DRI-247 for week of 10-12-14: Rhyming History in the Middle East

An Access Advertising EconBrief:

Rhyming History in the Middle East

The historian George Santayana is best known for the comment that “those who do not remember the past are condemned to repeat it.” Another commentator amended Santayana by noting that, while history does not repeat itself literally, “it does rhyme.” Anybody literate in world history can cock an ear to the sound of developments in the Middle East today and recognize the rhymes.

Pedagogy is the art of focused oversimplification. Movies are a painless way of teaching history because they focus our attention through dramatic depiction on a visual canvas. Two famous movies provide a narrative paradigm for our Middle East historical rhyme.

Khartoum: The Death of “Chinese” Gordon and the Fall of the Sudan to Islamic Fanaticism

The 1966 film Khartoumdepicts one of Great Britain’s most famous military debacles: the capture of the Sudan from Egypt by forces led by Muhammad Ahmad, the Islamic religious fanatic known as “the Mahdi” (the “chosen one”). At first blush, no association with Great Britain is visible here, since Sudan was a protectorate of Egypt and part of the Turkish Ottoman empire – Sudan, Egypt and Turkey were not a part of the British Commonwealth. But Great Britain had long exercised influence in the Middle East for various reasons, and that influence extended to the use of military force in the region. One of the most famous of all British soldiers, General Charles G. Gordon, was Governor General of the Sudan and led the defense of its capital of Khartoum at the time of the invasion. Gordon’s death may have been the worst public-relations disaster ever suffered by British arms.

(1)Gordon was a professional soldier-for-hire, having served the Empire of China in putting down the Taiping Rebellion during one of the famous Opium Wars in the early 1860s. His talents included not only skill as a military commander but also formidable engineering skills. He also served with distinction in India and the Congo. Prior to the Islamic revolt, Gordon had served a previous stint as Governor General in the Sudan, during which he had played a key role in suppressing the slave trade. This was the culmination in Great Britain’s century-long crusade against slavery. It was fitting that Gordon, world-renowned as an evangelical Christian (albeit non-denominational in his belief), should have delivered this coup de grace to the institution of slavery. It was Christianity, alone among the world’s great religions, which had spearheaded the fight against slavery across the globe.

According to the movie, Gordon returned to the Sudan in early 1884 at the request of British Prime Minister William Gladstone. Gladstone was responding to public pressure created when another British professional soldier, Col. William Hicks, led an ill-fated expeditionary force of 10,000 Egyptian soldiers against the forces of the Mahdi. The Islamic leader had organized an army in revolt against Egyptian and Turkish rule in the Sudan, urging his followers to kill Turks. The movie’s narrator blames Hicks for failing to grasp the “one essential feature of the [Sudanese] desert: its immensity. The Mahdi led him on and on.” At the opportune moment, the Mahdists attacked and annihilated Hicks and his forces. In fact, the incompetence and indifference of the Egyptian military was also a factor in its defeat.

Can we hear the rhyme? For over 60 years, the United States has intervened militarily in countries that it did not own or officially protect. These included Korea, Vietnam, Cuba, Grenada, the Dominican Republic, Panama, Kuwait, Iraq, Afghanistan and Pakistan. In none of these cases was war declared, yet U.S. military forces were deployed and saw action. In each large-scale conflict, local forces were under the command of U.S. officers. The ability and spirit of the natives were questioned and success hinged at least partially on their efforts. In essence, then, the United States today is playing a role directly analogous to that played by Great Britain in the 19th century.

(2)An outcry to “avenge Hicks” prompted Gladstone to review his options. Gladstone was a liberal in the 19th-century sense of the word. He believed in free international trade as a medium to encourage peace among nations. He knew full well that British investors had a financial stake in the region and that the Suez Canal was considered a vital strategic interest of Great Britain. But Gladstone was viscerally reluctant to use the military power of the British government to bail out private investors. In the movie’s most chillingly prescient moment, he utters the line: “Britain will not assume the obligation to police the world.”

