In this post, I wrote about how government is overhead.
If you believe this view of government, then you shouldn’t use GDP (Gross Domestic Product) as an indicator of the health of our economy.
Gross Domestic Product is calculated by adding consumer, investment and government spending. If consumer and investment spending decline, as usually happens in a recession (and usually for good reasons), people believe that boosting government spending is a good thing because it helps offset the declines in the other components of GDP.
What’s wrong with that?
GDP tells us how much economic activity there is. It doesn’t say if that activity is healthy or not. But we assume it does. We assume GDP is like to our income. We assume (and I think we are taught) that it’s the “income” of the economy, so more of it is good and less is bad.
But it’s not really income of the economy. It’s the total economic activity of the economy.
Let’s say you made $50,000 in income, spent $40,000 and invested $10,000. Your GDP, or total economic activity, was the sum of the three or $100,000.
$5,000 of your income came from a part-time job that you decide to quit. Your income drops to $45,000 and your total economic activity drops to $95,000.
Confusing your total economic activity with your income, you decide to borrow $5,000 and spend it to keep your economic activity at $100,000.
Many people will instantly see the problem with using economic activity in this fashion and advise against borrowing the money. They would also likely point out that your income level and how much you have left to invest after spending are better measures of your economic health.
But if you cloak such words as income, spending and investment with other words like GDP, consumer, investment and government spending, we lose our senses and start to believe it’s okay to borrow $5,000 to keep GDP at $100,000.
If we recognize that consumer and investment spending is the better estimate of the economy’s income and view government spending as an expense, we will make better decisions. For example, when economy’s “income” declines, we will want to reduce our expense, rather than increase it.
Not quite convinced? Here’s one more way to look at it.
Again, the three components of GDP are consumer, investment and government spending. Where does each of these come from?
Consumer and investment spending are the result of value created in society. Chipotle makes a burrito, I buy it. We both come out ahead (or we wouldn’t have traded).
Government spending also comes from this value creation process. Your expenses are enabled by the value you create at your job or with your business. I do something for my employer, they pay me. We both come out ahead. I spend some of that income on a Chipotle burrito.
As an expense, government spending comes from our income. Without income from our productive pursuits, we would not have government. As our productive pursuits have become ever more productive over the centuries, we’ve been able to afford bigger governments. Increase government spending and that leaves less income to spend on other things.
Since government spending comes from our income, it makes no sense to increase it in response to a decline in income. Rather, we should reduce it and look for ways to increase our income.
And, the secret to increasing our income is by encouraging, rather than discouraging, market-based innovative pursuits, just as it has been since humans have been evolving.