Gross Domestic Poor-measure-of-growth
Measuring economic growth using Gross Domestic Product (GDP) is inadequate. This article aim's to quantitatively & qualitatively outline why this is so and highlight the role of well-being metrics for encouraging a more active dialogue between economic theory and statistical practice that influences policy decisions. This can be done with a broader dashboard of indicators that would reflect the distribution of well-being in society and its sustainability across Economic, Social and Environmental (ESE) dimensions in answering "what is 'growth'?".
Gross Domestic Product aka National Income
On January 4, 1934, in response to US senate resolution No. 220 of the 72nd Congress, a report was complied by the United States Division of Economic Research of the Bureau of Foreign and Domestic Commerce on national income from 1929-32 (1). Dr. Simon Kuznets, who was responsible for the preparation of the final estimates, as well as the organisation and the text of the report, noted this about the national income:
Kuznets' defined national income as “the net output of commodities and services flowing during the year from the country’s productive system in the hands of the ultimate consumers.” National income became the basis for what we now know as GDP. Kuznets' language here of 'scarcely be inferred' is driving home the point on GDP's weakness as an indicator of economic performance and social progress; as superbly outlined by Nobel Prize–winning economists Joseph Stiglitz and Amartya Sen, along with the distinguished French economist Jean Paul Fitoussi in their 2010 book titled 'Mismeasuring Our Lives; Why GDP Doesn’t Add Up' (2).
Fast forward to 2nd September, 2020, 11:30 AM Canberra time, the Australian Bureau of Statistics (ABS) announced "The Australian economy fell 7.0% in the June quarter 2020, the largest fall in Gross Domestic Product (GDP) since quarterly measurement began in 1959" (3) and with it, confirming Australia had entered a 'recession' under the traditional definition of 2 quarters of negative GDP growth. The following charts show Australian's recent and historical quarterly GDP values respectively.
For data prior to 1959, you may wish to try searching https://search.data.gov.au/. This is the central source of Australian open government data.
The Organisation for Economic Co-operation and Development (OECD) said governments and central banks will need to continue to provide support into 2021, after huge efforts this year that have bloated balance sheets and stretched fiscal budgets (4). The question readers should be asking: How did the global economy bounce from record depths in April and May? Well, this was done by central banks expanding their?balance sheet to $28 trillion, while governments?unleashed trillions of dollars in fiscal support. These monetary and fiscal policy decisions with respect to GDP will be discuss later in this article.
“The problem is that this V-shaped recovery is not going to happen,” OECD Secretary General Angel Gurria said on Bloomberg Television. “What we are saying is... don’t take away the support, don’t take away the relief, too fast.” See OECD GDP forecasts below, with Australia forecast to have positive real GDP growth of 2.5% in 2021.
Due to the COVID-19 pandemic, subsequent lockdowns & travel restrictions, some have questioned if this is a true 'recession'; economic activity slowing under its own steam. In a larger context, it depends on what additional economic indicators help to confirm this, what definition you use to define a 'recession'. According to the US's National Bureau of Economic Research (NBER); "A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales" (48).
For context, a 'depression' has been defined as an extreme recession?that lasts three or more years, however some stipulate 8 quarters of declining GDP growth or an annual decline of real GDP?of at least 10%. For example, the US had a 'depression' in the 1890s. However looking at the National Bureau of Economic Research's estimates, the economic contraction began in January 1893 and continued until June 1894. The economy then grew until December 1895, but it was then hit by a second recession that lasted until June 1897.?Additionally, the unemployment rate exceeded 10% for 5-6 consecutive years (5).
As some governments have implemented the purposeful shutting of the economy to protect its citizens from an incredibly contagious respiratory disease with no vaccine, other economic, social and/or environmental indicators may have to be relied upon to confirm if this is a true 'recession'. In any case, government’s targeting GDP creates certain outcomes, misaligning incentives, hence the expression:
What gets measured gets?managed
What we measure affects what we do. If we measure the wrong thing, we will do the wrong thing. If we don’t measure something, it becomes neglected, as if the problem didn’t exist.
GDP also has no mechanism to measure the value of alternatives that use less capital, labor and resources to get the same results (53).
Economic growth is an economy's ability to satisfy people's wants, whatever they are, that is, to produce wellbeing. Having more stuff in stores isn't growth, wasting our limited productive capacity. Economic means simply economising, or finding the better use of scarce resources. GDP calculates the turnover of money, not the quality of its use. Let's go back to basics and look at how GDP is calculated.
