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Economics

The unseen hand

The assessment of economic growth based on Gross Domestic Product is a fallacy, because GDP is merely a measure of the amount of money in an economy. The one thing it does not measure, which is central to economic progress (note progress, not growth), is the level of entrepreneurial activity. This has important implications for the efficacy of government interventions and solutions to the current economic crisis.

I have written about GDP before, but to refresh the reader’s memory, GDP is basically the sum total of recorded business activity at the consumption level plus government spending expressed in money terms. If the government spends more, GDP rises; give more money to consumers, GDP rises; give more bank credit to consumers or business, GDP rises. Cut government spending, GDP falls. This is not contentious and has nothing to do with economic progress. Importantly, it excludes future entrepreneurial activity, except to the extent that an entrepreneur has actually spent some money putting his future plans into action. The obsession with GDP means that entrepreneurial activity, which is Adam Smith’s unseen hand that guides our future, is invisible to economic planners.

If that was the only consequence of confusing a money quantity with economic progress the results would not be so serious. Instead, misleading statistics such as GDP are leading all governments into bad policy decisions, and their choice has narrowed down to either ever-greater reflationary attempts to pump up GDP, or alternatively facing a collapse in the GDP number as bank credit contracts. The situation facing the eurozone already precludes any compromise between these extremes, while other nations believe they can print their way out of this difficulty.

The twin errors of misunderstanding GDP are the failure to see that monetary inflation is concealing a deepening economic depression, and it encourages policies that destroy entrepreneurial activity, or economic progress itself. This is a deadly combination, the equivalent of being in a hole and continuing to dig.

We cannot expect politicians to stop digging deeper and faster when their economic advisors are calling for more shovels. All politicians are fully committed to the fallacies that result from confusing GDP with economic progress. They pursue economic policies that are the equivalent of eating their own children. The children being eaten are savers, increasingly raided to sustain the status quo: savers whose savings are a precondition for entrepreneurial activity, and without which increasing numbers of us become reliant on the state.

There can be little hope that this lunacy will be abandoned while statistical nonsense such as GDP growth persists. The underlying economic depression, evidenced by high levels of unemployment, is symptomatic of economies burdened by misallocated resources. The solution is to do exactly the opposite of actions currently being pursued. To quote Calvin Coolidge: “Perhaps one of the most important accomplishments of my administration has been minding my own business. Government shouldn’t play a part in everyday life.”

It is still possible to do this. What is required in our leaders is a sound understanding of economics instead of belief-based neoclassicism. Thus armed, a politician should be able to explain the proper course of action to the reasonable majority, and implement it with their support.

This article was previously published at GoldMoney.com.

2 comments to The unseen hand

  • mrg mrg

    I broadly accept your argument, but you overstate your case:

    “GDP is merely a measure of the amount of money in an economy”

    UK GDP was £4.7b in Q1 1955, and £360b in Q1 2010 — 76 times greater [1]. Was all of that growth due to an increase in the money supply?

    GDP is certainly a bad measure, but it will inevitably be influenced by genuine economic growth along with false growth indicators like government waste and currency debasement.

    [1] http://www.guardian.co.uk/news/datablog/2009/nov/25/gdp-uk-1948-growth-economy

  • Craig

    Was all of that growth due to an increase in the money supply?

    Yes — it had to be. If the BOE hadn’t printed any money [and, please, I'm using the term loosely] since 1955, the GDP would still be roughly £4.7b. Now, the amount of goods and services would have grown, but their prices would have had to drop to accommodate the amount of sterling.

    In other words, the pound’s purchasing power would have increased.

    A good example of this is Japan. The Keynesians and neo-classicists insist that Japan’s economy stagnated the last decade. But the BOJ kept a very tight rein on the money supply — GDP couldn’t rise. Nonetheless, unemployment remained low, Japan produced more and more goods, and living standards are as high as they’ve ever been.

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