Practical analysis for investment professionals
14 December 2014

Book Review: GDP: A Brief But Affectionate History

GDP: A Brief but Affectionate History. 2014. Diane Coyle

Should anyone other than a statistician care about the fine points of calculating gross domestic product? In GDP: A Brief but Affectionate History, economist Diane Coyle offers a striking example of why investors and policymakers ought to pay closer attention. Most developed countries use chain-weighted price indices to derive real (inflation-adjusted) GDP. That is, they revise the weights of GDP’s constituent goods and services annually to reflect structural changes in their national economies. However, this comparatively recent refinement in methodology has not been applied to historical GDP series. Quantitative macroeconomic historian Angus Maddison stated that if the pre-1950 data were chain-weighted, American history would undergo a major reinterpretation. Contrary to the standard account, the United States would be credited with much lower GDP growth than the United Kingdom in 1929. Coyle contends that governments’ economic policies would have to be revised as well because economists rely on the historical data to formulate their understanding of what drives growth.

Chain-weighting is just one of many problem areas in the measurement of national economic output. Coyle, a visiting research fellow at the University of Oxford’s Smith School of Enterprise and the Environment, recites a classic paradox arising from the standard practice of excluding unpaid services from the computations: If a man marries his housekeeper and stops compensating her for her work, he reduces GDP.

Financial services present a special challenge. The output of other services is measured by fees, but financial institutions generate their revenue largely by capturing a spread between borrowing and lending costs or through speculation. Economists have devised convoluted techniques to avoid the unacceptable—but possibly correct—conclusion that financial services subtract from GDP, on balance.1 Studies indicate that the resulting methodology overstates the financial industry’s contribution to GDP by 20%–50%. GDP also misses the informal economy (essentially, people working “off the books” to evade taxes), which is estimated to be 25% of GDP in Greece and a nonnegligible 7% in the United States.

In addition to highlighting problems of implementation, the author makes the larger point that even from a conceptual standpoint, GDP is a less than wholly satisfactory measure of “the economy.” For example, people surely derive a massive benefit from internet services for which they pay nothing, yet GDP captures none of it. In a similar vein, Coyle writes, “The record industry’s sales of music have declined in dollar terms but there is almost certainly more rather than less listening to music.”

Curiously, the alternatives to GDP that Coyle discusses do not include gross output. Just two months after the publication of GDP: A Brief but Affectionate History, the US Bureau of Economic Analysis began reporting this number on a quarterly basis.

Gross output, introduced by Chapman University economist Mark Skousen in The Structure of Production (New York University Press, 1990), counts not only final sales of goods and services but also the value of intermediate steps in their production. If policymakers were to focus on gross output, they would be less inclined to regard consumer saving as a contractionary reduction in consumer spending, which, as journalists and politicians tirelessly point out, accounts for approximately 70% of US GDP. Consumer spending represents less than 40% of gross output, which suggests that efforts to boost the economy should place greater emphasis on business investment.

Another topic not covered in the book is GDP’s displacement of gross national product (GNP), circa 1990, as the most widely cited output measure. Economist Joseph Stiglitz attributes considerable significance to the switch, explaining that GNP measures the income of the people within a country while GDP measures economic activity in the country. Therefore, if an economic activity occurs inside the country but generates income primarily for foreigners, it is counted in GDP but not in GNP. That difference is important, for example, in the case of a private, foreign-owned mine. The full revenue gets credited to GDP, but aside from a state royalty of perhaps 0.5%, the income accrues mainly to overseas shareholders.

In fairness, the book’s length (just 168 pages, including endnotes and index) precludes addressing every GDP-related topic of interest. As a potted history of approaches to quantifying national output from the 18th century onward, GDP: A Brief but Affectionate History deserves high marks. It is particularly edifying to learn about the military motivation behind the initial attempts. Governments came to realize early on that their capacity for waging war was related to the size of their nations’ economies. Simon Kuznets, who pioneered GDP computation in the United States, thought an enlightened society should publish a version of its national accounts that excludes expenditures on armaments. He also suggested that it would be salutary to omit most advertising outlays, as well as many financial and speculative activities.

Coyle’s historical acumen does falter in recounting one incident in history. On 28 September 1976, British Chancellor of the Exchequer Denis Healey was scheduled to fly to the annual meeting of the International Monetary Fund (IMF). He suddenly returned from Heathrow Airport to convene a press conference in which he announced that the United Kingdom was requesting an emergency loan from the IMF. The loan was conditioned on a dramatic reduction of the nation’s fiscal deficit as a percentage of GDP. Britain’s prestige suffered a severe blow from being compelled to go hat in hand to the IMF. That, combined with the draconian public spending cuts required to meet the IMF’s conditions, helped defeat the Labour Party government in the election that swept Conservative Margaret Thatcher into power. Much later, a revision of the originally reported GDP and borrowing needs showed that the United Kingdom’s fiscal situation was not as dire as it initially appeared. Healey contended that if the correct figures had been known, the government would not have needed to apply for the loan. In that event, Coyle speculates, Thatcher might not have won such a large majority, demonstrating once again the importance of GDP’s intricacies.

According to Coyle, Healey was heading for Washington, DC (where the IMF is headquartered), when he made his about-face from Heathrow. In reality, the site of the IMF’s 1976 annual meeting was Manila, Philippines. Coyle is by no means alone, however, in misstating Healey’s itinerary. The Oxford Dictionary of National Biography claims that he was headed to New York. Historian Kevin Hickson erroneously stated that Healey was scheduled to attend the Commonwealth Finance Ministers meeting. (The Financial Times’ report that Healey’s flight was bound for Hong Kong appears to be technically correct. British Airways did not inaugurate direct flights to Manila until 1980, so if Healey was booked on that carrier, he would have had to take a connecting flight, very likely from Hong Kong.)

More book reviews are available on the CFA Institute website or in the Financial Analysts Journal.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

About the Author(s)
Martin Fridson, CFA

Martin Fridson, CFA, is, according to the New York Times, “one of Wall Street’s most thoughtful and perceptive analysts.” The Financial Management Association International named him its Financial Executive of the Year in 2002. In 2000, Fridson became the youngest person ever inducted into the Fixed Income Analysts Society Hall of Fame. He has been a guest lecturer at the graduate business schools of Babson, Columbia, Dartmouth, Duke, Fordham, Georgetown, Harvard, MIT, New York University, Notre Dame, Rutgers, and Wharton, as well as the Amsterdam Institute of Finance. Fridson's writings have been praised widely for their humor, rigor, and utility. He holds a BA in history from Harvard College and an MBA from Harvard Business School.

2 thoughts on “Book Review: GDP: A Brief But Affectionate History”

  1. Kevin Denny says:

    Why spend so much of the review on such a trivial point at the end? Who cares?

  2. Mohammed Al Alwan says:

    an excellent summary of the book thank you

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