Calculations
GDP (also known as aggregate demand) = C + I + G + (X - M)
GDP does not account for health, infant mortality, morbidity, suicide rates, crime, poverty, environmental health/decay, family breakdown, loss of leisure time, lack of civility in communities, lack of concern for future generations, the 'value' to society that mothers provide in looking after their new-born babies etc. Additionally, GDP doesn't reflect changes in the?balance sheet, i.e. debt, which we will discuss later in this article.
During COVID lockdowns, C, I, X & M have all been suppressed, hence G has increased substantially. Australia's federal and state government spending is now (projected) to be more than the Global Financial Crisis (GFC) (6). This stimulus was borne out of the government balancing a shut down of the economy on the one hand with ensuring people had enough money for necessaries on the other. I would posit that governments were not targeting government spending here to ensure GDP didn't slow down, it is just currently how our economic success is measured. And granted, Keynesians would state that a pandemic is one reason why this system exists; to step in when the market stops, I.e. counter-cyclical fiscal policy.
However the shutdown was government mandated. Could the market have solved this? What is not measured but are potentially positive ESE outcomes includes a reduction in global CO2 levels, regeneration of forests, US revolving credit - i.e., credit card debt - shrank for the 5th consecutive monthly decline (7), citizens and corporates explore working from home more often, some heading back to study and the potential for new entrepreneurial projects to blossom in the next 3-5 years.
Targeting GDP leads to higher consumption, leading to more extraction of commodities from the earth, causing environmental sustainability taking a back seat to economic goals (the Keynesian manta of consumption is the way to prosperity instead of savings). Aggregate demand also does not include money itself in its assessment, only the price. Hence GDP doesn’t account for the depletion of natural capital and ecosystem services (I.e. the work of pollination by bees) or if spending is ‘good’ or ‘bad'.
So how do we decide is spending is 'good' or 'bad'? The market coordinates this for us, not government policy? By buying a good or service, consumers demonstrate their preferences (8). In contrast, politicians, parties and civil servants produced nothing which is sold in markets. No one buys government 'goods' or 'services'. They are produced and costs are incurred to produce them, but they are not sold and bought. On the one hand, this implies it is impossible to determine their value or if this value justifies their costs. Because no one buys them, no one actually demonstrates that they consider government goods and services worth their costs.
From the viewpoint of Austrian economic theory, it is thus entirely illegitimate to assume government goods and services are worth what it cost to produce them, and then to simply add this value to that of the privately produced goods and services to arrive at GDP. It might as well be assumed that government goods and services are worth $0, that they are not 'goods' at all but 'bads', and hence, the cost of politicians and the entire civil service should be subtracted from the total value of privately produce goods and services; much like the financial 'services' industry. Indeed, to assume this would be far more justified. You could use the GDP formulae without government spending; PGDP = C + I + (X – M); Private Gross Domestic Product.
However, you can juxtapose this against indiscriminate goods that have no profit motive, like street lamps, emergency services and military protection. It's hard to control for a good that people can get for free or wouldn't pay for. This also applies to negative externalities such as pollution. The 'company' that would provide this service is a government with taxes (instead of a subscription fee to a private company) (9).
Overall, this supports the view of a balance sheet approach with a broader dashboard of 'growth' indicators to drive policy, otherwise our society may produce year-on-year 'broken windows'.
Parable of the broken window
Claude Frédéric Bastiat?was a French Austrian-economist, legislator, and writer who championed private property, free markets, and limited government.?In his 1850 essay "Ce qu'on voit et ce qu'on ne voit pas" ("That Which We See and That Which We Do Not See"), he outlines that money spent to recover from destruction, is not actually a net benefit to society (10).
The?parable?seeks to show how?opportunity costs, as well as the?law of unintended consequences, affects economic activity in ways that are unseen or ignored. The belief that destruction is good for the economy is consequently known as the?broken window fallacy. For example, if society constructs a building, say housing 100 people one year that is collectively purchased for $10,000,000, this figure is included in GDP calculations. Great news! 100 people have found shelter, security and it have improved their living standards. However, say next year the building is completely demolished and this costs $500,000, this figure is also included in GDP calculations. 2 years of positive GDP, no recessions, great success no? The 100 people living there have seen their living standards drop dramatically; now homeless. The reasons to demolish are many; structural safety issues, in the way of government/commercial projects, perceived oversupply reducing speculative capital appreciation of surrounding buildings or bank credit inflation etc. as has happened to parts of ghost cities in Shanghai, China (11).
