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Austerity and Gross Domestic Production

Eugen Bohm-Bawerk's picture





 

This was originally posted on Bawerk.net. Follow us on twitter @EBawerk

 

The Europeans tried austerity, the act of reducing budget deficits, and they did not like it. It was no fun, so they decided to focus on growth instead. We have no idea what that means, but apparently they believe they can go back to the heydays when consumption had nothing to do with actual production. For example, the Greeks ran a massive goods deficit with the rest of the world (and they still do). At the peak this amounted to a staggering sum of 48 billion euros. At the time that meant almost 12 thousand euros per Greek worker, which corresponds roughly to what he made on a net basis that year! In other words, the Greek worker got 12 thousand euros from his employer which he spent on consumption and simultaneously consumed an additional 12 thousand through indebting himself to foreigners. According to the Organization of Economic Co-operation and Development (OECD) saving rates in Greece, as per cent of disposable income, is deeply negative and has been for many years. In other words, the Greek society has consumed far more than they themselves produced of value. This is not unique to the western world; on the contrary, most western countries have consumed more than they have produced for quite some time.

Knowing a thing or two about capital theory we would expect output in these economies to nosedive over the same period. Production comes out of capital accumulation and if society regresses through capital decumulation it follows logically that output must fall.  However, if we look at consumption and GDP in Greece since 2000 we find a positive correlation! And even more striking, the correlation between savings and GDP is negative! Everything we have ever learnt about personal finance, building a business or capital theory seems lopsided! According to the data it is the exact opposite! The more you consume and the less you save the more you grow your economy!

To make matters even more obscure, we can also find a positive correlation between government expenditure and output. If the government spends more money output increases and visa verse. No wonder the Europeans found austerity boring. Only an evil person (or an environmentalist) would advocate austerity when faced with such “proof”.

 


  

Source: Eurostat, OECD, own calculations

  


Source: Eurostat, own calculations

 

In order to answer this apparent conundrum we need to ask ourselves what GDP actually measure? In “Taking the Pulse on the Economy: Measuring GDP” by Landefeld et al. we learn that “the method [to calculate GDP] produces consistent estimates of the value of final sales to consumers…” in addition one has to add “government expenditures on goods and services”. This is what economists call final demand, or expenditure, approach. In other words, gross domestic production is derived primarily from household and government consumption. We say primarily, because statistical bureaus do adjust for net exports and government transfer payments. However, as per cent of the total these are relatively small.

The Bawerk.net reader will immediately understand why we consistently call GDP for gross domestic consumption, or GDC.  It does not measure production at all, but rather consumption. And due to today`s perverted credit system the two can be completely decoupled both for individuals and nations!

Historically the so-called GDP concept were made out of the Keynesian worldview expressed in the infamous tautological equation Y = C + I + G + X where output (Y) equals consumption adjusted for net export.

Through a complete obfuscation of the terms and expression now used in our daily conversation about economics we often hear utter nonsense such as the US economy is driven by household consumption. In sheer ignorance one can even hear self-proclaimed experts; banksters and pundits state that 70 per cent of the US economy is household consumption. If that were true, we would see the following development in the US of A:


  

The simple fact that we do not see this should be enough to discredit the whole notion of GDP and we recommend everyone to start call it what it really is; gross domestic consumption, or GDC. Only by doing so can we once again have a meaningful conversation about economics in general and austerity in particular. Yes, if you reduce consumption, then measured consumption as expressed by GDC will also fall. Conversely, if you lower your saving rate GDC will increase.

However, there is an entirely different way of thinking about GDC. We have established that GDC measures aggregate demand. We also know that aggregate demand can be expressed in currency units. In other words, GDC = AD = M2*Velocity. We also know that M2 = monetary base * multiplier. Substituting for AD, we can say that GDC = Velocity * (Monetary base * multiplier). In this sense we can deconstruct the GDC for every nation with available statistics as pure monetary phenomena. The next chart shows US GDC as reported by the Bureau of Economic Analysis (BEA) and broken down to its logical monetary constructs.

 


 

 


  Source: Bureau of Economic Analysis (BEA), Federal Reserve (Fed), own calculations


Suddenly it becomes obvious how destructive programs such as quantitative easing (QE), which allocate resources directly into the ominous 1 per centers pockets, can actually lift GDC. At this point the reader might ask if the price deflator used to calculate a real GDC number will compensate for the effect from QE-programs.

We test for that by deflating GDC with various price gauges, such as the official BEA GDC deflator, the BLS CPI, the Billion Prices Project (only from 2008) and ShadowStat`s constant CPI methodology to see what have happened with real GDC. Interestingly enough, the BEA deflator that is actually used to derive the real GDC number is the most lenient. Even using the CPI we get consistently lower GDC growth. If we were to use Mr. Williams’s constant CPI methodology concept we see how detrimental overconsumption can be to actual wealth creation, to the extent GDC measures wealth.

  


 

Source: Bureau of Economic Analysis (BEA), Bureau of Labor Statistics (BLS), Billion Price Project (BPP), Shadowstat (SGS), own calculations

 

Conclusion

The concept we call gross domestic production is highly distortive. It obfuscates intelligent debate in economics as the true underlying force for economic growth, capital accumulation, is seen as detrimental to prosperity.  

 

 

 


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