Michael Mandel: Phantom GDP?

Michael Mandel reports that there may be problems with how GDP is calculated, though the magnitude of the problem is unknown. Here's the short version:

The Real Cost Of Offshoring, by Michael Mandel, BusinessWeek: Whenever critics of globalization complain about the loss of American jobs to low-cost countries such as China and India, supporters point to the powerful performance of the U.S. economy. ...

But new evidence suggests that shifting production overseas has inflicted worse damage on the U.S. economy than the numbers show. BusinessWeek has learned of a gaping flaw in the way statistics treat offshoring, with serious economic and political implications. ...

The short explanation is that the growth of domestic manufacturing has been substantially overstated in recent years. That means productivity gains and overall economic growth have been overstated as well. And that ... "helps explain why wage growth for most American workers has been weak," says Susan N. Houseman, an economist at the W.E. Upjohn Institute for Employment Research who identifies the distorting effects of offshoring in a soon-to-be-published paper.

The underlying problem is located in an obscure statistic: the import price data published monthly by the Bureau of Labor Statistics (BLS). Because of it, many of the cost cuts and product innovations being made overseas by global companies and foreign suppliers aren't being counted properly. ... (For a detailed explanation of how import price data are calculated and why the methodology is suspect, see [here].)

The result? ...[O]ffshoring to low-cost countries is ... creating "phantom GDP"--reported gains in GDP that don't correspond to any actual domestic production. The only question is the magnitude... "There's something real here, but we don't know how much," says J. Steven Landefeld, director of the Bureau of Economic Analysis (BEA)... Adds Matthew J. Slaughter, an economist at ... Dartmouth College who until last February was on President George W. Bush's Council of Economic Advisers: "There are potentially big implications. I worry about how pervasive this is." ...

[P]hantom GDP can be created by the introduction of innovative new imported products or by the offshoring of research and development, design, and services as well--and there aren't enough data in those areas to take a stab at a calculation. "As these [low-cost] countries move up the value chain, the problem becomes worse and worse," says Jerry A. Hausman, ... at Massachusetts Institute of Technology. "You've put your finger on a real problem." ...

[T]he new numbers also require a reassessment of productivity and wages that could add fire to the national debate over the true performance of the economy in President Bush's second term. ...

More broadly, it becomes clear that "gains from trade are being measured instead of productivity," according to Robert C. Feenstra, an economist at the University of California at Davis... "This has been missed." ...

Phantom GDP helps explain why U.S. workers aren't benefiting more as their companies grow ever more efficient. The cost savings that companies are reaping "don't represent increased productivity of American workers producing goods and services in the U.S.," says Houseman. In contrast, compensation of senior executives is typically tied to profits, which have soared alongside offshoring. ...

The effects of phantom GDP seem to be mostly concentrated in the past three years, when offshoring has accelerated. ... The one area where phantom GDP may have made an earlier appearance is information technology. ... "At least a portion of the productivity improvement in the late 1990s ought to be attributed to falling import prices," says Feenstra of UC Davis, who along with Slaughter and two other co-authors has been examining this question. ...

Comments

[Outside the Box]

The fact that half the profits on the S&P now come from overseas, up from 1/3 in 2002 show that overseas production is the part that is growing. US workers can't compete on the international market due to the high domestic cost of living. We have to create a more efficient society as a nation in order to compete. Inefficient sectors like health care are placing an unsustainable load on the backs of US workers.

US workers can only get a share of products/services they actually produce, and not even US companies want to invest here under current circumstances. Good article. A wake up call.

[spencer]

What he wrote about how import prices enter into the calculations has to about one of the stupidest pieces of economic reporting I have ever seen.l

In round one the imported table was more expensive then the domestic table. So when the price of the imported table falls below the price of the domestic table and displaces it the calculation will actually show that the price of the imported good has actually fallen more then the price of the domestic good. So according to his own example the data will actually overstate the fall in prices.

example.
..........domestic....imported
time 1.... $100.......$125
time 2.... $100........$90

%............0.........-28%

so the import price index will show a 28% drop.

While the price the consumer pays goes from
$100 to $90, or a 10% drop. this is what the CPI or the gdp deflator will show

[spencer]

To follow up, the above showed what the cpi would report and what would happed to real consumption.

But what would happen to gdp is very different.