Is digging a hole one year and filling it back in the next economic progress; that which pairs with Australia's societal progress in other areas of science, technology, education and human rights?
Paradox of thrift
With respect to targeting GDP growth, there is a counterintuitive argument with respect to savings called the the?Paradox of thrift (12). This refers to the supposed ill effects that savings?has on an economy in a 'recession'.?According to the standard Keynesian explanation, a reduction in consumption spending (~70% of GDP calculations) drives an economy into recession. When individuals and businesses increase their savings, this only compounds the problem of a reduction in private consumption spending, leading to further decreases in economic activity.
The Austrian school disagrees. It does not accept that demand?is the driving force of an economy, rather, it is the production?of goods which allows demand to take place. You can't demand a car unless it has first been created; Says Law. Not only is savings not a bad thing, it is savings which allows for greater production by increasing a business's capital?stock. It allows low-time preference individuals to deploy capital for good and services with greater utility or business opportunities. Without delaying consumption there is no way in which to invest in the tools, machinery or labor necessary to achieve a higher output.
Economic Growth Vs. Economic Development
Economic development is defined as the progress in the socio-economic structure of the economy (13).
"Distinctions must be kept in mind between quantity and quality of growth, between costs and returns, and between the short and long run. Goals for more growth should specify more growth of what and for what" - Simon Kuznets
The problem is that GDP has functioned as an 'income statement'. In order to evaluate if our progress is sustainable, we need full cost accounting; a 'balance sheet' approach. Below outlines a comparison table between economic growth (I.e. GDP) vs. economic development (I.e. dashboard of indicators).
An alternative GDP indicator that has been used with some success, a dashboard of indicators, is the Genuine Progress Indicator (GPI).
Genuine Progress Indicator
The GPI is based on the concept of sustainable income, presented by economist John Hicks in 1948 (14). Sustainable income is the amount a person or an economy can consume during one period without decreasing consumption during the next. GPI is measured by 26 indicators, however presented in the simplified form:
GPI = A + B - C - D + I
A subtle yet powerful formulae change taking on a 'balance sheet' approach; determining whether economic activity is increasing benefits more than costs. The state governments in the U.S. of Maryland and Vermont have adopted GPI as an official indicator (15).
Kubiszewski et al. 2013 compared GDP to GPI across 17 countries (containing 53% of the global population and 59% of the global GDP) for the period 1950–2003. They found:?
Many scientists argue that even current consumption levels are not sustainable (16, 17). (Note here that even though we have been incorrectly predicting ' peak oil' for decades, a more appropriate metric to use here would be Energy Returned On Investment or EROI). As of 2011, humans were using ~135% of the resources that can be sustainably generated in one year (18). Based on this estimate of the degree of current overshoot, they conclude that a 35% increase in the technical efficiency of global production would allow the global ecological footprint to be brought back within global biocapacity. This degree of technical improvement appears to be feasible (19). This is supported by the writings of Irish-French economist, Richard Cantillon. Cantillon's highly sensible and sophisticated 'optimum-population' realisation that human beings will flexibly adjust population to standards of living, and that their noneconomic values will help them decide on whatever trade-offs they may choose between a slightly larger population or a smaller population and higher standards of living; also known as the Anti-Malthusian approach. Anti-Malthusian theories have their supporters (~political right & down), just as Malthusian theories do (~political left and up). The difference in what one believes is how that person looks at the current evidence of 'growth'. Technical efficiency can be applied to transport & logistics, energy, farming yields, financial innovation to increase money 'flow', communication, health care, among many others.
Once reached, continuing improvements in environmental protection, full employment and product quality would allow the GPI/capita to rise without the need for further increases in global GDP. It may be possible to increase economic welfare without having to grow GDP. This flies in the face of how we determine economic success.
In the figure below, Kubiszewski et al. shows that Australia experienced increases in GDP/capita and GPI/capita until the mid-1970s. Between 1994 and 2006, GDP/capita rose sharply, however, GPI/capita did not experience a similar increase due to environmental and social losses Australia was experiencing at the same time (20, 21). Ecological footprint/capita shows a slow decrease over the study period (I.e. we had less of a burden on our environment via recycling, energy conservation, technological innovation, economies of scale, etc.). Biocapacity/capita decreases significantly & life satisfaction remained relatively constant.