Can we hear the rhyme? That line of movie dialogue reverberates in our ears today. Every policy discussion of every undeclared war involving us has raised the specter of the U.S. as “world policeman.” In 1884, there was no concept of international law and no international agency with the mission of enforcing it, let alone a mandate to deter or punish international aggression. After World War II, though, the World Court and the United Nations existed. Yet the U.S. still found itself intervening in conflict after conflict and maintaining a military presence in most of the countries of the world. To be sure, this is a function of the ineffectual, corrupt status of the U.N. and the dubious legitimacy of “international law” in the realm of national aggression. Even so, no thoughtful American can watch Khartoumwithout shuddering at this point.

(3)The movie Gladstone escapes his dilemma, at least temporarily. The British public is clamoring for Gordon to be sent back to the Sudan, the scene of one of his greatest triumphs. Queen Victoria herself supports this plan. (The Egyptians welcome the return of Gordon, whom they regard reverentially as a potential savior.) Gladstone’s advisor, Foreign Secretary Granville, suggests that Gordon be sent to the Sudan but put on a tight leash, with orders only to evacuate British and European military and civilian personnel. Gladstone objects that Gordon, notorious for keeping his own counsel, will exceed his orders and do his best to “embroil the government” in war. Another advisor, army officer J.D.H. Stewart, interjects that if Gordon were sent to the Sudan without powers or army, he could not hope to stand up to the Mahdi. “He would simply fail.” At which point, Granville ripostes, “What a pity.” Gladstone understands that Granville is implying that Gordon be set up to fail as a scapegoat for an administration that is unwilling to take responsibility for employing the necessary military force.

Can we hear the rhyme? Once again, the reverberations from this exchange are painful to our modern ears. In Korea, the U.N. – but acting as a token front for a venture under U.S. leadership and predominantly staffed by U.S. forces – began by prosecuting a so-called “police action” rather than a full-fledged war. What was the result of this moderate, carefully calibrated, half-hearted military action? The U.N. forces came within an eyelash of being pushed off the Korean peninsula by North Korean forces (aided by Chinese and Russian advisors and materiel). Only when the U.S. dropped all pretense of fighting a police action and began to fight a war of annihilation against North Korea did our forces turn the tide of battle, first against North Korea and later against the combined North Korean and Chinese forces.

Later in Vietnam, this scenario repeated itself. The U.S. began by sending military advisors under the Eisenhower and Kennedy administrations. This half-measure proved inadequate against a North Vietnam aided by China and the Soviet Union, so the Johnson administration began a policy of gradual escalation of hostilities. Bombing of Viet Cong sanctuaries and, later, North Vietnam itself were a key part of this strategy. But only when U.S. forces annihilated the Viet Cong in South Vietnam during the Tet Offensive did we emerge militarily victorious. We were victorious in the sense that the Viet Cong were eliminated and North Korean forces were evicted from the South. But just as Gordon’s first victory in the Sudan did not prove decisive, so did our military victory in Vietnam not prove lasting. Our support was withdrawn from South Vietnam while Communist support was maintained in the North, and South Vietnam could not stand on its own against the subsequent North Vietnamese invasion.

In Kuwait, our military victory was swift and decisive, since the volunteer U.S. army was far superior to any other military force in the world. But rather than eliminate the enemy, we stopped short of proceeding to Baghdad and deposing Saddam Hussein.

In the Iraq invasion of 2003, the initial military effort was once again irresistibly successful. But subsequent terrorist activities, based in surrounding nations, were treated using police tactics rather than full-fledged, rapid military force. Only when a change in leadership produced a “surge” in military force did the U.S. succeed in retaking its lost ground, much as it had in Korea and Vietnam earlier. Then the U.S. withdrew its forces – and within a short time, the opposition had reformed and reasserted itself.

Now the U.S. has returned to the Middle East again – to fight Islamic fanaticism, again. We are proposing a moderate strategy of limited involvement, using bombing as a gradual step with the possibility of using ground troops later. Again.

We should note that the movie’s conference between Gladstone and his advisors was a dramatic invention by Khartoum‘s screenwriter Robert Ardrey. (Ardrey was highly respected in Hollywood and received an Oscar nomination for this screenplay. He eventually left Hollywood to write best-selling books on anthropology [!].) Among the numerous complications left out of the movie is the army actually sent to Egypt prior to Gordon’s arrival. But the movie’s implication of vacillation and inconsistency in the Gladstone administration’s military actions is fully justified.

