Foreword
There’s an old saying to the effect that “if it isn’t measured, it isn’t managed”. The corollary of this is that if it’s mis-measured, it’s highly likely to be mis-managed.
It you’ve been visiting this site for any length of time, it won’t come as much of a surprise to you that GDP does not, as is so widely assumed, measure economic output in any meaningful way.
Far from quantifying the amounts of material goods and services produced in any given period, gross domestic product is a tally of transactional activity, which is a very different thing. It’s perfectly possible, indeed commonplace, for money to change hands without any material economic value being added.
But were you also aware that the inherent flaws of GDP have rewarded some policy prescriptions whilst penalising others?
As we shall see, much of the “growth” delivered by the neoliberal policy revolution most closely associated with Margaret Thatcher and Ronald Reagan was the purely cosmetic effect of statistical distortion.
What really happened in the years after 1980 was that the West was de-industrialised, and simultaneously loaded with ultimately unsustainable debt, processes that were falsely validated by the vagaries of GDP.
1. A Grossly Distorted Process
It won’t surprise you that I sometimes get alerted to articles in which my work is mentioned. This led me to a recent piece at Business Day – and I’m very glad it did.
Author Nicholas Shubitz sets out an excellent statement of the faults of GDP before going on to reference our C-GDP calculations to illustrate what might really have happened to economic output in modern times.
His article is an all-in-one heads-up on why the calculation of Gross Domestic Product is a grossly distorted process. He’s equally good on the economic and policy distortions created by the mis-measurement of economic performance.
Back when economies were “mostly industrial and debt levels low”, GDP worked reasonably well as a measure of economic activity, writes Shubitz.
But when, at the end of the 1970s, the new neoliberal leadership started “promoting deregulation, privatization and financial liberalisation”, the deceptive characteristics of GDP came to the fore.
“Because GDP treats all spending equally, regardless of whether it comes out of income or borrowing”, Shubitz says, “it cannot distinguish between genuine expansion of productive capacity and debt-fuelled financial speculation”.
“Everyone intuitively understands”, he goes on, “that flipping a piece of real estate, or repeatedly securitising the same pool of mortgages, can produce economic activity in the financial sector that adds to GDP without creating real value. These transactions expand balance sheets but not productive capacity, and we call it growth”.
He goes on to suggest that, if meaningful data was available to us, we might find that the gap between the sedate economic performance of the G7 and the better-performing BRICS nations has been even wider than is already recognised.
A personal view is that what we can also infer from these realities is that the false validation conferred on neoliberalism by the quirks of GDP has contributed very significantly to the widening of inequalities of incomes and wealth between the West’s ‘haves and have-nots’.
2. Three Phases of Divergence
The template we use here at Surplus Energy Economics divides the post-war experience into three distinct chapters.
Between 1945 and the 1970s, policies were shaped by a Keynesian Consensus, which promoted the “mixed economy” of optimised public and private sector provision.
During the 1970s, Western voters were persuaded that the traumas of that decade weren’t caused by oil crises, as was actually the case, but by “left-wing” government policies and “over-mighty” organised labour.
Accordingly, the Keynesians were replaced by a Neoliberal Ascendancy, whose emphasis was on tax cuts, privatisation of publicly-owned assets, breaking the power of organised labour and shrinking the State. (Britain, perhaps uniquely, experienced this doctrinaire extremism twice, once as The Madness of Queen Margaret, and again as The Madness of King Tony).
The ensuing divergence between comparatively sluggish economic growth and fast-expanding debts and quasi-debts culminated in the global financial crisis of 2008-09.
At that point, policymakers abrogated the fundamental principles of market capitalism, intervening in the financial markets to artificially reduce returns on capital. Contrary to free market precepts, the cost of capital was rigged, using QE, ZIRP and NIRP, whilst the over-extended were rescued from the consequences of their mistakes and misfortunes.
Free market theory, let’s remember, is explicit on both of these issues. Markets must be free to put a price on risk and, whilst winners must be left to enjoy the proceeds of their acumen, the victims of market vicissitudes should not be rescued.
With market capitalist principles abandoned in all but name, the Neoliberal Ascendancy was replaced by a Post-Capitalist Expediency (PCE), whose aim is the maintenance of the status quo, including its greatly widened inequalities, by all available means.
But the fundamental trajectory of the neoliberal era, far from changing, has been reinforced under the auspices of the PCE, with debts and quasi-debts rapidly out-growing reported economic “output”, even though the latter has become an ever more misleading, artificially-inflated metric.
Since the end of 2007, whilst reported global GDP has grown by $90 trillion PPP (at constant values), debts have increased by $270tn, and broader financial liabilities by not less than $670tn.
These distortions would look even more acute were we to include, within broad liabilities, the “gap” between pensions promises and the resources actually set aside to honour them.
Whilst the ultimate consequences of these divergences are obvious – with only the timing of the inevitable crisis open to question – we need to start by assessing what’s really happened to economic output in modern times.
3. Principle of Money as Claim
From the start of the Surplus Energy Economics project, a series of fundamental precepts has been paramount.
One of these is the principle of money as claim, which states that, having no intrinsic worth, money commands value only as an “exercisable claim” on those material products and services for which it can be exchanged.
From this, it follows that we need to think in terms of the two economies of the material and the monetary, drawing a clear distinction between the quantum of claim and the quantum of substance.
Most of the data required for calibrating the flow and stock of the “financial” economy is readily available in the public domain. The challenges have been (a) to measure the “real” economy of physical products and services, and (b) to translate this material calibration into a monetary format which enables us to benchmark the financial economy against its physical substrate.