What is 'growth'?
Let's pause and reflect back on this article's original question; what is 'growth'? We can see that depending on what is measured and defined as 'growth' will influence what we do as a society. I believe that the underlying premise for economic government policy via a market (I.e. the voluntary exchange of goods and services between individuals) is to improve 'living standards' (49). (Note: a market is not a system or a policy. It does not exist in any legislation, law, bill, regulation, or book. It is what you get when people act on their own, with their own property, within human associations of their own creation and in their own interest). These 'standards' are incorporated into a broader dashboard of indicators. An interesting observation by Inglehart, R. 1997 (22), is that 'living standards' or well-being produces diminishing returns the higher a country's GNP/Capita (figure above) as an economy transitions from a manufacturing/goods producing economy to a lifestyle/service based economy. Does this support the notion that developed countries will have 'lower for longer' economic growth rates ('low' being <1-2%)? We will discus this point later in this article. The observation by Inglehart, R. is aptly supported by the publication 'The Economist' showing the Social Progress Indicator (SPI) vs GDP/capita.
We can see this in the transition of developed country economies from manufacturing to a more service based economy. This is not to suggest that manufacturing should to be actively displaced when reaching a certain GDP/capita threshold; as it could be argued that developed country's products are of greater value and higher quality, hence improving 'living standards'.
Yet, throughout time we can see that the US's population-&-inflation adjusted GDP/capital/generation is extremely varied. The 'Greatest Generation' having the highest with the current 'Millennials' losing out most (however they would have a higher standard of living). What would separate these generations would be differing monetary systems and the economic revolution that is the driving force behind a nation at that time. Their improvement in 'living standards'? Hard to tell from this chart alone (23).
Inclusive Wealth Index
Another alternative measure is the Inclusive Wealth Index (IWI). It is a sustainability index that is meant to replace GDP and measures wealth using countries' natural, manufactured, human and social capital (24); a classical economic model. It was revealed in the Inclusive Wealth Report; an analysis of 20 countries representing 56% of world population and 72% of world GDP, including high, middle and low-income economies on all continents.
Many of the assets critical for maintaining productive bases are either not priced or are priced at much lower levels than they should be. This is especially true for natural capital and human capital assets. Natural capital assets such as forests and water bodies have only been valued for the products they provide for the market, such as timber and fish. However, these ecosystems offer a much larger suite of services, such as water purification, water regulation and habitat provisioning for species, among many others. These are clearly valuable services (25). Referencing the report's chart above, it shows Natural Capital 'NC' per capital declining overtime.
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Other Alternatives
Created by Yale Universities' Center for Environmental Law & Policy, the Environmental Performance Index (EPI) provides a data-driven summary of the state of sustainability using 32 performance indicators across 11 issue categories ranking 180 countries on environmental health and ecosystem vitality (54).
MAP presents reliable, easy to understand information across a range of social, economic, environmental and governance measures for Australia (26, 27). This page was first published on 14 November 2013, however last updated 8 May 2014.
Created by the OECD-hosted High-Level Group on the Measurement of Economic Performance and Social Progress (HLEG), the Better Life Index compares well-being across countries, based on 11 topics the OECD has identified as essential, in the areas of material living conditions and quality of life. It looks at indicators such as Housing, Income, Jobs, Community, Education, Environment, Civic Engagement, Health, Life Satisfaction, Safety, Work-Life Balance (28). Australia currently sits in 2nd behind Norway using this index.
SPI measures the extent to which countries provide for the social and environmental needs of their citizens. 54 indicators in the areas of basic human needs, foundations of well-being and opportunity to progress, show the relative performance of nations. The index is published by the nonprofit Social Progress Imperative and based on writings by Joseph Stiglitz, Amartya Sen & Jean Paul Fitoussi (29). In July, 2013, Paraguay became the first country to officially start using the SPI as a basis for policy decisions (30).
HDI statistics rank countries. It considers the overall development in an economy regarding the standard of living, GDP, living conditions, technological?advancement, improvement in self-esteem, the creation of opportunities, per capita income, infrastructural and industrial development and much more.
One of the central problems of aggregate measures of national income and well-being is this means only activities that can be tracked, counted, and ranked based on dollar values and production totals will be among those activities reported as having value. But what about those things that can't be measured? The driving force of human action, and therefore of the human market economy, are the valuations of individuals. Economics analyses the logical attributes and consequences of the existence of individual valuations (50).
