August 22, 2017 12:00PM

Confusing GDP with Economic Welfare

What links the solar eclipse, Brexit, female labor market decisions and the border adjustment tax? 

Discussion of all these issues seems to confuse or conflate measured economic activity (GDP) with general economic welfare.

Take the eclipse first. On 18th August, NBC News ran a story headlined “Solar Eclipse Will Cost America Almost $700 Million in Lost Productivity.” For starters this is a bizarre headline. Productivity is usually measured as output per worker‐​hour, so it is unclear why taking a break to watch the sun disappear would affect the amount you produce in the hours you do work.

Most likely the authors really meant total output, or GDP. Even then it is not clear that this need be true. Workers may have become more productive before or afterwards to compensate for their “time off.” They may also have worked longer in other periods to compensate for the break.

But let’s suppose workers all really did take the time off without any compensating effort or hours elsewhere, and as a result total output fell across the US. Would this matter and would it be “bad for the economy”?

The point of free markets is that they allow us as individuals and groups to make decisions to fulfill our own objectives. Clearly, many of us make decisions not to maximize our lifetime productivity or measured output, and thus do nor maximize GDP. Think of the lawyer who decides to change career and become a teacher, or those with marketable skills who decide to use their time for voluntary work or family life.

If in the process of making free decisions we decide to dedicate more time to activities that reflect our own preferences, then we are maximizing our own welfare. Though the measured economy may be marginally smaller as a result of the eclipse, the fact that many individuals decided it was worth their while to take time out to view suggests their lives were enriched by the experience.

The nature of free choice also gets downplayed in the debate about female labor force participation. Often we hear how much of an economic boost there would be if more women worked, or female productivity improved, and certainly this might boost measured GDP and even improve the public finances. But if decisions to spend a period out of the labor force, or else to pursue an occupation with more time for family‐​related activities, reflects personal preferences (for either sex), then allowing these free decisions raises economic welfare. It doesn’t “hurt the economy.”

Another example of this arose in the debate about the proposed border‐​adjustment tax. A new paper by Seth Benzell, Laurence Kotlikoff and Guillermo LaGarda modeled the effects of the Republican “Better Way” plan on taxation, and found a significant overall boost to the US capital stock, wages and GDP. Yet by 2100 they found that GDP would actually be lower. Bad news for the US economy, right? No, because (as the authors argue) this would be a reflection of higher wages leading to more people deciding to spend time on leisure. In economic welfare terms, they would still be better off.

Similar reasoning applies in other areas. Several UK economists criticized a report by the Economists for Free Trade group last week for adding the savings from not having to make net contributions to the EU budget to other growth benefits to obtain a total GDP boost. This critique was right as a matter of arithmetic – after all, a £ saving to taxpayers is not the same as the overall effect of that saving on the economy. But undoubtedly a reduction in the burden on UK taxpayers would increase their economic welfare, because they would be free to make more individual decisions about how to spend their money.

All this is not to say that GDP is not, in many cases, a good overall proxy for welfare. Bad policies can both curb reduce GDP and overall economic welfare. Of course, there are other known limitations to its use too including that it includes the production/​consumption of goods with negative externalities, leaves out illegal or domestic activity, and often cannot keep up with the improvements in quality of goods.

What the above examples show, however, is that we should be particularly wary when people start talking about how people’s free decisions “hurt the economy.” We value leisure and the ability to fulfill our own desires too.