(4)Six months after the fall of Khartoum, the Mahdi himself died of typhus. He has provided a line of succession, however, and his successors continued to stir up trouble in the Sudan for years after his demise. This, coupled with the political furor caused by Gordon’s death and the abortive and futile military actions by the Gladstone administration, eventually motivated Great Britain to send another army to the Sudan. This one was commanded by an expert in desert warfare, General Kitchener, who had been a major serving in the Sudan during Gordon’s tenure. Kitchener’s forces destroyed the Mahdist army at the famous battle of Omdurman in 1898. Eventually, the Sudan attained independence from Egypt and freedom from the orbit of Great Britain.

Can we hear the rhyme? In Korea, moderation in the pursuit of war led to a stalemate that has lasted for a half-century. In Vietnam, it led to a Communist victory after American military victory. In Iraq, it left Saddam Hussein free to create havoc and necessitate our eventual return to Iraq – an outcome analogous to the British return to the Sudan. And now the U.S. has returned to the Middle East again to fight the same old aggressor – Islamic fanaticism – with a new name.

Douglas MacArthur said “In war, there is no substitute for victory.” Victory consists of complete subjugation of the enemy by the destruction of its means to fight and the surrender of its political authority. The attainment of these objectives requires a declaration of war and prosecution of war with a single-minded and wholehearted devotion to those ends. The U.S. has abandoned both of these principles, much as did Great Britain in the 19th and 20th centuries.  

 

(5)When Gordon arrived in the Middle East, his first move was to fortify his position by enlisting allies among local governments. The movie shows him visiting a neighboring sultan and former slaver named “Zobeir Pasha.” Gordon asks for aid against the Mahdi, whom Gordon depicts as a common enemy. This request is hindered by the fact that Gordon had ordered the execution of Zobeir Pasha’s son during his war against the slave trade. Sure enough, Gordon meets with a stony refusal. This movie interlude is a stand-in for various real-life efforts by Gordon to build a coalition against the Mahdi – efforts that enjoyed little success.

Can we hear the rhyme? In every major military conflict of the last 60 years, the U.S. has faced the task of recruiting local support. In most (but not all) cases, this has entailed appealing to local tribes and factions. In Vietnam, for example, the U.S. was able to recruit the Montagnards, mountain tribesmen who were bitter enemies of the Viet Cong dating back to the time when they were called the Viet Minh. Unfortunately, winning over the “hearts and minds” of the remaining South Vietnamese population was a tougher job that took most of the war to accomplish. Distinguishing between friendly or neutral South Vietnamese and hostile Viet Cong was one of the biggest day-to-day headaches plaguing U.S. troops. In Iraq, most of the publicity surrounding the Bush administration’s agonizing struggle against terrorist counterattacks has focused on tribal and ethnic feuds between Sunni, Shiites, Kurds and other sects and factions.

(6)The biggest set-piece scene in Khartoumand the movie’s dramatic highlight is the climactic battle scene, in which Mahdist forces invade the city and butcher the inhabitants. The death of Gordon himself is a memorable scene based on a famous painting by George Joy, entitled “Death of Gordon.” Gordon is shown descending the staircase from his office residence in the midst of the battle for the city. Such was the awe commanded by his presence among friend and foe alike that the battle stops dead for a few eerie seconds as the Mahdists pay the infidel devil his due by allowing him to descend a few steps unmolested. Then a soldier launches a spear into Gordon’s chest and the great soldier falls off the steps in perfect imitation of the painting. Acting in violation of the Mahdi’s personal injunction, his men behead Gordon and carry the head in triumph on a spear across the city. On Gordon’s lips, it was said, was an ironic smile.

Although the locale of Gordon’s death was apparently correct, the battle itself was another dramatic invention by Ardrey. A local official betrayed Gordon and the Egyptians by allowing the Mahdists nocturnal access to the city, vitiating the necessity of launching an assault. Estimates of the ensuing slaughter vary from a conservative 10,000 to a more expansive 30,000. Interestingly, the movie shifts the locus of local corruption to economics; the local official hoards grain and sells it on the outside. When his corruption is discovered, Gordon orders his execution.

