Tuesday, May 31, 2016

"The Prosperity Puzzle"

Longtime readers will know most of this stuff but we post it because:

a) Nordhaus is one of the smartest economists out there and
b) Irving W-B is pretty sharp in his own right and is the King of the hyperlink to boot.

From Irving Wladawsky-Berger:
The April 30 issue of The Economist includes a special briefing on The Prosperity Puzzle. The briefing highlights how tricky it is to compare living standards across countries, across economic classes within a country, and, - arguably hardest of all, - across time.

“Which would you prefer to be: a medieval monarch or a modern office-worker?,” it glibly asks.  “The king has armies of servants.  He wears the finest silks and eats the richest foods.  But he is also a martyr to toothache.  He is prone to fatal infections.  It takes him a week by carriage to travel between palaces.  And he is tired of listening to the same jesters.  Life as a 21st-century office drone looks more appealing once you think about modern dentistry, antibiotics, air travel, smartphones and YouTube.”

The point is further illustrated by referencing the research of Yale economist William Nordhaus.  In the mid 1990s, Nordhaus looked at the evolution of the price of light over the past two centuries in Do Real-Output and Real-Wage Measures Capture Reality? The History of Lighting Suggests Not.

He first calculated the price of light by adding up the prices of the things people bought over the years to make light, - from candles in 1800 to compact fluorescent light bulbs in 1992.  This is the traditional way that prices are calculated using GDP, - “a measure of the value of all final goods and services produced in a period (quarterly or yearly).”  By this GDP-like measure, the price of light rose by a factor of between three and five over the past two centuries.  Next he calculated the change in the true price of light, by estimating the price in cents per lumen-hours, a measure that would quantify the considerable innovations in generating light over the same time period.  By this measure, the true price of light has plummeted by considerably more than a hundredfold since the early 1800s.
Nordhaus’ research implies that the true price of light “has been underestimated by a factor of between nine hundred and sixteen hundred since the beginning of the industrial age.  If the case of light is representative of those products that have caused tectonic shifts in output and consumption, then this raises the question of whether the conventional measures of real-output and real-wage growth over the last two centuries come close to capturing the true growth.”

According to The Economist, not only is GDP a poor measure of material well-being and prosperity, but it’s not even a reliable gauge of production.  Our heavy reliance on such a deeply flawed measure may account for our prosperity puzzle, “distorting levels of anxiety in the rich world about everything from stagnant incomes to disappointing productivity growth.”

GDP was first developed in the 1930s at the request of the US Congress to quantify the full economic impact of the Depression.  In the 1940s it was used in the US and the UK to help estimate their economies’ capacities to make guns, tanks, airplanes and everything necessary for the second world war.  Since then, GDP has become the key measure of a country’s production capacity, while GDP per capita is generally viewed as an indicator of a country’s standard of living.
Most measures of economic performance used by government officials to inform their policies and decisions are based on GDP figures, including setting taxes, fixing unemployment and managing inflation.  But, many concerns have been raised about the adequacy of GDP-based measurements given the major structural changes that economies around the world have been experiencing over the past few decades.

GDP does not adequately capture the growing share of services and complex system infrastructures that characterize advanced economies.  In the 1950s, the industrial sector made up more that a third of GDP, and the service sector was a bit over 50% in the US and the UK.  Today, services account for close to 80% of of their economies, while manufacturing has significantly declined....MORE