In time 1 a million tables are produced domestically.
So that is what gdp would show.

In time 2 zero tables are produced domestically and
a million or imported.

Remember, gdp measures output or production, not consumption. But what we do is measure consumption
and adjust that for imports and inventories to indirectly measure output. Many people do not understand this and make all types of errors because of this.

So in time 1 gdp would show the value of the million
tables produced.

but in time 2 zero tables or produced so that is what gdp would show. But consumption records the million tables that are imported. But to get to domestic output -- what gdp measures -- the million imported tables are subtracted from consumption to derive the number of tables produced domestically. In the real gdp accounts they would subtract the value of the imported tables from consumption to derive the number produced domestically.. In this case the number imported is the same as the number consumed so the result is to show that zero tables were produced domestically -- or gdp.

[save_the_rustbelt]

Gee, I'm a half-wit bookkeeper and I figured that something smelled years ago.

Come to the Rustbelt, see what freer trade is doing to the working class.

[cm]

OTB: Luckily, efficient corporate command and administration hierarchies, efficient legal maneuvering, and efficient executive compensation take some inefficiency off of workers' backs.

[robertdfeinman]

Is the GDP (or GNP) a useful measure? Somehow the assumption is that if economic activity is growing in the aggregate then this must be a good thing.

It would seem that using the GDP as a measure only insures that policies will be implemented that serve to make the GDP grow. What is really needed is a way to make society more successful. How success is measured is a good topic for debate. I would claim that success is making sure that everyone can live up to their potential while making sure that we leave the world in a good enough shape so that future generations have the same opportunities.

From this objective follows various social policies having to do with health, education and environmental protection. To me it seems that the wealthy autocrats that are currently running things have a different idea of success. Their's is that they should maintain their privileged status and that the rest of society should be provided just enough so that they can work to support this class and not rise up against it.

Most of them have yet to realize that one can't hide behind a wall as they did in South Africa when the health of the planet is at risk.

There have been many measures proposed as a replacement for the GDP, many of them factor in things like child mortality, life expectancy and other similar items. I know it's hard to quantify these items, but that doesn't mean the effort shouldn't be made.

[jamzo]

i would like to see a good treatment of how us tax policies promote or constrain us firems manufacturing in us vs manufacturing outside us

[dissent]

I worked in a major computer systems vendor from 85 to 97. I know a lot of people in that world and I'm aware of changes in the industry. I think what people don't realize re: offshore outsourcing is how thin and chaotic American companies who heavily rely on that now are. They burn through new American hires is 5 to 10 years, then push them out. The high profits as a result of low cost overseas labor have covered up many, many flaws, in management, execution, staff development, planning. I think all these areas have deteriorated, because low cost labor is where the profit margin is, and the companies are chasing that over a cliff, sacrificing much of what were their strengths. To name two specific companies: IBM and HP. Wow. You would not believe the deterioration.

[cm]

dissent: I would claim that offshoring is those companies' response to their problems, not the primary/initial cause of it. The companies you name in particular, like many other "dinosaurs", largely suffer from maturation of the industry, as their whole accounting and incentive models are based on perpetual growth. Growth can hide a lot of inefficiency.

As far as large segments of the computer/IT market are concerned, desktop/server machines are now a commodity, and much of purchasing is driven by maintenance of computing stock, i.e. replacement of old or broken hardware, not "new" demand. The same is to some extent true for business software.

[cm]

Likewise IT and computer related services.

Of course, "commodity" does not mean it is ready for offshoring to low labor cost regions, which is the common misconception. It just means a more or less stable state of the art, but it's still an art that has to be mastered by any new participant.

[Mike Mandel]

Just responding to spencer. The key point is that the table was not imported at time 1. Therefore the import price office of the BLS has no record of it. As a result, they assign to it, basically, the ongoing inflation rate of other imported goods.

[ilsm]

str,

You have usually been very informative.

I have wondered if the GDP is growing, how can it be (sustained) if we are selling 'assets' to buy things?

Why sell or borrow to grow consumption unless income is declining relative to consumption?

The US worker has not been gaining in terms of income.

Not sustainable, whether you look at GDP growth, productivity or the shady "dark matter" hypothesis to explain the way we can continue to "grow" consumption by borrowing from the world.