Can we hear the rhyme? A recurring theme in U.S. military conflicts has been that the people on whose behalf we are ostensibly fighting reject our help or even line up against us. In Korea, the early-arriving troops on the Korean peninsula noted that North Korean troops could blend in with the local population so well that pursuit was especially frustrating. In Vietnam, numerous stories of GIs betrayed and booby-trapped by locals made American troops wary and trigger-happy in their interactions with the South Vietnamese. In Iraq, the kickoff of American intervention with the subjugation of the country created a climate of mistrust that lasted for the remainder of the U.S. occupation. This creates the anomalous picture of an American military purportedly serving a noble, altruistic cause but in practice having to convince the beneficiary or even browbeat him to fight off opposition. What accounts for this picture, let alone its repetition?

The common factor is rebellion or revolt against the established order. Great Britain in the 19th century and the U.S. in the 20th century found themselves defending the established order against change. In a rebellion, it is often difficult to tell friend from foe and one never knows when one may become the other. In the movie, there is a key scene when Gordon boldly infiltrates the Mahdi’s camp, accompanied only by his friend and servant, Khaleel. While there, he learns that the Mahdi’s intention is to attack Khartoum and massacre all opponents – indeed, to conquer the entire Ottoman Empire, massacre all Turkish opposition and create an Islamic empire on the world stage. This meeting never took place – it was inserted to bolster the movie’s position that Gladstone should have decisively intervened militarily in support of Gordon and against the Mahdi. In other words, the Mahdi was portrayed as more than just a local rebel. He was an international aggressor. Gordon knew this and was a hero for single-handedly resisting him and warning the world. Gladstone displayed political cowardice in ignoring this warning – or so the movie contends.

This same theme resounded throughout U.S. military interventions. In Korea and Vietnam, Communism was the international aggressor. There were certainly good grounds for adopting this stance, since modern Communist doctrine vacillated between the export of international revolution a la Lenin and the more cautious doctrine of “socialism in one country.” But even after the collapse of Communism at the close of the 20th century, the doctrine of international aggression was preserved as justification for military action.

The Practical Value of the Middle East Rhyme

To be useful, historical rhyme must not only present a discernible pattern. It must also point the way to a desirable plan of action. It is one thing to suggest that the U.S. has fallen victim to the same political temptations as did Great Britain before her, for largely the same reasons. Of what practical value is this knowledge?

Our analysis suggests that both Great Britain and the U.S. were trying to do what Las Vegas gamblers would call “making their point the hard way.” It is one thing to say “I find this state of affairs deplorable and I want to see it changed.” That does not make the statement “I will change it using the means I propose” necessarily correct. The next EconBrief will explore the reasons why both these great powers found it so excruciatingly difficult to effect change using military force. Not surprisingly, those reasons are economic. It is even less surprising that the better plan would be to deploy economic logic rather than boots on the ground. A recent op-ed by the noted Latin American economist and political advisor Hernando De Soto points the way.

DRI-315 for week of 4-20-14: Is GDP NDG in the Digital Age?

An Access Advertising EconBrief:

Is GDP NDG in the Digital Age?

For years, we have heard the story of stagnant American wages, of the supposed stasis in which the real incomes of the middle and lower class are locked while the rich get richer. Various sophisticated refutations of this hypothesis have appeared. Households have been getting smaller, so the fact that “household income” is falling reflects mainly the fact that fewer people are earning the income that comprise it. “Wages” do not include the (largely untaxed) benefits that have made up a steadily larger share of workers’ real incomes ever since World War II.

But there is something else going on, something more visceral than statistics that leads us

to reject this declinism. It is the evidence of our own senses, our eyes and ears. As we go about our daily lives, each of us and the people around us do not exhibit the symptoms of a people getting materially worse off as we go.

For over thirty years, we have been forsaking the old broadcast trinity of network television stations, at first in favor of cable television and recently for a broadening array of alternative media. For over twenty years, our work and home lives have been dominated by desktop computers that have revolutionized our working and personal lives. For over ten years, an amazing profusion of digital products have taken over the way we live. Cell phones, smart phones, tablets, pads and other space-age electronic wonders have shot us out of a consumer cannon into a new world.

Can it really, truly be that we are worse off than we were before all this happened? As the late John Wayne would say if he were here to witness this phenomenon: “Not hardly.”

