Political leaders in the developed world want economic growth but instead they are maximising ‘False GDP’, increasing resource consumption rather than increasing national financial prosperity. This problem is independent of the fact that GDP does not measure the wellbeing of a country’s population. GDP was only ever meant to perform the important role of estimating a nation’s financial prosperity. Financial prosperity is not sufficient for wellbeing, and in well-documented cases throughout history has even reduced wellbeing, including life expectancy. (Yes, I’m writing a book about it, see below).
Failure to detect the flaws in official GDP figures is consistent with the observations of Professor John Kay of the London School of Economics confirming that few economists understand GDP any more. See his remarks here and here).
‘False GDP’ misleads policymakers because of the relatively new practice of judging ‘growth’ on recent official quarterly estimates of GDP. This means that fixed asset investment looms large as a component of this ‘False GDP’ before it has fulfilled its purpose of creating prosperity in future years. Unfortunately the fastest-growing and most profitable fixed asset investments are not included because they are too hard to measure or estimate. This causes policymakers to divert capital investment to easily-measurable but less profitable capital assets such as new production capacity for export, high speed rail, and hub airports. These are inferior to the ‘intangible fixed assets’ which are the investments of choice for major enterprises and which employ more and more labour in developed economies. When the capital investments start to generate (or destroy) value added in later years the national accounts will reflect it and the bias in their initial inclusion no longer distorts the figures – but by that time democratic governments have stood or fallen on the basis of short-duration False GDP measures and the economy has been harmed by unprofitable capital investment and missed opportunities.
The solution is to use other non-audited indicators for managing the economy and for quickly judging results. As long ago as the 1990s private sector industry stopped using cumbersome ‘financial accounting’ indicators such as accounts receivable to manage a business and developed ‘management accounting’ indicators instead.
To clarify the nature of economic growth and prosperity, Hugh Small’s forthcoming Giving Away the Planet goes back to the Stone Age origins of the economy, informed by the last few years’ startling discoveries about human evolution. This is a topic neglected by many economic historians who (disagreeing with both Adam Smith and Karl Marx) believe that innovation and the free market only began with the agricultural and industrial revolutions of the 16th and 17th centuries.