No two economies are the same because no two sets of circumstances in which an economy operates are identical. It is therefore pointless to measure all economies with the same yardstick without taking into account local peculiarities. To be specific, the index we call Gross Domestic Product (GDP) has proved inadequate when utilized to measure the absolute value of an economy; even less adequate when utilized to judge the different parts of an economy’s balance sheet. And what is unfortunate about the approach we now take when dealing with the subject of public finance is that the method by which we handle the data often leads the captains of the ship of state to make bad decisions.
So the question that comes to mind is this: Would a modification of the way we compile the information and assess the GDP of a jurisdiction help mitigate the consequences of the current approach? The answer is yes but only if we create a smarter system to replace the old one. This can be done by adopting the right perspective and by keeping it in mind as we collect the data. If we can do this, the captains of the ship of state will have the tools to properly assess the significance of things like the size of the deficit and the accumulated debt as compared to the size of the GDP; and the captains will make better decisions as a result.
To create a new system we must collect the data having a better understanding as to why we are collecting it. To this end, we shall have to recognize that despite the large number of factors influencing the shape and value of an economy, we will be classifying all economies in only one of two broad categories: the mostly producing economy or the mostly consuming economy. The reason for doing this is that there is now incongruity between the way we define GDP on the one hand and the way that the economy actually works on the other hand.
The incongruity begins with the definition which says that the GDP is the sum of all activities which take place in an economy but then include in the compilation not only the figures for production but also those for consumption. According to the definition, therefore, the name should be Gross Domestic Production and Consumption (GDP&C) not just Gross Domestic Production (GDP). Thus, if we classify the economies as being mostly one or mostly the other, we acknowledge the fact that an economy is a complex thing made of at least two parts. This acknowledgement alone should ease the confusion and help us diagnose the problems when they occur thus lead to better solutions.
With those two classifications in mind, we see that in some economic jurisdictions the P in GDP reflects the activities generated by the production of goods and services more than they do its consumption though the latter also generates some activities. And we see that in other economic jurisdictions the P in GDP reflects the activities generated by the consumption of goods and services more than they do its production though the latter also generates some activities.
The capital and the infrastructure of the mostly producing jurisdictions consist of installations where the workforce labors to maximize the output of the installations. In these places, the people use a minimum quantity of commodities which they turn into useful products by adding as much transformational value to them as possible. Thus, a small quantity of iron, copper, paint, plastics electricity and so on is transformed into a state-of-the-art refrigerator or some other product. When all such works are done, the sum total of the added values goes into the GDP of the jurisdiction.
By contrast, the capital and the infrastructure of the mostly consuming jurisdictions consist of retail outlets and a workforce that labors to maximize their profit by merchandizing the products and services they procure from the producing jurisdictions. They buy from the producers at a low price, sell to the customers at a higher price and consider the spread between the two prices to be the added value of their process. When all such processes are done, the sum total of the added values goes into the GDP of the jurisdiction.
Now look closely at what happened here: what used to be consumption has become part of the P in GDP which means it is now considered to be production. But really, if you consider both the production and the consumption to be production, it is like drawing up a balance sheet where the assets and the liabilities are called assets and where there are no liabilities. In such a system, the GDP looks big, the deficit and the debt look small by comparison and the approach encourages you to borrow more and more under false pretenses. Then one day it hits you that you are not producing enough of the real goods and services which will pay for what you consume. And you realize that you have been deceiving yourself so then what do you do?
Well, if the mostly producing jurisdiction and the mostly consuming one were part of the same economy like being of the same country, the difficulties that may arise will be overcome because the producers of the jurisdiction are also its consumers, and a rough balance between the two will eventually materialize. That is, the auto worker will shop for clothes; the textile worker that makes the clothes will shop for a vacation; the hospitality executive that provides the vacation will shop for a car which was made by the auto worker who went shopping for clothes in the first place. And each of these citizens, together with everyone else in the country, will keep the country at full employment which is the ultimate goal of a well run economy. Where the difficulties can turn into a serious problem is when the producing jurisdiction and the consuming one belong to different countries. In this case, the complications that start small will tend to grow large and will threaten the arrangement unless something is done to impose a balance.
Several lengthy scenarios can be written to illustrate how a relationship such as that can grow and become a big problem. What may be said in brief, however, is that the consuming country will feed on the products and services of the producing ones at its peril. And in the event that the consumers become so preoccupied with consumption that they neglect to save and lend to each other, the foreign producers will lend to them. If this situation goes on for too long and the producers lose the appetite to extend more credit to the consuming country, a nightmare scenario may develop whereby the producers will cannibalize on the capital, the assets and the resources of the consuming country thus hollow it of its industries.
And because there is no free lunch, future generations will be asked -- even compelled -- to pay the bill drawn up by the generation that took it all and then disappeared. This sort of scenario is not a far fetched one but has a good chance of developing because the likelihood is that the said generation will have neglected to clean up after itself before departing the cushy life it has led at the expense of its descendants.
And so we ask: How does a system look like that can prevent the nightmare scenario from developing? The answer is that in addition to making a clear distinction between the production side and the consumption side of an economy, the system will have to differentiate between three types of consumption. They are (a) the basic consumption (b) the required consumption and (c) the vain consumption. To see how this will help improve our understanding of the situation, we discuss each type in brief.
(a) Whether we are an individual, a business or a nation, basic consumption is what we normally do everyday. And when we say basic we do not exclude the luxurious. For example everybody needs a home to live in and a means of transportation to travel. Here the word basic does not mean that the home or the transport must always be modest. Indeed, living in an upscale house and driving an upscale car are considered basic as long as they are not absurdly or needlessly extravagant.
(b) The required consumption are the things you are forced to do just to lead a normal life, the things that other people do not have to do and you wish you did not have to do either. For example, if you live near the North Pole where the temperature goes down to 65 degrees below zero, you are forced to spend an enormous amount of money to keep warm, the reason for which you are paid a higher salary than usual. But contrary to what it looks like on paper, the size of your salary does not make you any wealthier because you are forced to spend the money in what may be called a “wasteful” manner. Yet, your high consumption goes into the GDP and inflates it thus make the situation look rosier than it really is.
(c) As for the vain consumption, it is what you do to keep up with the Joneses and to impress them. For example, you pay a grotesquely extravagant price to buy an antique car which you seldom drive or never drive at all but leave on display alongside the house to impress your neighbors or to have the tabloids write about you. Some people buy and sell such cars and other items like them, a habit that adds false value to the GDP of the nation and to the per capita income of its citizens. And all this happens as no one gets anything out of this wacky hobby of a nutty individual.
But if we modify the system and compile the data while keeping in mind the notions discussed above, we can create a smart method by which to assess the true value of the GDP and use that in more useful ways. And to always keep the correct perspective in mind, we need a more appropriate definition for GDP so here is one: GDP is the production of goods and services that satisfy both the basic consumption of a nation and the necessary part of the required consumption. The definition deliberately excludes what goes into the generation of the “wasteful” part of the required consumption as well as the entire vain consumption.
Faced with the realities of life but armed with better tools, the captains of the ship of state will have a more realistic view as to what they preside over, and a better understanding as to what they must do to keep the ship of state afloat and help it sail to the desired destination. In this vein, a back of the envelop calculation indicates that the GDP of the United States of America stands somewhere between 6 trillion and 7.5 trillion dollars. Compare this figure to the external debt of the country and someone should feel uneasy.