The pace of this technological revolution has not only been too fast for most of us to stay abreast of it. It has left many of our 20th century institutions blinking in the dust and gasping for breath. Mainstream economic theory and national income accounting, in particular, are trying to gauge the impact of a 21st-century revolution using the logic and measurement tools they developed in the first half of the 20th century.

The Case Study of Music

Music was one of the great consumer success stories of the 20th century. Thomas Edison’s invention of the phonograph paved the way for the recording of everything from live artistic performances to studio recordings of musicians and singers to the use of recorded sound tracks for motion pictures. The recordings themselves were contained on physical media that ranged from metal discs to vinyl to plastic. At first, these “records” were sold to consumers and played on the phonographs. Sales were in the hundreds of millions. Artists included some of the century’s most visible and talented individuals. The monetary value of these sales grew into billions of dollars.

Since recordings were consumer goods rather than capital goods, sales of records were recorded in the national income and product accounts. Or rather, the value added in the final, or retail, transaction was included. The value-added style of accounting was developed with the inauguration of the accounts in the late 1930s and early 40s in order to do three things: (1) show activity at various stages of production, but (2) highlight the new production of consumption goods each year to reflect the fact that the end-in-view behind all economic activity is consumption (3) by including only the additional value created at each stage to avoid double-counting.

As the 20th century came to a close, however, record albums were replaced by small audio discs that could be played on more compact devices. And these were soon supplanted by computers – that is, the playing medium became a computer and the music itself was housed within a computer file rather than a substantial physical object. As technology advanced, in other words, the media grew smaller and less substantial. But the message itself was unaffected; indeed, it was even improved.

How do we know that the value people derive from music has not been adversely affected by this transition to digitization? In The Second Machine Age, authors Erik Brynjolfsson and Andrew McAfee consider the question at length. In terms of physical units, sales of music have fallen off the table. Just in the years 2004-2008, they fell from roughly 800 million units to less than 400 million units – a decline of over 50% in four years! And the total revenue from sales of music fell 40% from $12.3 billion to $7.4 billion over the same period. By the standards we usually apply to business, this sounds like an industry in freefall.

In this case, though, those standards are misleading. During that same time span, the total unit-volume of music purchased still grew when purchases of digitized music where factored in. And acquisitions of music free of charge by various means swelled the total much, much larger. One of the things economists are best at is analyzing non-traditional markets, which is why Joel Waldfogel of the University of Minnesota was able to infer that the quality of music available to consumers has actually increased in the digital era. Today, anybody with a smartphone can access some 20 million songs via services like Spotify and Rhapsody. For those of us who recall the days of LPs and phonograph needles, the transition to today has been dizzying.

But the economics of the digital age have driven prices through the floor. As Brynjolfsson and McAfee observe, it is the same process that has driven the newspaper business to the wall and its readers online; the same one that has driven classified-advertising from newspapers to Craigslist; the same one that impels us to share photos on Facebook rather than buying prints for friends and family. “Analog dollars,” they conclude, “are becoming digital pennies.”

This creates an unprecedented marketplace anomaly. Measured by the value it creates for human beings, which is how economists want to measure it, the music industry is booming. But measured in dollars’ worth of marketplace transactions, which is how economists are currently able to measure it, the music industry is declining rapidly.

GDP RIP?

If the music industry were a singularity, we might treat it as a mere curiosity. It is not, of course; the gap between price/quantity product and value created yawns wide across the spectrum of industry. “By now, the number of pages and digital text and images on the Web is estimated to exceed one trillion…children with smartphones today have access to more information in real time via the mobile web than the President of the United States had twenty years ago. [!] Wikipedia alone claims to have over fifty times as much information as Encyclopedia Britannica, the premier compilation of knowledge for most of the twentieth century.”

“…Bits are created at virtually zero cost and transmitted almost instantaneously worldwide. What’s more, a copy of a digital good is exactly identical to the original… Because they have zero price, these services are virtually invisible in the official statistics. They add value to the economy, but not dollars to GDP… When a business traveler calls home to talk to her children via Skype, that may add zero to GDP, but it’s hardly worthless. Even the wealthiest robber baron would have been unable to buy this service [in the 19th century]. How do we measure the benefits of free goods or services that were unavailable at any price in previous eras?”

