Government Value Addition to GDP

Mariana Mazzucato in her seminal book, "Value of Everything" adds to the nuances of value addition in GDP, that by the Government included.

GDP of a nation is the gross value added measured in monetary value- what the industry produces minus the costs of material inputs or the intermediate consumption. It is the difference between the resource side and the consumption side and matches the sum of the value added across the nation’s production chain. It equals the income of all people in the economy as well. 

For a specific industry, the value added is simple: EBIDTA plus Employment cost. For the Government, it is simply the employment cost as Government does not generate EBIDTA. This is an inherent flaw in National accounts that assumes that government activity does not create value. 

This takes us to the crucial question that does the Government actually create value? The answer to me is simple. The government can do what no others can do and they step in where there is a market failure, like creating basic infrastructure, providing primary education, defense for the country, or even take the best example from India, providing toilets as there are no market for toilets in the interiors of India. Governments also provide Judiciary, allows protection of private property and rights, which includes intellectual property, the harbinger of progress for humanity.

But we cannot ignore the other side of the government when economic crisis strikes and the government acts to stimulate demand in the economy through spending. This side of the government is easier to understand in the context of value creation. How much should the government spend is not standard, the French are at 58% (govt spend to GDP), while the Chinese are at 30%. 

Take India’s example of the building of the Golden Quadrilateral, connecting the four corners of India by a road network. This is a pure government investment, can we really say that it did not create any value? But that is how National accounts would treat this. 

Keynes in his multiplier as a concept brought out the positive role of government that stems from spending by the government. If $1 spent by the government through the multiplier effect create more than $1 of economic activity the multiplier would be more than 1. The neo- classical economists would not agree and argue that most multipliers are less than 1 as the government spending would crowd out private investment and that the sum of consumption is one. 

Surprising that what is lost in the government's value addition in GDP, the same is not true for the financial sector, which seems to be adding a lot if one goes by the trends.

For Financial Services we have a problem, if all businesses could finance their working capital needs and investment needs from their retained earnings then there would have been no need for financial intermediation; in any case such intermediation for industries would appear as intermediate consumption and therefore would not add to the value added for the industry. In fact if more interest rates are charged then the gain by finance would be at the cost of the industry. 

But for individual households this is not tenable. This and the plethora of products that the financial sector creates, its contribution to GDP has been rising at an exponential rate in the developed countries. Some of this precludes sheer gambling activities like the famous John Paulson did, betting that house prices will fall and made $2 Billion from the bet when House prices crashed in 2008, while the households picked up the losses, the GDP surely for the country dropped precipitously while income of Paulson zoomed. 

So the financial sector is not simple to understand, as long as it plays the role of creating value in the economy, it adds to the GDP in a wholesome manner, otherwise it could well be making a zero sum contribution to GDP as it happened in the housing crisis when extreme risk taking by the financial sector created risk- cascades morphing into a full fledged financial crisis that brought down the very asset prices that it facilitated to inflate through credit default swaps and other risk instruments. 

Mariana Mazzucato raises a valid observation on financialization of innovation in the non-financial sector; such initiatives have mostly been found to have extreme short term inequitable rewards for some actors with more private knowledge and raises doubt whether such activities are value adding at all for the overall economy of a nation. 

This can be extended to any financialization of output in the economy.