AS A MEASURE OF PAST ECONOMIC ACTIVITY, THE GDP WORKS WELL

                         Roanoke Times
                 Copyright (c) 1995, Landmark Communications, Inc.

DATE: TUESDAY, February 23, 1993                   TAG: 9302230346
SECTION: EDITORIAL                    PAGE: A-8   EDITION: METRO 
SOURCE: JOHN ROUFAGALAS
DATELINE:                                 LENGTH: Long
AS A MEASURE OF PAST ECONOMIC ACTIVITY, THE GDP WORKS WELL
IN AN ARTICLE published in the Roanoke Times & World-News Feb. 10, Lawrence M. Parks, president of Systematic Asset Management Corporation (an investment-advising firm in New York) poses an important question: How can we measure the growth potential of an economy? Instead of giving a meaningful response to this question, however, he proceeds to present certain arguments against using the gross national product as a measure of growth potential. Parks' discussion of the intended uses of GNP is flawed in several important respects. As a teacher of economics, I feel that your readers are entitled to a correct, albeit more academic, explanation of the uses and misuses of GNP.
GNP does not measure growth possibilities and was never intended to. Instead, GNP, or its most recent counterpart, the gross domestic product, is designed to provide a periodic evaluation of the level of economic activity. As it is calculated at the end of the period, it measures what has happened, and not what will happen in the future.
Traditionally, governments have used either or both of the following methods in estimating the GDP. In one method, commonly referred to as the expenditure approach, the government adds up the total value of goods and services purchased by (1) households for final consumption; (2) expenditures by business owners such as raw material, labor services, research and development and new capital; (3) government purchases of goods and services; and (4) expenditures on American exports by our trading partners minus our purchases from other countries. All the above components are estimated using current prices, since current prices reflect how much buyers in the society are willing to pay for the goods and services they want.
Second, the government may compute GDP by adding together all the incomes of all the people in the economy. Thus, the GDP is the sum of all labor and interest income, rents and profits. Obviously, the two measures of GDP yield the same final number.
In his commentary about the weaknesses of GNP as a measure of economic activity, Parks falsely states that shutting down IBM's research and development, and the early retirement of the scientists and engineers it employs, would have no effect on GNP "because GNP does not include R&D." Such remarks by a respected financial adviser, entrusted with our confidence and monies, raise serious questions about the value of his advice. Had Parks taken his principles of economics a little more seriously, he would know that expenditures on R&D, including the salaries of engineers and scientists as well as related expenditures, are included in both measures of GNP as defined above. Thus, contrary to Parks' conjectures, early retiring of the IBM R&D work force and reassigning engineers and scientists to lower-wage occupations will reduce (not increase) earned income and the GNP.
In further comments about the shortcomings of GNP, Parks seems to suggest that the GNP should include the value of "many intermediate outputs that are part of the real economy . . . " Again, he is clearly mistaken. The value of these intermediate outputs is counted as investment expenditures or are reflected in the value of the final values of goods and services incorporated in the GNP. In addition, Parks proposes that the purchases of goods and services by government should be excluded from GNP because "government spending is really consumption and should not be included in any measure of the economy." Is he suggesting that government activities, including expenditures on infrastructure, communication, defense, postal services, etc., are non-activities, that they do not generate any benefits to society? Or is he really saying that the government sector is not as efficient as the private economy in the provision of goods and services?
GDP is a measure of past economic activity. It is also used to compare economic performance for different time periods and is occasionally used as an index of well-being in the economy. Its actual measurement presents some problems. For example, it does not include most nonmarket and illegal activities. It counts the value of the work (i.e., income) of a hired maid, but not the value of similar work done by unpaid family members. It does not include the value of the work of unreported nannies, drivers and babysitters, or the toil of drug dealers and pushers. When used as a welfare index and compared over time, GDP has even more serious problems.
First, it treats consumer durables as if they are used only during a single period, even though consumers derive welfare by using the services of the durable goods over several years.
Second, it measures the total output of the economy but not how it is distributed. Increasing disparities in the income distribution lead to welfare reductions that do not show up in the GDP number.
Third, GDP does not adjust for the reduction in welfare due to economic "bads," such as pollution, increased delays in traffic and so on.
Finally, GDP does not include an account for the quantity or quality of leisure time enjoyed by members of society.
Despite its shortcomings, the GDP performs remarkably well when used to do what it was designated for, i.e., to measure past economic activity.
Finally, how about a measure of future economic performance? If not the GDP, then what? Future economic performance depends on present activity through the investment component of the GDP. Technological advances are incorporated in the new equipment. Low interest rates make this new equipment cheaper and thus increase the overall capital and future economic capacity.
Another component of investment is expenditures on human capital. Recent research indicates that investing in human skills can be at times more productive than investing in machinery. We all know that a better-educated worker benefits not only his or her employer but also the society as a whole. This is a powerful argument in favor of societal subsidies to the educational system.
As many academic and business leaders have advocated, the major cause of the worsening relative position of the U.S. economy in the global arena may be partially the direct result of the falling of the American level of education. Greater public and private investment in the education of the American work force, workers and managers alike, may be the most potent factor in enhancing our international economic competitiveness.

John Roufagalas is associate professor of economics at Radford University.

by Archana Subramaniam by CNB