Government Policy
Government policy has a huge impact on the well-being of its citizens. The systems that we have created, the interchange between governments, banking, money and how we measure 'growth' have diverged. Segments benefit at the expense of others. How did we get here? I believe that the award winning independent feature documentary 'Four Horseman' by Renegade Inc explains it best with respect to changes in the economic foundations of government policy over time (32).
"Milton Friedman and the neoclassical ideology beat the classical approach to economics and became the framework for what we today call capitalism. There are two main competing economic approaches which determine how we humans manage the world and distribute wealth. These are the classical and neoclassical schools. The classical school favours less government interference, more personal autonomy and recognises that humans cannot function without natural resources. The neoclassical school which has a more dismissive view of natural resources thinks governments should rule the economy, solve social problems and leave the free market to look after the distribution of wealth. The neoclassical school emerged around 100 years ago due to vested interests' desire to protect their assets. This meant that neoclassical mathematical models and assumptions were divorced from reality. They are based on what "ought to be", instead of the classical models which are based on "what actually is". It's these neoclassical models which favour large corporations that have been used to legitimise the financialisation of the global economy. Championed by Ronald Reagan and Margaret Thatcher, neoclassical economics still dominates policy making today."
Both schools have their downfalls thou. Neoclassical economics believes that active demand management is required by the government. Classical economics failed to account for technological advances and incorrectly assumed that supply creates its own demand. This is also a false paradigm. Both positivists (meaning adding regulation or policy is a method to achieve ESE goals); all of the schools of economics are, bar the Austrians.
Neoclassical Growth Theory outlines?the three factors necessary for a growing economy (33). These are labor, capital, and technology. The production function of neoclassical growth theory is Y = A (K, L)
Increasing any one of the inputs shows the effect on?GDP?and, therefore, the equilibrium?of an economy. However they are not all equal; the returns of both unskilled labor and capital on an economy diminish, exponentially decreasing returns, while technology is 'boundless' in its contribution to growth. For example, neoclassicists have historically pressured some governments to invest in scientific and research development toward innovation. They also maintain that the assumption that consumers behave rationally in making choices, ignoring the vulnerability of human nature to emotional responses; human action is defined as using means to obtain ends.
Standard economic theory today almost takes it as an axiom that we should be maximising GDP, conflating that number with societal well being, ignoring the massive market failures that advances in economic theory over the past century have taught us. It ignored our planetary boundaries and the many dimensions of well being that are not well captured by GDP, that actually go down as GDP goes up.
The issue here is that the neoclassical school, by ignoring land, has distorted the informational content contained in prices that is so useful to market participants in evaluating preferences and opportunity costs. Additionally, by ignoring money itself in their models, the build up of debt (I.e. pulling forward future consumption) doesn't allow market prices to absorb these social and environmental costs. Recently, we have seen the somewhat unimaginable. Some of our economies most precious resources, time and energy, going negative. Time being measured by the cost of money (interest rates), central banks and some home loans, individuals are being paid to take on debt. In April 2020, energy being measured by the cost of oil, went negative. The concept of prices' information content is best explained by Mark Spitznagel via Bloomberg (34).
Additionally, government policy has the unseen effect of progressive build up asymmetries (I.e. GFC). Decentralisation reduces large structural asymmetries. Via negativa (acting by removing) is more powerful and less error prone than via positiva (acting by addition); the classical school. More policy ≠ More growth. Morally, should we be deciding what is 'good' for others? Economic policy, from a classical school's point of view, should primarily be to enforce contracts and ensure no fraud exists.
What gets measured gets?managed. The attempts of governments to manage the economy with an inadequate measure of growth, on top of a misaligned economic school of thought, has caused a derailment of their goal to improve 'living standards'. Below will show some misguided examples of monetary and fiscal policy in attempt to manage GDP.
Monetary Policy
The Reserve Bank of Australia is responsible for Australia's monetary policy. In determining monetary policy, the RBA has a duty to contribute to the stability of the currency, full employment, and the economic prosperity and welfare of the Australian people (35). This is arguably a feedback loop with GDP measurements (as measured in RBA monthly updated chart packs (36)). Also, by combining certain monetary measures, we can see many second order affects on the market. One measure is the Core Price Index (CPI).
