GDP Was Designed For Warfare Not Welfare

When intellectuals first began to think about economics, they tended to think about the interests of the elites who controlled the government.  That is how economics got its name back in the 16th century.

The term economics comes from the Ancient Greek οἰκονομία from οἶκος (oikos, “house”) and νόμος (nomos, “custom” or “law”), hence “rules of the house (hold for good management)”.

The elites who were developing economics named it for the study of how to manage the royal household’s affairs.  Under monarchy, the royal household’s affairs were the affairs of the nation.  One of the early goals of this national management was to measure what the royal household was producing.  There are several ways to account for national income and production, but the dominant measure since WWII has been Gross Domestic Product or GDP.

Diane Coyle recently wrote an excellent book entitled, GDP: A Brief But Affectionate History.  The book basically gives three motivations why people have wanted to produce a national income (GDP) statistic.

1. To measure welfare
2. To understand and deal with the Great Depression (and Keynesian macroeconomics).
3. To manage national economic resources for warfare.

However, Coyle stresses that the last motive was the real impetus behind spending millions of dollars hiring droves of statisticians and economists to finally develop the fairly precise measurement that became GDP.  She traces the martial motivation for GDP measurement back to the 1665.

In 1665, a British scientist and official, William Petty, produced estimates of the income and expenditure, population, land, and other assets of England and Wales, with the aim of assessing the country’s resources to fight a conflict and finance it through taxes… Petty wanted to prove not only that the country could bear a higher burden of taxes but also that it was capable of taking on its powerful neighbors Holland and France. There was no need for it to win more land or increase the size of the population to ensure victory, because the available land capital and labor could be used to better effect.

…Another early set of estimates, by Charles Davenant in 1695, had the title, An Essay Upon The Ways And Means Of Supplying The War, making his aim perfectly clear. The word statistics has the same origin as state, and originally referred to the collection of figures concerning the state, specifically taxes. It proved to be a major advantage for England to have consolidated national income statistics, enabling calculations about the scope for increased output and tax revenues, when its larger and seemingly more powerful neighbor France lacked such information. (p. 8)

There have been many disparate attempts to measure national income over the centuries, but more resources have been devoted to measures that could be used for accounting for war resources.  For example, Adam Smith’s influential conceptualization of national income in The Wealth of Nations (1776) excluded money spent on warfare because it is unproductive and Smith was more interested in measuring material welfare.  Smith considered services to be an intermediate good that did not directly contribute to the stock of measurable wealth.  Smith only considered physical goods to be real wealth and he did not think that services directly produce anything except to the extent that they ultimately contributed to the production of physical goods.  Because the government mostly produces services, government activity was also generally excluded from his conceptualization.  This idea was later adopted by Karl Marx and the Soviet Union which did not count services in its main national income statistics.  GDP rejects this idea and includes services including those produced by government (which mainly produces services).

Simon Kuznets received a Nobel Prize for his efforts as one of the founders of modern GDP.  In the early 1930s, Franklin Delano Roosevelt began funding Kuznets’ efforts to measure national income because Roosevelt wanted to get a clearer understanding of the Great Depression.  At the same time and for similar reasons, Colin Clark was funded by the British government to develop similar statistics on the other side of the Atlantic.  Both of these economists were motivated by wanting to measure the changes in national welfare during the Great Depression.

Simon Kuznets… was keen to develop a measure of economic welfare. But the demands of wartime meant his ambition was overtaken by the need to measure production and productive capacity, in order to use scarce material resources and labor as efficiently as possible” (p. 91)

…”[Kuznets] argued that Commerce’s method [of including government military expenditure] tautologically ensured that fiscal spending would increase measured economic growth regardless of whether it actually benefited individuals’ economic welfare.” In the policy tussle in Washington, Kuznets lost and wartime real-politik won. (p.16)

…An official US history of the national income accounts describes it this way:

Before GNP [gross national product] was made available, projected defense expenditures were sometimes erroneously subtracted from projected national income, producing a residual that was interpreted as the amount of production left for non-war goods and services… The assessment was overly grim because national income fell short of the total market value of goods and services produced, of which defense spending was a component… By including all government purchases as part of national Products, the GNP statistics established the role of national government in the economy as that of an ultimate consumer, that is as a purchase of goods and services for final use.

…This decision [to include government spending] was a turning point in the measurement of national income, and it meant that GNP (or later GDP) would be a concept strikingly different from the way the economy had been thought about from the dawn of modern industrial growth in the early 18th century until the early 20th century.  For two centuries “the economy” was the private sector. Government played a small role in economic life and featured mainly because it looked to raise taxes to pay for wars.

… By the time the wartime economists developed the modern concept of GDP, government was already a far greater presence than it had been. Subtracting defense spending from the older conception of national income would have wrongly given the impression that the war effort was going to involve a huge sacrifice in private consumer spending… (pp. 15-16)

In reality, the wars DID ‘involve a huge sacrifice in private consumer spending.’ The governments that created GDP measures wanted to hide the sacrifice and so they made it a positive in the national income statistics.  The leadership understood the psychological power of measurement. They promoted a measurement methodology that made war spending look good.

Coyle also shows how the U.K.’s efforts to develop GDP were motivated by the war effort too.

Keynes… fulminated [in his 1940 pamphlet How To Pay For The War]  about the inadequacy of the statistics available to him for calculating what the U.K. economy could produce with the available resources, what would be required for mobilization and conflict, what would be left for her for people to consume – and how much their living standards might need to fall. Planning for the war effort in particular needed much better statistics on how much was produced by individual industries, using what materials…

The motivating force of being at war should not be underestimated. Wesley C. Mitchell, the director of the National Bureau of Economic Research, said: “Only those who had a personal share in the economic mobilization for war could realize in how many ways and how much estimates of national income… facilitated the World War II effort.

Most people realize that GDP is used 1. as a measure of welfare and 2. for understanding recessions and economic growth (the raison d’être of macroeconomics).  These are the two main contemporary uses of GDP. But Coyle documents that a third use was probably a bigger reason for developing GDP: to help manage the economics of the war effort.

No wonder GDP is such a bad measure of welfare.  That was not what motivated the huge investment that went into developing it.  Many academics, from Adam Smith to Arthur Pigou to Simon Kuznets and Colin Clark had wanted to create a statistic to measure economic welfare.  Kuznets and Clark had initially worked on creating an economic welfare statistic before the war, but the realpolitik of WWII overruled their initial motivations and resulted in them producing GDP instead.

Once WWII was over, the cold war immediately began which maintained the wartime impetus for tracking economic production.  GDP also came to be the main macroeconomic performance and welfare measure, and it works fairly well for macroeconomics, but no economist would have created it as a welfare measure if that had been their primary aim.  In the beginning I listed welfare as the first use of GDP and warfare as the third because that is how the statistic is used today.  However warfare was the most important reason for developing the statistic and welfare the least.  That helps explain why it is such a bad welfare measure.

Note: The US actually used GNP rather than GDP until 1991, but the two measures are so similar for the US that I have treated them as synonyms.  The difference between the two has never been more than a couple percent in US history as you can see in a graph of both at FRED.