[Laurent GUERBY]

spencer, for the fun of it about GDP I wrote a while ago the following:

"""
The solution for GDP growth and the end of hunger

It's as easy as having one 100 USD banknote in the whole country.

How?

I asked an innocent question on Yahoo

http://answers.yahoo.com/question/index;_ylt=AjWwgnpZBZwjnCvl9H0O3GUTxgt.?qid=20070404120530AACIvMp

How to measure GDP in a simple setting?

Assume that the economy has two people Alice and Bob, and no tax. Alice has 100 dollars. Some day during the year she asks Bob a question and Bob asks for 100 dollars for the answer. Alice pays 100 dollars to Bob and Bob answers. Another day during the same year, Bob asks a question to Alice and Alice asks for 100 dollars to answer. Bob pays 100 dollars to Alice and Alice answers the question. No other economic event happen in the economy during the year. My question: what is the yearly GDP of this economy as would be measured by current standards?

Answer given:

Simply put $200
heres why
gdp is the total amount of all final goods and services produced in an economy each person produced $200
the second way to look at is by totaling all wages earned which is also $200

Which is $100 per person per year.

Now let's assume all people in our poor country play this game: ask your neighbour a question ("what time is it") and the price is $100, with no tax applied (a "free" economy). At the end of the day, the $100 banknote has been in the successive hands of all the people of the country and goes back to its original owner. $100 per people of GDP has been produced this day. Do it 365 days a year, you have a GDP of 365*$100 = $36500. For reference France per capita GDP is $27600.

So you just created a richer economy than France, and since you're rich, there's no longer any hunger problem.

Right?

France has also 72% of its GDP in the service activity. And remember that GDP as currently defined measures the speed of exchange of money.
"""

I'm still not sure that the GDP measure works as I describe here, do you confirm or is it wrong?

[save_the_rustbelt]

ilsm:

You are right, I think the benefits of increased trade are doing this:

1) 10% of Americans are getting very, very rich
2) 20% are doing ok
3) 70% are either staying even or declining

When the next recession hit it will be the 70% who suffer - again - for the sins of the politicians and the money changers.

[crack]

Laurent-

How about you take your two person economy and instead of asking a question you have Bob and Alice get married and divorced every day. Bob charges $100 for the marriage, Alice $100 for the divorce. Everyone is a winner!

[vorpal]

I can't believe it's taken this long for the economists to discover this.
I posted the following on Jan 24, 2006, on this obscure economics blog:
http://economistsview.typepad.com/economistsview/2006/01/why_is_us_produ.html#c13291441

vorpal says...

this one's easy.

Notice that "labor productivity" increases correlate strongly with drops in manufacturing employment.

God, I'm good.

[vorpal]

I also mentioned this on Dean Baker's blog.
http://blog.prospect.org/cgi-bin/mt/mt-comments.cgi?entry_id=16203

The productivity growth issue definitely deserves more examination and kudos to you for initiating the process.

[vorpal]

Finally, to beat a dead horse, this is what I said on Jan 12 2006, on this blog.

vorpal says...
If you look at the numbers, I think you'll see that the rapid rise in productivity in the late nineties corresponded with the massive loss of manufacturing jobs.

[im1dc]

Here is a copy of a post of mine on Gregory Mankiw's blog.

At long last a plausible explanation for how and why the Academic
Economists got Free Trade's benefits to America so wrong. The numbers they
have used to assert Free Trade is as great as Mother's Milk are phony, full
of holes and--GASP--phantom!

Ahemmm, I told ya so. The Data Aggregates that "mathed up" Economists are so
totally dependent upon blinded them to the fact that the Data Aggregates
were ginned up SWAG.

I was never fooled because I focused elsewhere--the real world.

When the 'Data' do not support/reflect the Real World, its the 'Data' that's
wrong every time and by extension therefore the Economists so-called "mathed
up" analyses.

COVER STORY From BusinessWeek

JUNE 18, 2007

The Real Cost Of Offshoring

By Michael Mandel

U.S. data show that moving jobs overseas hasn't hurt the economy. Here's why
those stats are wrong

BW link: http://tinyurl.com/2lvk53

[gordon]

For a description of another form of GDP distortion - "Pollyanna Creep" - see Williams' Shadow Government Statistics.