Focusing in on CPI, the Devonshire Research Group (DRG), an investment adviser in the US, produced a research presentation titled 'The Alternate Macro Economic View' that looks at historical US inflation (37). They conclude that the US official CPI calculation is governed, and possibly distorted, by numerous and complex technical decisions. The standard of living becomes?far more difficult for?many to maintain than published statistics suggest. The chart below highlights the changes to CPI calculations overtime.
Therefore, inflation becomes less a measure of purchasing power (and therefore a financial tool) and?increasingly a process of affecting macro-economic policies (and therefore a policy lever). Real GDP, yield curves, treasury issued inflation protected securities, government and union / minimum wages, HECS debt adjustments all rely on official inflation indices that are subject to these distortions.
This impacts real interest rates, the risk-free rate of return and the cost of capital; used to value future projects using discounted cashflow calculations. Real interest rates, already seen at historic lows, may be?strongly negative, making fixed income returns unattractive (see chart). Investors could be?using incorrect assumptions in their asset allocation models and investment decisions (people thinking they're making money nominally but actually losing in real terms. It can also push people to take riskier investments to chase higher yields). Capital preservation is compromised, portfolio allocations are distorted and return performance is overstated. By DRG's calculations, CPI is closer to 8% than the commonly accepted 3%.
Before considering DRG's final chart in this article, we need to touch on the GDP deflator; see calculation (38). This is a more comprehensive inflation measure than the CPI because it isn't based on a fixed basket of goods. Nominal GDP rises and falls, the metric doesn't consider the impact of inflation or rising prices on the GDP results. Real economic growth may be flatter or?actually negative, suggesting a prolonged 21st?century recession, not recovery.
To incorporate all this together; GDP, inflation and interest rates (39)...
Yet as we hit the 'zero bound' in interest rates, second order, unaccounted and negative economic outcomes begin to emerge (from a GDP targeting point of view). Previously, we asked if developed countries will have 'lower for longer' economic growth rates ('low' being <1-2%) as an economy transitions from a manufacturing/goods-producing economy to a lifestyle/service-based economy. Research conducted by Bank of America (BofA) seems to indicate that this is correlation, not causation. By managing interest rates (GDP policy lever), a second order affect occurs. Even thou lower rates indeed stimulate spending and lead to lower savings, this effect peaks at around 4% and then goes negative. When yields drop below 4%, the lower the propensity to spend, increasing the savings rate (Paradox of thrift). BofA demonstrates in the chart below that hyper-easy monetary policy is not inflationary but is deflationary; "as low growth & inflation make low-risk-asset income scarce (e.g. from government bonds), households are forced to reduce consumption and increase savings in order to meet retirement goals. Forced saving further depresses demand in a vicious cycle." (40)
Another second order affect of lower interest rates is market concentration. In a study conducted by Liu, Ernest et al, 2020 titled 'Low Interest Rates, Market Power, and Productivity Growth', it discusses how the production side of the economy responds to a low interest rate environment. It provides industry leaders (or large cap companies; with larger market share) a strategic advantage over followers, and this effect strengthens as the interest rate approaches 0%. It has reduced a market's propensity for creative destruction, a widening productivity-gap between industry leaders and followers, and slower productivity growth. A decline in the 10 year treasury yield generates positive excess returns for industry leaders and the magnitude of the excess returns rises as the treasury yield approaches 0%.
Additionally, to keep up with their standards of living, people have had to take on more debt; E.g. housing in Australia. This leads to credit exhaustion (41) and the potential for an elongated account-book recession from too much debt, as experienced by the Japanese beginning in the late 1980s.
In our dashboard of indicators, a minimum criterion would require it to cut total spending, cut overall tax rates and revenues and put a stop to its own inflationary creation of money.
Fiscal Policy Considerations
Consumption Tax vs. Income Tax: Prior to the passage of the 16th?Amendment?to the?Constitution, the?United States?primarily raised?government?revenues?using consumption?taxes (42). It took the passage of the 16th Amendment in 1913 (and passage of the Revenue Act) to?permit?congress?to create?income taxes. Initially, the United States did not have any incomes tax.
There is precedence to change income taxes with consumption based taxes (potentially progressive in style; the higher the purchase price, the higher the tax % as not to hurt low income earners from small, everyday purchases). A form of this is already in place, namely Goods and Services Tax (GST) in Australia and Value Added Tax (VAT) in Canada and the Europe Union. 166 of the?193 countries?with full UN membership employ a VAT, including all OECD members except the United States. The long term effects of a consumption tax would be a greater?accumulation?of savings, more capital to?invest and an economy that is fundamentally stronger than one using an income tax system.
