of production and act as if it’s the whole story or nearly the whole story. It’s just as wrong with GDP as it is with one year’s income.

Using GDP also leads to some fairly silly practices. If a house is built, it adds to GDP. If it is then torn down a year later, that also adds to GDP (because people were paid to rip it down). Unbelievably, you can just keep building and tearing down forever, and it will always add to GDP. Or the house can be sold back and forth between two rather strange real estate companies, each sale counted toward GDP.

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