Martin Feldstein on how GDP accounting underestimates growth and improvements in economic well-being

From Mark Perry.

"In today’s WSJ, Harvard University economics professor Martin Feldstein has an excellent op-ed (“The U.S. Underestimates Growth“) about a recent topic covered in a series of posts on CD  — how “the official statistics are missing changes that are lifting American incomes” (see especially the post “Another possible limitation of GDP accounting – it may fail to capture improvements in economic well-being in the Information Age“). Here’s an excerpt of Professor Feldstein’s op-ed (my emphasis):

Today’s pessimists about the economy’s rate of growth are wrong because the official statistics understate the growth of real GDP, of productivity, and of real household incomes. Government statisticians are supposed to measure price inflation and real growth. Which means that, with millions of new and rapidly changing products and services, they are supposed to assess whether $1,000 spent on the goods and services available today provides more “value” or “satisfaction” to American consumers than $1,000 spent a year ago. Even more difficult, they are tasked with estimating exactly how much it costs now to buy the same quantity of “value” or “satisfaction” that $1,000 could buy a year ago.

These tasks are virtually impossible, and the problem begins at the beginning—when an army of shoppers go around the country at the government’s behest to sample the prices of different goods and services. Does a restaurant meal with a higher price tag than a year ago reflect a higher cost for buying the same food and service, or does the higher price reflect better food and better service? Or what combination of the two? Or consider the higher price of a day of hospital care. How much of that higher price reflects improved diagnosis and more effective treatment? And what about valuing all the improved electronic forms of communication and entertainment that fill the daily lives of most people?

In short, there is no way to know how much of each measured price increase reflects quality improvements and how much is a pure price increase. Yet the answers that come out of this process are reflected in the CPI and in the government’s measures of real growth. This is why we shouldn’t place much weight on the official measures of real GDP growth. It is relatively easy to add up the total dollars that are spent in the economy—the amount labeled nominal GDP. Calculating the growth of real GDP requires comparing the increase of nominal GDP to the increase in the price level. That is impossibly difficult.
The measurement problem is particularly severe for new products. Consider a new drug that improves the quality of life, reducing pain or curing a previously incurable disease. The ability to buy that new product means that a dollar is worth more than it used to be, and that the properly measured level of real GDP is higher. The official method of calculating the price index doesn’t incorporate this new product until total spending on it exceeds some threshold level. It is then added to the government’s price calculations, but only to record whether the cost of the drug goes up or down. The main effect of raising well-being when the drug is introduced is completely ignored. The same is true of other new products.

The result is that the rise in real incomes is underestimated, and the common concern about what appears to be the slow growth of average household incomes is therefore misplaced. Official statistics portray a 10% decline in the real median household income since 2000, fueling economic pessimism. But these low growth estimates fail to reflect the remarkable innovations in everything from health care to Internet services to video entertainment that have made life better during these years, as well as the more modest year-to-year improvements in the quality of products and services.

While changes in officially measured real GDP statistics don’t fully capture increases in Americans’ standard of living, year-to-year fluctuations are still useful as one indicator of business-cycle conditions.

MP: As I concluded in my related post, perhaps all of the discussions about GDP being below potential GDP and fretting about sub-par economic (GDP) growth are really simply a reflection of the fact that GDP is really no longer the best measure of economic performance, economic growth and economic well-being in the Information Age. Professor Feldstein seems to come to the same conclusion.

And here are a few other economic factors that have significantly improved our economic well-being over time that aren’t captured at all in official GDP statistics: a) increased convenience and b) increased selection of products.

Convenience. We can now shop from home using the Internet as a convenient alternative to the much more time-consuming process of physically driving to a store, paying to park in some cases, dealing with crowds of people, waiting in line to pay, etc. According to GDP accounting, $1,000 worth of expenditures on clothes, books, DVDs, wine, food, electronic goods, and footwear counts exactly the same for GDP whether you purchased those items online from the convenience and comfort of your home using websites like Amazon, eBay, Zappos, Lands End and Jos. A Bank or whether you physically visited brick-and-mortar stores to make those purchases. For many consumers today, the economic value of the significant increase in the convenience of shopping from home using the Internet never gets captured, even though $1,000 of goods purchased online must have more economic value than $1,000 of goods purchased in stores because so many of us now make a majority of our purchases online.

Selection. When I look through old Sears catalogs from previous decades like the 1950s, 1960s and 1970s, I’m always impressed by the relative lack of selection for items like household appliances. Especially in the 1950s and 1960s, the selection of appliances like refrigerators, freezers, ovens, ranges, dishwashers, washing machines and dryers was extremely limited – sometimes to fewer than 5 or 6 models, frequently with no choice of color. Today, the Sears website offers more than 400 different ranges, more than 500 different refrigerators, more than 100 washers, more than 200 dryers, and about 50 different freezers. Want a gas grill? Choose from almost 80 different Sears models from $39 to $5,000. The increased selection over time available to consumers for hundreds of other items generates significant economic benefits that are never captured by official GDP statistics.

For transportation, we now have more options than ever before, and those options increase economic well-being without ever necessarily making a contribution to increasing GDP.  For local travel, we can now choose between traditional taxis and options that never existed before like Lyft, Uber, Sidecar, Gett (in NYC), Zipcar and Car2Go; and for long-distance travel we have new options available like Megabus, Bolt Bus, Peter Pan, Best Bus, Vamoose, in addition to Amtrak and air travel (there are 123 options daily for travel between DC and NYC by bus or train).

The selection and variety of food and restaurants available today is greater than ever before, there are more than 3,000 breweries now in America, Airbnb and EatWith give us new travel options that never existed, and the list goes on and on.

Bottom Line: Increased convenience and increased selection definitely make our lives better, raise our standard of living, and increase our economic well-being – even though that economic value can’t be measured and therefore won’t ever be captured easily by GDP accounting. I’ll take 1-2% sub-par economic growth measured by real GDP if it means I’ll continue to experience an increase in my economic well-being from the continuing introduction of new products, ongoing increases in the quality of existing products that can’t accurately be measured, continued increases in the selection and variety of products and services available, and increases in convenience that save me time and make consumption easier than before."