In principle, the workings of the “real” or material economy are relatively straightforward. Energy is used to convert other raw materials into products and services, within a continuous process of creation, consumption, relinquishment and replacement. This supply of material goods and services to society is known in SEEDS terminology as output.
The difference between material output and economic prosperity is determined by the fact that energy is never “free”. Rather, whenever energy is accessed for our use, some of that energy is always consumed in the access process, and is not available for any other economic purpose. The “consumed in access” component is known here as the Energy Cost of Energy, stated as a percentage and abbreviated ECoE.
First, then, we need to calculate material output, and the deduction of ECoE from this number then gives us economic prosperity. These numbers can be expected to correlate closely with, respectively, the total amount of energy used in the economy and the surplus energy which remains after ECoE has been deducted.
The latest output from these calculations is set out in Fig. 2 at the end of this discussion.
4. Inclusion of Borrowed Money Spending
How, though, can we calculate top-line material economic output, and express it in financial language? For the reasons outlined above, GDP cannot be used for this purpose, primarily because it is hugely distorted by the inclusion of the “spending of borrowed money”.
The SEEDS solution has been to strip reported GDP of the “credit effect”, leaving us with a calculation of underlying or clean economic output, which is abbreviated here as C-GDP.
This process is illustrated in the first set of charts.
In the years between 2005 and 2025, whilst reported global GDP increased by $102tn PPP at constant prices, debt expanded by almost $300tn. Broader obligations are stated as the “assets” of the financial sector which, by definition, are the liabilities of the non-financial economy, since nobody else can honour them. With these included, commitments upwards of $7.50 have been taken on to generate each growth dollar.
Since filing data with the FSB is voluntary, and a number of jurisdictions – including about forty enormously-leveraged offshore financial centres – do not report their numbers, the global aggregate of financial assets can only ever be an informed estimate. The SEEDS calculation is that broad financial assets increased by not less than $735tn between 2005 and 2025 (see Fig. 1A).
Starting with debt, the second chart compares annual global growth with net borrowing over the past twenty years. Through those years, GDP growth averaged 3.3% per annum, whilst borrowing averaged 9.7% of GDP.
Adjustment both for borrowing and for increases in broader financial assets enables us to calculate annual growth (or contraction) at the “clean” level of C-GDP. On this basis, and as the third chart shows, average growth for the period between 2005 and 2025 falls to 1.4% from the reported 3.3%.
There’s no such thing as a “year zero” in economics, so SEEDS retrofits adjusted growth rates to calculate a C-GDP series backwards from the start date which, at present, is 2025. This shows that, between 2005 and 2025, economic growth falls to 32% from the reported 94% (Fig. 1D).
To put this in context, we need to recall that global population numbers increased by 25% between 2005 and 2025. On the basis of reported GDP, the World’s average person was 56% better off last year than he or she had been twenty years previously.
On the C-GDP basis, however, this average person’s betterment falls from 56% to just 6%, leaving him or her woefully ill-equipped to carry his or her greatly expanded share of debts and quasi-debts.
Figure 1. Click on the image to enlarge.
5. Energy Cost of Energy
We know, by looking back at Fig. 1A, where the divergence between economic output and liabilities eventually ends. This conclusion is an obvious one, even before we factor in the depletion of non-energy raw materials and the relentless, exponential rise in the Energy Cost of Energy.
A point necessarily arrives at which the very idea that debts and quasi-debts can ever be honoured “for value” loses all of its remaining credibility. That’s the moment at which the authorities, for want of any alternative course of action, start pouring huge amounts of newly-created money into the system in a desperate effort – which fails – to prop up the existing financial system.
It’s equally interesting, though, to look at what has already happened along the road to the expansionary destruction of the purchasing power of fiat money.
Faced with the potential collapse of the banking (credit) system during the GFC I of 2008-09, decision-makers indulged in the moral hazard of rescuing the over-extended from the consequences of their miscalculations and misfortunes.
The “moral hazard” involved here is that anyone once rescued assumes that they are at liberty to take excessive risks on the understandable assumption that, if “things go wrong” again, they will once more be bailed out. There can be few better illustrations of the recklessness thus endorsed by the authorities than the wave of capital now being malinvested in AI.
At the same time, though, the authorities intervened to slash the cost of capital using QE, ZIRP and NIRP. Since asset prices tend to perform inversely to the cost of capital, this drove the creation of an “everything bubble” across a multiplicity of asset classes.
The super-inflated rise in asset prices has created the lethal illusion that we have more than enough value acting as collateral to support our gargantuan debts and quasi-debts. In reality, though, these aggregate asset values exist purely in paper form, and will evaporate as soon as the inevitable GFC II crisis arrives.
Essentially, it’s wholly erroneous to value asset aggregates on the basis of marginal transaction prices. This implies that we could somehow monetise the entirety of stock market or real estate value at their current prices, even though the only people who could buy these assets in their aggregates are the same people to whom they already belong.
The foregoing processes have had two specific consequences. First, they have greatly enriched the (generally older) owners of existing assets at the direct expense of those (generally younger) people who had yet to acquire real estate or stock portfolios.
Second, these processes have intentionally skewed the relationship between asset values and all forms of income (which include dividends and pensions as well as wages and salaries). Returns on capital don’t necessarily need to out-perform earned incomes when the balance between asset values and earnings has been forcibly re-set in favour of the former.
Figure 2. Click on the image to enlarge.
All of this, of course, is exactly what we’d expect of a Post-Capitalist Expediency dedicated to the continuation, not just of the status quo, but of the inequalities embedded within it.
By the same author:
A Lesser Evil ~
The Economy and the Environment,
Objectively Considered
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