Thursday, July 16, 2009

Measures and Measurement

In many economics courses, teachers will spend time explaining the various economic statistics that are released regularly. This is good because the information can provide some basic guidance about the past, current or possible future state and can be helpful in making economic decisions. But there is a problem.

One often gets the idea that the data contains more information than it actually does. And almost as often, one may think the data contains less. At which point, many of us and many of our students may wonder "what's the point?"

Ryan Streeter raises the same question in a recent issue of American Interest (hat tip to Arts & Letters Daily). In his article, he notes that the data we collect and depend was inadequate when came to forecasting the current downturn. That's debatable. There were many people who foresaw problems and said so. I suspect many of us actually were unable or unwilling to see what they saw.

Nevertheless, whether the information was or was not there, we are unraveling a financial and economic mess that was many years in the making and may take a while to unravel. In the interim, Streeter points out that politicians call for better regulation to avoid a relapse. But they miss the fact that better regulation presupposes better monitoring, which in my mind presupposes adequate (and improved) measurement. Streeter then discusses four basic economic measures we use to measure our collective health and finds them wanting. It is to this point that this blog is addressed. For while I agree with his call to action, I think that part of the problem is a basic misunderstanding of what the data does and does not say. That is where we need to focus when discussing economic measures with our students. And just for the record, I'm willing to stand corrected on my understanding, as well.

The four measures that are the focus of this piece are Gross Domestic Product (GDP), the Savings Rate, the Consumer Price Index (CPI), and the Poverty Rate. The author then suggests some possible remedies. While they are admirable, they also have the potential for problems.

Gross Domestic Product - Streeter makes an excellent early point. While consumerism is painted as a "bad thing" by most - consumption is the point for economics. By that I mean, and I read him to mean, that it is the satisfying our wants (consuming) that drives economic activity. We teach our students that our wants are unlimited. Indeed, I tell my students that they stop wanting only when they die.

He points out that goods and services are counted as consumption when purchased. He goes on to point out that this true even if "people cannot afford them and probably do not need them." Putting the normative aspects of that statement aside, the problem he cites can be countered by realizing that each individual has different time horizons for need - my mother always kept a well-stocked pantry that contained items she used rarely. But she did intend to use them and purchased them when the price was attractive.

Conversely he talks about goods that are produce but sit unsold - inventories. Granted they are produced with the intention of someone consuming them, but inventories can build. And while technically this falls under the heading of investment (I in the GDP equation), it still is a problem for consumption. The counter argument is that inventory problems are less now than they were because many producers have gone to lean manufacturing processes to reduce the problem. Still it exists and can be brought into classroom discussion.

Streeter then brings up an interesting point - citing Adam Smith he discusses productive and unproductive labor. What many feel are unproductive, others may feel is productive. The value of some of the services cited in the article, like beauty, is in the eye of the beholder. And probably are measured by opportunity cost and personal utility. If having someone do something for me (my taxes, my lawn, my will) frees me to do other things I am better at or enjoy more, I don't think that's "unproductive." And I think a case can be made that it's making me more productive.

Savings Rate - Here Streeter's explanation is likely to surprise many, and rightly so. He points out that much of what most of us consider saving is not counted as such. Money invested in 529s, 401(k) s and Roth IRAs are not counted as savings. This explains the headlines that, until recently, decried our falling (and sometimes negative) savings rate. This happened at the same time that more and more of us owned stocks, bonds, mutual funds and real estate. Conversely, without knowing this, many of us may have wondered why with a now rising savings rate the financial markets aren't doing better.

Consumer Price Index - This issue is batted around regularly. One need only look back a few days on this blog to see a post relating to it. The real issue may not be what consumption is missed by the CPI, but rather why we obsess about the measure. Granted it's easy to understand. But it's also easy to understand the shortcomings. That's why many agencies use other broader measures of inflation and consumption like the Personal Consumption Expenditures (PCE).

Poverty Rate - Streeter discusses many of the shortcomings of this measure, noting it was originally based on subsistence diet - a minimal measure of consumption, if you will. I would add one thing to his discussion, the fact that the measure should consider regional differences. Anyone who has moved around knows that it costs more or less to live in some parts of the country than others. Consequently, a measure of a subsistence diet - or a minimal level of consumption - should account for the differences.

In the end, the author discusses some ways to remedy the flaws of many of our economic measures. I found his call for a way to internalize risk in the measures interesting, but unworkable; if only because the future is unknowable. We can improve ways of measuring the potential for risk, but ultimately we can't eliminate it. There will be "black swans," the unexpected. And it is not illogical to base future expectations on past performance, because that's all we have to go on.

A dynamic economy is by its nature unpredictable. This does not mean Streeter's call for better measures should be ignored. But we go too far if we think improvement will provide us with perfect foresight. One of the things that this financial crisis will do, like all crises before it, is focus our attention on developing new and better understanding of how the economy works and how to measure new things. But I suspect we'll always be a little behind.

I welcome your thoughts.


spencer said...

Your comment on savings not including 401s, IRAs, etc is only partially correct.

Savings include the sums you or your employer place in the tax exempt account. But it does not include the change in the value of the account -- capital gains or loses.

So if you put $100 in an IRA and it grows to $150 the original $100 is included in savings but the $50 increase in the account is not included in savings.

It is treated this way because the national accounts is a measure of
what is produced and consumed in the economy. So the $100 you earned producing something is counted in the national accounts.
But the $50 capital gain does not impact what is produced in the economy so capital gains from the stock market or housing appreciation, etc., are not included in production or savings.

Tim Schilling said...

Thank you for clarifying that. I was thinking, like Streeter apparently, that the whole amount was not counted.

Your explanation makes much more sense.

出会い said...
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