This understates the case. As Brynjolfsson and McAfee acknowledge, most of the new digital services substitute for existing services whose sales contribute to GDP. Thus, the digital bonanza actually lowers measured GDP at the same time that our well-being rises. In economic jargon, the effect on GDP’s function as index of national welfare is perverse.

This leads many people, including these authors, to the conclusion that GDP is no longer an adequate measure of national output. If this is true, it makes our monthly, quarterly and annual preoccupations with the growth rate of GDP seem pretty silly. The government agency whose task is the compilation of economic statistics is the U.S. Bureau of Economic Analysis. Its definition of the economy’s “information sector” aggregates sales of software, publishing, movies, audio recordings, broadcasting, telecommunications, and data processing and information services. These sales account for about 4% of measured GDP today. Yet we are commonly understood to be chest-deep in a new “economy of information” that is replacing the economy of tangible goods and services. Either this perception or that 4% metric is wrong; the latter seems vastly more probable.

What’s more, the irrelevance of GDP increases by the nanosecond.

New Products

Of course, not all digital products and services are substitutes for existing counterparts. Some of them are genuinely new. If these are similarly hard to incorporate in GDP, the distortion may be only half as great as that described above. But the digital revolution has displayed a propensity for creating things that were unknown heretofore but that soon became necessary accoutrements of daily life.

Longtime macroeconomist and textbook author Robert Gordon estimated the value of new goods and services added but missed by GDP at about 0.4% of GDP. That may not sound like much, but since the long-term average annual rate of productivity growth is around 2%, it would mean that we are overlooking 20% of annual productivity.

GDP and Investment: The Bad News Gets Worse

GDP is failing because it neglects to measure the tremendous increases in consumption and well-being conferred by the digital age. But GDP also measures investment, or purports to. Are its failings on the consumption side mitigated by its performance with investment?

No, they are magnified. The production of digital goods and services is heavily dependent on intangible assets rather than the familiar plant and equipment that are the focus of traditional investment. Brynjolfsson and McAfee identify four categories of these intangibles: intellectual property, organizational capital, user-generated content and human capital. It comes as no surprise to find that the measurement of these assets largely eludes GDP as well.

Intellectual property encompasses any creation of the human mind to which legal ownership can be attached. Patents and copyrights form the backbone of this category. A great deal of spending on research and development (R&D) constitutes investment in intellectual property.

Yet R&D has long been recognized as almost impossible to accurately measure because only its cost is transparent, while the value (e.g., capital) it creates often escapes measurement.

Organizational capital is an even broader concept intended to capture the value inhering in brands, processes, techniques and conceptual structures owned by particular businesses. This category long predates the digital age but is idealized by companies like Apple, whose brand and unique corporate style complement its portfolio of intellectual property to create perhaps the world’s most productive company. Accountants have long sought to put a price tab on things like “good will” and “brand name.” We have observed that the transition to a computer-savvy work force has necessitated investment in procedures and processes far greater than the initial spending on the computer hardware and software – spending that doesn’t show up in the national income accounts as investment.

User-generated content is a true digital innovation. Facebook, Twitter, YouTube, Pinterest, Instagram, Yelp and countless other websites are largely created by their users. The value of this approach is both undeniable and subjective, as anybody who has every previewed a restaurant on Yelp or planned a vacation with TripAdvisor can testify. The feedback generated these sites provides an object lesson in the generation of information – the kind of information that economists had to assume that people already knew because we didn’t know how markets could make it available to them. Now we do.

Human capital was a concept invented and popularized by economists Theodore Schultz and Gary Becker decades before the Internet existed. The talents, skills and training that we receive make us better productive “machines,” which inspired the analogy with physical capital.

How important are these intangible assets in the modern economy? Nobody knows with certainty, but – as always – economists have made educated guesses. Brynjolfsson and McAfee estimate the value of organizational assets as some $2 trillion. The preeminent theorist of investment, Dale Jorgenson, estimated that human capital is worth 5-10 times as much as the stock of all physical capital in the U.S. Investment in R&D has been estimated at roughly 3% of GDP in recent decades.

