Mismeasuring the Economy Jude Wanniski June 13, 1996

The reason Polyconomics has always paid so little attention to reports or forecasts of the Gross National Product (GNP) or Gross Domestic Product (GDP) is that early in my self-taught education in economics I learned that the accounting concepts on which these measures of the economy are based were hopelessly flawed. The reason is that the National Income Accounts established by Simon Kuznets in 1932 as a means of reckoning the path of the economy were designed at the very end of our national experience as a laissez faire economy. The federal government’s involvement in national commerce largely was a function of national defense, including veteran’s pensions, and the diplomatic corps. In the depression year of 1932, for example, GNP was $58 billion, the national debt was a third of that ($19.5 billion), revenues were $1.9 billion, outlays were $4.7 billion -- a mere 8% of GNP, as opposed to 21% today. Notice the deficit that year was $2.7 billion, which was 140% of revenues, compared to the current deficit that is closer to 10% of revenues. The accounting unit was a gold dollar defined at $20.67 per ounce, which means we would multiply all the above by 20 to get a clearer picture of then and now. 

As the New Deal brought the federal government increasingly into the management of the economy, distortions began to creep into the national income accounts. Roughly 20 years ago, Prof. Robert Mundell pointed out to me that when you marry your housekeeper, there is a decline in GNP in the national income accounts. When you divorce your housekeeper, GNP rises. GNP also rises when the government takes over a welfare role from a private charity or church. It rises when government houses your parents in a nursing home instead of you caring for them in your home. It rises when the tax law becomes more complicated, requiring the training of more lawyers and accountants. Instead of using gold as a deflator, which provides the most accurate picture of a unit of labor’s purchasing power, the national income accounts have their own GNP deflator, which minimizes the erosion of the dollar’s value in an inflation. When the great monetary inflation hit the U.S. economy following the breaking of the dollar/gold link in 1967-71, it threw all the private Generally Accepted Accounting Principles into chaos. The GAAP had been designed at the turn of the century, following the quarter century of monetary deflation that followed the 1873 Gold Standard Act -- which forced the dollar gold price back to $20.67 from levels twice that during the floating dollar of the Civil War’s “greenback” era. This led to hasty debates about the GAAP in the 1970s, specifically LIFO (last-in, first out) and FIFO (first-in, first-out) rules of inventory accounting. This, because the inflation caused punitive taxation of inventories under GAAP designed with a deflation bias. 

At the same time, the formalized floating of the dollar in 1973 sent the dollar/gold price soaring far beyond the fluctuations of the Civil War era. This meant the GNP deflator, which has a modestly distorting effect when the gold price is relatively stable, in recent years has had an enormously distorting effect as gold’s value has swung about wildly. In the 30 years since the end of 1965, the nominal value of publicly traded equity has risen to $5.73 trillion from $650 billion, for example. This is an 881% increase. The GNP deflator reduces the increase to 115%. If we convert this capital stock to ounces of gold, we get a much less happy story. The $650 billion converts to 18.6 billion oz. @ $35. The $5.73 trillion converts to 14.9 billion oz. @ $385. To correct for population, we divided by 194.3 million in 1965 and by 262.75 million today. We find the per capita value of publicly traded equity in 1965 at 95.5 gold ounces and at only 56.7 oz. today. By this method of measurement -- which eliminates most of the distortions of the national income accounts -- the value of the nation’s productive capital stock has not risen by 115% but is only 60% of what it was in 1965. 

This is what leads me to argue that the United States has been in recession for the last 30 years, with the exception of the 1982-88 Reagan years. It is what explains why it now takes two breadwinners to produce the same after-tax income as one did 30 years ago. It explains why the electorate is not happy with the economy even though President Clinton tells everyone how good they have it. It explains the anxiety of ordinary people who worry about their futures and that of their children. It explains the frustration with the two major political parties, which operate within the parameters of the national income accounts -- and inevitably wind up arguing over budget numbers that have little relevance in the measurement of the economy’s potential. It explains the bond market’s frustration with a Federal Reserve Board that tells us it uses these GNP measurements in determining how fast the economy can grow, when it should be concentrating solely on providing a stable unit of account -- which in itself would cause the economy to grow more rapidly in a good way. 

We note with dismay that Treasury Secretary Bob Rubin now opposes cutting tax rates on capital gains, on the grounds that the economy is growing about as fast as it can. He even cited the recent Wall Street Journal op-ed by Herbert Stein, who was President Nixon’s chief economic advisor, in support of his stand pat argument. Stein, now 79, argued that the Kennedy tax cuts of 1964 only worked in traditional Keynesian demand-stimulus fashion because the economy was then operating under its long-term potential, and that tax cuts now only would add to the deficit and cause a rise in interest rates. By our measure, of course, the economy was operating far closer to its potential in 1964 than it is today. The Journal page-one piece yesterday, reporting on the one million men who have dropped out of the work force because they have given up finding a job, should be added to the million men in prison who are basically the flotsam and jetsam of the 30-year recession. If only because he has for 50 years been trapped in the national income accounts, Stein has personally done more economic damage than any other Ph.D. economist who has worked inside the federal government. An arch-enemy of supply-siders, he was at hand for Nixon’s doubling of the capital gains tax in 1969 and the closing of the gold window in 1971. He remains a determined foe of capital gains tax cuts as a means of spurring entrepreneurial capitalism. In one of the ironies of history, Stein now has been hired as the chief economist of the Microsoft internet magazine. The publisher, Michael Kinsley, a graduate of the London School of Economics, has been the most ardent foe of capgains tax cuts in the news media. This leaves us to surmise that now that Bill Gates is secure at the top of the heap, he intends to pull up the ladder.

The nation’s total wealth, in publicly traded equity and debt -- stocks and bonds -- is almost exactly what it was 30 years ago, at 26 billion oz. of gold. In our supply-side model, alas, investment produces far more growth than savings, equity finance more growth than debt finance. The nation’s household balance sheet has had a negative shift in its debt/equity ratio, which can realistically be corrected only by increasing the amount of equity. This can best be accomplished by cutting the capital gains tax and by fixing the dollar/gold price, which would cause the economy to grow faster and at the same time cause the value of equity to rise faster than the value of debt. Bear in mind, though, that GNP need not rise all that rapidly for this to happen. As men remarry their housekeepers and as lawyers and accountants simply shift to useful production from useless production, the economy will be growing much faster than it will appear to the Beltway’s GNP bookkeepers.