There’s a review in today’s New York Times of Diane Coyle’s new book on the history of GDP calculation. Shot through it is a crazy confusion, abetted—nay demanded—by standard economic practice.
It all goes back to the primordial distinction between positive and normative analysis. Positive analysis is explanatory, predictive, or simply descriptive: what and why. Normative analysis is evaluative: should. We economists beat the heads of our poor charges each year in introductory classes with this distinction. Positive analysis, we say, can be validated by reasoning and evidence, while normative analysis is ineluctably conditional on the values of whoever is doing the evaluating.
Yes and no. The distinction is important, but it is not ironclad. There are lots of ways the two types of analysis are connected, and I won’t get into the philosophical issues here, but it is obvious, just from paying attention, that economics wants to have a single analytical framework to answer both positive and normative questions. Economists don’t want one model to predict what the equilibrium outcome will be and another, using completely different elements and based on different assumptions, to rank that outcome against others according to how beneficial it is. Most models in economics do double-duty: they support positive and normative analysis equally.
So it is with GDP. This is indispensable for the heavy lifting that positive economics, especially macroeconomics, requires. You wouldn’t be able to document whether you were in a boom or a recession without it, or at least not nearly so well. For instance, our NBER judgments of business cycle dating are surely more accurate today than their retrospective judgments of cycles before GDP measurement was established during the New Deal. But GDP is also invoked as a measure of economic “success”—our policies are said to work if they crank up GDP growth or fail if they don’t.
Understandably, GDP has come in for a lot of criticism regarding its measurement of economic well-being. It includes a lot of stuff that doesn’t make us better off (more cops if they’re just a response to an upsurge in crime), leaves out a lot of stuff that does (unpaid labor inside and outside the home), ignores harmful consequences of economic activity (pollution and resource depletion), and utterly fails to price many goods in a way that reflects their actual value to society (such as government-supplied services, which are priced at cost of production). Finally, consumers (such as you and me) do not always spend our income in ways that maximize our well-being, and in some documented cases (e.g. commuting to work) spending can go up while well-being goes down. Personally, I’m convinced: GDP is a deeply flawed indicator for normative purposes.
But what of positive analysis? There I think we’re on much more solid ground. GDP measures the size of the market economy. We happen to live in a market economy, so this is a useful measure. It works well for predicting market consumption, imports, paid employment, that sort of thing. If you think about it, the very characteristics that people criticize from a normative standpoint—how the selection of traded goods and the prices they trade for misrepresent their true impact on us—are the ones that make GDP work for a well-defined set of positive tasks. If we priced things according to their “true” value (supposing we could do that) instead of their market value, we would lose the market part.
Alas, it is sometimes necessary to blur this distinction. For example, we need to have a conception of real GDP so we can tease out the rate of inflation. Since the qualities of goods are constantly changing, they need to be priced in order to distinguish between price increases that contribute to inflation and those that reflect quality improvements. (Or maybe prices are constant but should be seen as contributing to inflation because quality has gone down.) Estimating the value of quality (hedonic regression) brings us closer to the line separating normative from positive. I think the line is not (necessarily) crossed, however, if the (monetary) willingness to pay for quality is kept distinct from the effect of quality on consumer well-being.
And where does that leave us? The distinction between positive and normative analysis is important and needs to be maintained. There should be no presumption that the concepts and models that work for one will work for the other. We should not sacrifice the fit between model and purpose in one realm in order to be able to shoehorn it into the other. I think, though I will not follow it up here, that welfare economics has suffered mightily from attempts to squeeze its analysis into the same models that work well for positive—explanatory and predictive—work.
So let’s not visit the same damage on our properly-functioning positive models, like GDP. Keep and even improve GDP as a measure of the size of monetary flows within an economy, and look elsewhere for appropriate indicators of human well-being. (I have a hunch that economists, who are good at the first task, will prove to be less well-suited to the second.) Do positive well, and do normative well, and don’t let either get in the way of the other.