The degree of distortion in GDP numbers – specifically in measures of productivity, which compares growth in inputs and output – is harder to gauge in this case than in the consumption example. Some intangible assets, like R&D and human capital, are longtime thorns in the sides of statisticians; their measurement has always been bad and may be no worse now than before. In some cases, the distortions in investment may offset those in consumption, so that the measure of productivity may be accurate even though the numerator and denominator of the ratio are inaccurate. But the elements most closely associated with the digital revolution, such as user-generated content, impart a huge downward bias to measured productivity in the national income accounts.

A New, Improved GDP?

Economists and other commentators have done a good job of diagnosing the havoc wreaked on GDP by the digital revolution. Alas, they have rested on those laurels. In the “solutions and policy proposals” section of their work, they have fallen back on the tried and trite. GDP was a sibling of macroeconomics; the economic logic underlying the two is the same, with the operative word being “lying.” Macroeconomists are loathe to repudiate their birthright, so their reflex is to cast about for ways to mend the measurement holes in GDP rather than abandon it as a bad job. Hence the rosy glow cast by Brynjolfsson and McAfee over nebulous concoctions like the “Social Progress Index” and the “Gallup-Healthways Well-Being Index.” As for the touted “Gross National Index” of Bhutan, the less said about this laughable fantasy (treated in a previous EconBrief), the better.

The authors cite the comments of Joseph Stiglitz, whom they call “Joe” to profit by the implied familiarity with a Nobel laureate: “…Changes in society and the economy may have heightened the problems at the same time that advances in economics and statistical techniques may have provided opportunities to improve our metrics.” The “improvements” don’t seem to have included the ability to stop the scandalous misuse of the concept of “statistical significance” that has plagued the profession for many decades.

In fact, GDP has been known to be a failure almost since inception. Introductory economics textbooks routinely inculcate students in the shortcomings of GDP as a “welfare index” by listing a roster of flaws that predate the digital age, the Internet and computers. It has ignored the value of household services (predominantly provided by women), ignored the value created by secondary transactions of all kinds of used goods, undervalued services and thrown up its figurative hands when confronted by non-market transactions of all kinds. Its continued use has been a grim tribute to Lord Kelvin’s dubious dictum that “science is measurement,” the implication being that measuring badly must be better than not measuring at all.

What’s more, the blame cannot be laid at the feet of economic theory. It is certainly true that the digital age has brought with it a veritable flood of “free” goods – seemingly in contradiction with Milton Friedman’s famous aphorism that “there is no such thing as a free lunch.” Hearken back to Brynjolfsson and McAfee’s words that “bits are created at virtually zero cost.” A fundamental principle – perhaps the fundamental principle – of neoclassical microeconomics is that price should equal marginal cost, so that the value placed on an additional unit of something by consumers should equal its (opportunity) cost of production. When marginal cost equals zero, there is nothing inherently perverse about a price approaching zero. No, the laws of economics have not been suspended on the Internet.

Careful comparison of the age-old flaws of GDP and its current failure to cope with the challenges posed by digital innovation reveal a common denominator. Both evince a neglect of real factors for lack of a monetary nexus. The source of this insistence upon monetary provenance is the Keynesian economic theory to which the national income accounts owe their origin. Keynesian theory dropped the classical theory of interest in favor of a superficial monetary theory of liquidity preference. That is now proving bogus, as witness the failure of Federal Reserve interest-rate policies since the 1960s. Keynesian theory gives spending the pride of place among economic activity and relegates saving and assets to a subordinate role. Indeed, the so-called “paradox of thrift” declares saving bad and spending good. No wonder, then, that the national income accounts fail to account for assets and capital formation in a satisfactory manner.

Instead of tinkering around the margins with new statistical techniques and gimmicks when they have not even mastered basic statistical inference, economists should instead rip out the rotting growth root and branch. Reform of macroeconomics and reform of the national income accounts go hand in hand.

End the Reign of GDP

The digital age has merely exposed the inherent flaws of GDP and widened its internal contradictions to the breaking point. It is time to dump it. The next measure of national output must avoid making the same mistakes as did the founders of the national income accounts nearly 80 years ago.

The next EconBrief will outline one new proposal for reform of the national income accounts and explain both its improvements and shortcomings.