Note: This is the latest entry in the Acton blog series, “What Christians Should Know About Economics.” For other entries in the series see this post.
The Term: ‘The Economy’ (aka Gross National Product)
What it Means: When people refer to “the economy” they are usually referring to a particular idea—Gross Domestic Product (GDP)—which is itself simply an economic metric. GDP is often used as a single number that “measures” the economy. Imagine you wanted to put a price tag on the value of all the final goods and services produced by every sector of the economy (all of the crops grown, all of the lattes served at the coffee shop, all of the hours billed by lawyers, etc). The total number you’d put on the price tag is the GDP.
Why it Matters: Humans have seemingly unlimited wants and needs—but a limited amount of resources. This is known as scarcity, and it’s the fundamental problem in economics. The primary way we solve this problem is through market exchanges: you make something I want or need and I give you something you want or need in return (we do this indirectly through the use of money). The occurrence of all of these exchanges is what we call “the economy,” which is why we can use the metric that measures the sum of all of these exchanges—GDP—as a synonym. When we say the economy is growing/shrinking, we are saying the total value of the goods and services being exchanged (GDP) is increasing/decreasing.
An economic unit (whether a family, country, etc.) is generally better off when everyone is able to meet all (or nearly all) of their material needs and many of their material non-necessary desires. That is why economic growth is so important. While the issue is complex and requires some nuance to fully explain, the simplistic answer is that economic growth matters because people continue to have babies.
As the population increases, more resources are needed to feed, clothe, and shelter all of the new people that are being created. To understand why this happens, let’s consider a scaled-down economic model.
Imagine a village that has 100 people living in a state of economic equilibrium, that is, their economy is neither growing nor shrinking—their GVP (Gross Village Product) never changes. Everyone has just enough food, clothing, shelter, and other amenities to take care of themselves—no more and no less than enough for subsistence living. Now let’s imagine that a “baby boom” occurs, and 20 new children are added to the village. What happens to the standard of living for the villagers? Assuming that they redistribute their resources equitably, everyone (including the new children) will only have 83% of the resources they need to survive. Over time, they will begin to starve or die of malnutrition.
We can see this occurring today in countries with low economic growth (i.e., stagnant or declining GDP). As the population increases, there are not enough resources for everyone to rise above the poverty level.
Similarly, in the U.S. we need to create around 400,000 new jobs every month just to keep up with the babies that are growing up and entering the labor market. If the economy does not grow there will be no jobs for them. In the short term, we can merely shift resources around through redistribution (e.g., unemployment compensation, welfare) to prevent the unemployed from going hungry. But without long-term growth (e.g., long-term increases in GDP) a country’s wealth becomes depleted, causing instability and social breakdown.
However, if the new workers do find jobs and are engaging in productive labor, the economy will automatically grow as these laborers buy goods and services. Economic growth is, after all, a natural byproduct of productivity.
Economic growth is not a goal that should be pursued for its own sake, nor is it a means to achieve a materialist paradise. Economic growth is not the chief end of man, but merely the blessing that results from fulfilling God’s dual cultural mandate: Be fruitful and multiply and steward the earth’s resources.
Other Stuff You Might Want to Know:
The “Economy” is a 20th century invention — “It’s the economy, stupid,” is a popular variation on a theme political strategist James Carville came up with for Bill Clinton’s 1992 presidential campaign. Most everyone who heard that phrase understood it referred to the current economic situation. But if Carville had said it a hundred years sooner, say in 1892, few people would have understood what he meant.
We hear the phrase “the economy” so often that it’s hard to believe it was a 20th century invention. But it was invented for the Great Depression. As Zachary Karabell, author of The Leading Indicators, explains:
It was invented because there was clearly a perception that there was something really, really bad going on but they didn’t really know what. You could see there were homeless people on the street, you could see there were the Okies heading from their Dust Bowl farms off to California by the tens of thousands, but there was no way of really grasping it.
How GDP is measured — GDP can be determined in three ways. One of the most common is the expenditure approach (i.e., all expenditure incurred by individuals during 1 year). The formula is:
Y = C + I + G + (X − M)
Where (Y) is the sum of consumption (C) (i.e., consumer spending), investment (I) (e.g., investment made by businesses), government spending (G) (e.g., government salaries, weapons systems), and net exports (X – M) (i.e., the stuff we send to other countries minus the stuff we import from others). Notice a problem with this approach? Increasing government spending automatically increases GDP.
GDP is not GNP – Gross Domestic Product and Gross National Product sound so similar that many people assume they’re the same. The key difference is that GDP is based on the geographical location of production while GNP is based on ownership of production. So if a U.S. or foreign firm operates within the borders of the U.S., it’s production counts toward GDP. But if a U.S. firm operates in a foreign country, it’s output counts toward GNP, but not GDP.
GDP numbers are issued every 3 months, but are frequently revised — GDP numbers come out quarterly, but since it’s hard to be exact, they are often revised afterward. For example, at the end of April, 2014, the government reported economic output had grown by only a 0.1 percent annualized rate. But a month later (May 29, 2014), the consensus estimates are that the economy actually shrunk by 0.5 percent.
GDP is an indicator of recessions — The technical indicator of a recession is two consecutive quarters of negative economic growth as measured by GDP. (This is the standard definition, though the National Bureau of Economic Research—the agency that officially determines recessions—does not necessarily need to see this occur to call a recession.)
GDP is not a measurement of the standard of living – If you divide a country’s GDP by the number of people living in that country, you get GDP per capita. This number, however, doesn’t really tell you much about individual living standards. It would be like dividing a family’s income by the number of people in the family. A family may earn $100,000 a year but that doesn’t mean the two children in a family of four each have $25,000 of their own money. Decreasing GDP can be a sign that a nation is worse off than it should be, but an increase in GDP does not necessarily mean the standard of living has increased. Sometimes it’s just improper accounting. For example, in 2010 Ghana made its GDP go up 60 percent overnight just by changing its measurement conventions. The standard of living for Ghanians, however, did not increase just because of the accounting change.
GDP shouldn’t be judged for being something it’s not – In 1968, Presidential candidate Robert Kennedy famously said that GDP “does not allow for the health of our children, the quality of their education or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials.” All of that is true—and completely irrelevant. GDP can tell us about the state of our economy, but the economy cannot tell us the state of our souls. We shouldn’t criticize a metric for failing to measure something it was never intended to gauge.