This debate could result has been endless tinkering with?kinds?of taxes, coupled with neglect of a far more critical question:?how much?
Debt: In the current Keynesian economic system, governments step in when private enterprise growth has stalled. However, leaning too much on debt to 'prop up' the economy comes at a cost. Here too we see diminishing returns with respect to GDP.
The following chart, produced by independent researcher Steve St. Angelo using data from the Federal Reserve, shows the relationship between total U.S. debt from all sectors (public and private) versus domestic GDP (43). Total US debt is shown in?blue?while GDP in?red.?You'll notice that total debt and GDP from?1950 to 1970 remained relatively even.?It wasn’t until after 1970 that debt increased more than the GDP.?This was potentially due to:
These conclusions pairs with those noted by Kubiszewski et al. 2013 regarding global ecological footprint/capita exceeding global biocapacity/capita around 1978 and life satisfaction not significantly improving since 1975.
Additionally, all debt is borrowed against future supplies of affordable energy (55). Since global economic activity is dependent on a continued abundance of energy, it follows that all money borrowed against future income is actually being borrowed against future supplies of affordable energy. Our system of debt has used this additional supply of energy to increase consumption rather than to use this energy as a replacement. This is what’s called Jevons Paradox: every increase in efficiency or energy production only increases consumption.
Mortgage Lending: Australia's residential mortgage lending is a substantial source for credit creation by banks. Real estate is also a major source of tax revenue and GDP growth for Australia. Hence, there is an economic incentive for the government to not let the housing market falter too much. In July, 2019, the Australian?Prudential Regulation Authority (APRA) made changes to fiscal policy with respect to housing. It stated that the minimum interest rate buffer that APRA considers a prudent Authorised Deposit-taking Institution (ADI) would use in its serviceability assessment is 2.5% (I.e. 2.5% over the loan’s interest rate) (44).?The time of writing, this assessment rate would be ~5% (2.5% home loan rate + 2.5% buffer). APRA confirmed its updated guidance on residential mortgage lending will no longer expect them to assess home loan applications using a minimum interest rate of at least 7%. Common industry practice had been to use a rate of 7.25%. This makes it easier for people to obtain loan approvals to buy houses, with this activity driving growth in GDP. Recently, proposed changes on responsible lending obligations by the government has been met with concern (51).
Immigration: Lastly, not specifically fiscal policy however a potential third order affect on driving GDP, immigration policy. The?Center for American Progress, an independent nonpartisan policy institute, has calculated the potential differences in GDP growth rates from varied immigration policy (45). Increasing the size of a nation's population would drive economic activity/demand and money velocity.
Update 11/02/2024
In the Director’s Statement about the Congressional Budget Office’s new report, The Budget and Economic Outlook: 2024 to 2034, it states:
The labor force in 2033 is larger by 5.2 million people, mostly because of higher net immigration. As a result of those changes in the labor force, we estimate that, from 2023 to 2034, GDP will be greater by about $7 trillion and revenues will be greater by about $1 trillion than they would have been otherwise.
From these four simple policy examples, we can see how the influence of maximising and measuring GDP affects how we construct government policy. There is room for further research on changes to how we measure ESE outcomes would influence government policy decisions.
Possible Policy Solutions
National Income = Capitalist Income + Labor Income; therefore majority of national income gains have been accumulated by capitalist income; shareholders. The benefits of cooperative business policy is that risk and reward is taken on by the employees, while also providing an incentive to produce better goods and services (I.e. living standards) as they see these rewards.
However, for more information, a detailed expose of the productivity pay gap has been published by?Blair Fix (47). The key issue is that Neoclassical & Classical economists both define productivity?in terms of income; the sum of the?quantity?of each commodity multiplied by its?price.
There are many things that government can do however it must not attempt to prop up and raise wages. It can stop taxing business so heavily, cut regulations that are hampering recovery and stop taking action against symptoms; such as falling stocks or housing prices and business failures.
Conclusion
If we hope to achieve a sustainable and desirable future, we need to rapidly shift our policy focus away from maximising production and consumption and towards improving genuine human well-being (GPI or something similar). This is a shift that will require far more attention to be paid to environmental protection, full employment, social equity, better product quality and durability and greater resource use efficiently; reducing the resource intensity per dollar of GDP.
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