Charles Adams – The measurement problem in political economy: a solution

It is accepted that Gross Domestic Product (GDP) is not fit for purpose, especially in this age of climate change. Charles Adams proposes an alternative.

Charles Adams is professor of physics at Durham University in the UK and blogs at progressivepulse.org

 

To apply the scientific method, something must be observed and measured. If we cannot measure it, “express it in numbers” then as William Thomson (Belfast 1824 – Largs 1907) said [1]:

our knowledge is of a meagre and unsatisfactory kind”.

If we can measure something, it must have units. Now units may not seem like the most exciting topic, but in economics they reveal its soul—what it wants to be and what the implications are. No one disputes that we can measure life expectancy (in years) or energy consumption per year (in Joules), but beyond that economics has a measurement problem. What are the units of economic activity? What counts?  Only when money changes hands do we count it as economic productivity. Being paid to look after someone else’s kids counts but looking after your own kids does not—even though the work involved is the same. Writing and selling books like Adam Smith counted but cooking Smith’s dinner did not because the cook (Margaret Douglas) was Adam Smith’s mother and he did not pay her a salary. In making these value judgements we assign a status to activities that may or may not be commensurate with their actual value. Aspects of the human experience that are not easily measured—happiness, health, love, freedom and community—are economically overlooked. Implicit is the assumption that we can separate different aspects of human life into an economic and a non-economic sphere. In the `economic sphere’ we can add up all the monetary exchanges and get a number, a gross domestic product (GDP or GNP measured in inflation-adjusted euros or dollars). Once we have a number we can activate a policy to maximise that number. But what if we used the wrong numbers? What if the failure of neoliberalism is actually a failure of choosing the right metric?

There are many problems with choosing GDP maximisation as the goal of society, and these problems has been apparent for some time. As Robert Kennedy said in 1968:

“…[GNP] counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage. It counts special locks for our doors and the jails for the people who break them. It counts the destruction of the redwood and the loss of our natural wonder in chaotic sprawl. It counts napalm and counts nuclear warheads and armored cars for the police to fight the riots in our cities. It counts Whitman’s rifle and Speck’s knife, and the television programs which glorify violence in order to sell toys to our children. 

Yet the gross national product does not allow for the health of our children, the quality of their education or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our wit nor our courage, neither our wisdom nor our learning, neither our compassion nor our devotion to our country, it measures everything in short, except that which makes life worthwhile.”

Even within the economic sphere GDP does not account for externalities like damage to the environment. It is neutral on questions of distribution: GDP growth rate of 3% with all the gain going to the top 0.01% is considered superior—purely quantitatively—to growth of 2.5% with the gains distributed amongst everyone. Long before Kennedy, economists knew that money was not a good measure of what is important and so invented another quantity called utility—a measure of how useful something is—but this raises other questions. Can we measure utility? What are its units? For example, imagine I am a carpet weaver. When I wove my first carpet I was very proud and would not sell it to anyone, but after I had woven ten carpets I was happy to sell all of them, including the first, as it was no longer anything special—just another carpet.  A sale only occurs if you and I both believe that we can increase our utility via exchange. Money is simply the accounting tool that allows me to obtain something of equivalent utility later. The units of utility are money. If utility is important to us, should we be maximising utility rather than GDP? If we assume that everyone has the same diminishing marginal utility—the more we have of something, the less satisfaction we receive from it (like the carpet maker), then utility maximisation is solved by taking from the rich and giving it to the poor, as per Jeremy Bentham‘s (London 1748 – 1832) maxim:

‘the greatest happiness for the greatest number

However, this raises questions about freedom and incentivisation, and as it is not clear whether we can measure individual utilities anyway, along comes Robert Nozick’s utility monster claiming that utility maximisation is solved by giving everything to him!

The Italian engineer and economist Vilfredo Pareto (Paris 1848 – Celigny 1923) proposed a possible solution to the utility measurement problem, by claiming that only relative utilities matter. Instead of an absolute (or cardinal) utility we assign a rank-ordered list (or ordinal scale): What is best, second best, third best, etc… and make choices based on this list.  As long as buyer and seller believe they are both increasing their ordinal utility then the exchange can go ahead, regardless of the unknown cardinal values. But in 1936 a mathematician named Franz Leopold Alt (Vienna 1910 – New York 2011) proved that you cannot make this distinction—if there is an ordinal scale then there is also a cardinal scale. Economists had to accept the maths, and the absolute cardinal utility was re-established defined by units of money. Furthermore to avoid the redistribution dilemma, the concept of diminishing marginal utility was abandoned, and we ended up with the GDP money metric. In this money-metric world everything has a price and anything that doesn’t simply has no economic value. We are completely justified in being selfish because every extra 100 euros we earn, adds to global GDP. As we cannot accurately discount the future we underestimate the importance of spending now to save later. Tackling climate change might seem expensive now, but will avoid larger costs in the future. Investment in health and education are a cost now, but will more than pay for themselves later. Money becomes a short-term constraint on what we do, whereas in the long term the only constraints are resources, time and desire.

As we increasingly suffer from its negative side effects, we hear more and more demands to abandon the GDP money metric. There has been a burgeoning of interest in alternative systems of economic measurement starting with the UN’s human development index (HDI) that includes health and education as well as income. But why not include freedom too? The trouble is that we end up returning to our measurement problem.

A solution: Median disposable income

We know that money buys freedom but we cannot simply maximise freedom by giving people more money. The only result would be inflation. Better is to maximise disposable income for everyone—net income minus essential spend on basic subsistence, housing and energy (rents that act as a drag on productive activity).

Increasing disposable income for the whole of society opens up choices—including ones that GDP cannot measure, for example to do more in the community or spend more time with the kids. Disposable income changes the focus towards productive economic activity rather than wealth extraction. Investment in housing, sustainable energy, and transport infrastructure provide the foundation for a freer society where we are enabled to pursue a productive life.

A second key ingredient in choosing the right metric is to use median measures rather than a crude average (or mean). To see the difference, imagine a football team where one player is earning one million pounds per week and the other ten earn one hundred pounds. The average salary is 91 THOUSAND pounds per week whereas the median income is only one hundred pounds PER WEEK. If the pay of the star player is DOUBLED then average income ALMOST doubles while median income REMAINS THE SAME.

By optimising median income we optimise the distribution such that everyone can be maximally economically active. The importance of using the median measure is discussed on Jonathan Andreas’ medianism blog.

If political-economy is to be of any use, it should not just try to understand the world but also try to improve it. Progress implies that something should be optimised. The GDP money-metric is a crude goal for life, better to maximise median disposable income, first by addressing the optimal distribution and second by provision of universal basic services (health, education, housing, and transport). By switching away from GDP to median disposable income we get closer to maximising freedom, and that matters.

 

[1] Lecture on Electrical units of measurement, May 3, 1883. Popular Lectures vol. 1, p. 73

 

 

3 Comments

  1. The answer to the rhetorical question is the market system. Granted, perhaps 1/5th of the UK public are in receipt of a means-tested benefit, so we give them money and let them decide what best to do with it.
    The author is explicit at the end of his piece that basics should not be provided in this way, and it must be State provision. This is more akin to communism than social democracy – no thanks.

    • A means-tested benefit is also a State provision. The NHS is a State provision. Key is to recognise where markets fail. Market’s works well for private goods but not so well for public goods. Hayek also advocated that basics should be provided by the State: The Road to Serfdom, p. 66. see e.g. https://mises.org/library/road-serfdom-0

      We are both interested in freedom maximisation.

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