Unintended Consequences: Some Problems with National Income Accounting
It is trivial to say that any cardinal number can be added to another to answer the question of “how many” or “how much” of something there is. The trick lies in teasing some relevance out of the resultant sum. The relevant tradeoff in constructing any aggregate is between the advantage of reduced complexity of a unique figure summarizing data and the disadvantage of the information lost from any individual figure within the set.
This realization was what Friedrich Hayek had in mind as he reviewed John Maynard Keynes’s 1930 Treatise on Money. Disappointed with the turn that he saw economics taking, Hayek lamented that “Mr. Keynes’ aggregates conceal the most fundamental mechanisms of change” (1931: 277).
There is an enduring appeal to macroeconomic theorizing. The urgency of the problem of 2.8 million unemployed Americans (5.8 percent of the workforce) seems to be a more important problem than, say, your neighbor losing his job. Likewise, the fact that Canadian per capita income was $52,000 in 2013 seems a more useful statistic than the salary of, e.g., Mike, from Canmore. Aggregates are appealing. They´re also dangerous when misapplied.
Although the misapplication of macro-aggregates is well-known, there is a deep-rooted commitment amongst the economics profession to accepting them at face value, cognizant of their limitations. In this vein, I’ve (2013) written about how the velocity of money commonly discussed is one such misapplication. The benefit of the equation of exchange is the simple relation between money and expenditures. What the common reckoning of money’s velocity loses sight of is that not all expenditures are paid for with money—purchases on current account and initial funding provided by fractional-reserve bank created money are two such examples. It’s not incorrect to say that velocity is the ratio between nominal expenditure (PY) and some monetary aggregate (M), but what this velocity means (if anything) is the key to understanding its implications.
The rate of unemployment provides a similar example. It may be that 5.8 percent of Americans who want a job don’t have one, but for any one individual there are only two relevant unemployment rates. You either have a job or don’t creating own-unemployment rates of either 0 or 100 percent.1 Instead of discussing an unemployment “rate”, perhaps we should be discussing the unfortunate phenomenon in terms of the rate of job finding, as I’ve suggested in Howden (2014). This, too, is an aggregate, though one that hits a little closer to home for any one unemployed individual.
It’s not that we need to rid ourselves of the baggage of macro-statistics completely. Rather, we need to 1) critically assess whether they are appropriate, if so, 2) for what role, and finally 3) whether they are consistent as a tool we can use to tell the story we want.
Consider the national income accounts. That gross domestic product is analogous with the aggregate income of an economy is something every first year economics student learns. GDP certainly appears to be important, even to those who think money doesn’t matter. The author of the textbook I use in my Principles class, Greg Mankiw, reconciles this paradox by noting that [a] a large GDP does in fact help us to lead a good life. GDP does not measure the health of our children, but nations with larger GDP can afford better health care for their children. GDP does not measure the quality of their education, but nations with larger GDP can afford better educational systems. GDP does not measure the beauty of our poetry, but nations with larger GDP can afford to teach more of their citizens to read and to enjoy poetry… In short, GDP does not directly measure those things that make life worthwhile, but it does measure our ability to obtain the inputs into a worthwhile life. (Mankiw and Taylor 2010: 485)
Incomes themselves and aggregate income in particular, are useful to the extent that they allow one to keep “score” of their monetary contribution to society. More to the point, they let you see how this contribution varies over time. Quite literally, they tell you when you are faced with a change of fortune.
Surely any objection to aggregates cannot be solely on the basis of losing sight of the trees for the forest. Businessmen score their success or failure over the previous year by aggregating sales and costs to determine net income. Even vulgar unit-based expressions, such as sales per customer, are useful. This usefulness is not in spite of, but because of the fact that no one customer will be the average. In a former life I found myself as a clerk in a clothing store. Total sales and profit concerned me little, but I could depend on the average customer to spend $x and earn me $y in commissions. I motivated myself accordingly.2
Aggregates are much more useful than the seeming ins
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