Williams says (in part): "Varied academic theories, often with strong political biases, have been used to alter the GDP model over the years, resulting in Pollyanna Creep, where changes made to the series invariably have had the effect of upping near-term economic growth. Whether the change was to deflate GDP using "chain-weighted" instead of "fixed-weighted" inflation measures, to capitalize rather than expense computer software purchases, or to smooth away the economic impact of the September 11th terrorist attacks, upside growth biases have been built into reported GDP with increasing regularity since the mid-1980s."

[Laurent GUERBY]

crack, yes that's another possibility :).

My point is that in a service based economy GDP meaning is quite fuzzy.

I've always had a very hard time getting specific everyday life scenario GDP accounting by economists who otherwise cite GDP in all their sentences.

My guess is that 99.999% of them have not the slightest idea on how GDP is measured nowadays.

[reason]

OTB...
sorry can't agree, countries don't compete in that sense, only firms do. Real exchange rate movements SHOULD adjust so that some sectors grow while others shrink but the economy stays at full employment. The trouble is today they don't.

Spencer...
agreed BUT ... I still can't help wondering as im1dc says whether importing more components from overseas could not have led to an overestimate of productivity gains (particularly where those components such as software support are not easy measured). The extent to which this can happen, does of course depend on market structure. Come the next recessions, the apparent productivity gains could vanish in price reductions. That is the problem in trying to measure real output when RELATIVE prices are changing greatly.

Laurent Guerby,
my favourite explaination of the modern economy is two neighbours who start by cutting their own grass and painting their own houses. One likes mowing more, the other painting so they decide to specialise and pay each other for the work. Then the government comes and asks for a cut. Meanwhile GDP is soaring.
Yes it really does work that way.
But none the less there will be some improvement - the questions you quoted were probably important, and the knowledge to answer them valuable and specialised. And the specialist mower and painter will be more productive and save by more efficient use of equipment. It is just the GDP figure wildly inflates the benefit. And don't let me get on to resource depletion, pollution, commuting time, or instrumental equipment.

But there is an unmeasured benefit as well. They both spend more time doing jobs they like.

Jamzo...
I've been saying this for a while but nobody listens. If you have two imaginary "free-trading" countries, one with just VAT and one with just income tax, each raising 25% tax, then the country with VAT will have a more expensive currency. The reason is VAT taxes imports but not exports and income tax taxes exports but not imports.

Theoretically, exchange rate movements should nullify the advantage - but just compare the PPP Euro to the PPP dollar. Foreign exchange is a fixed game, and where it isn't it is dominated by speculative flows.

[Kelly]

OK folks, we can all dislocate our shoulders patting ourselves on the back and showing how WE said it first, or commence griping 'till the end times, or we can work this thing.
I submit that we need to address this part of the article;

------------------------
By BusinessWeek's admittedly rough estimate, offshoring may have created about $66 billion in phantom GDP gains since 2003 (page 31). That would lower real GDP today by about half of 1%, which is substantial but not huge. But put another way, $66 billion would wipe out as much as 40% of the gains in manufacturing output over the same period.

It's important to emphasize the tenuousness of this calculation. In particular, it required BusinessWeek to make assumptions about the size of the cost savings from offshoring, information the government doesn't even collect.
----------------------------
Now those that REALLY care need to help get the facts. This kind of thing is explosive only if it can be used by politicians and policy people. But those defending the status quo will seize on this as proof there is no “there there”.

[Outside the Box]

reason...Real exchange rate movements SHOULD adjust so that some sectors grow while others shrink but the economy stays at full employment. The trouble is today they don't.

The fact that the real world doesn't play out as a particular theory predicts means that the theory may need some fine tuning.

Iowa and Texas trade with each other just fine using a common currency. Iowa dollar bills don't have to decrease in value relative to Texas dollars for efficiency enhancing trade to take place between the two states. We should similarly be able to trade with China using a common currency, and still benefit. Pegging the yuan to the dollar simply means that we are using the equivalent of a common currency to trade with, just like Texas and Iowa do.

What is distorting trade is that Americans borrow oceans of money, and Chinese save oceans of money. The equivalent of Iowa citizens making products, but not buying the products made in Iowa or Texas. Then Iowa loans money to Texas to buy goods made in Iowa. More employment for Iowa workers, less for Texans. At least temporarily.

The Fed can't manipulate Chinese citizens into buying US goods by manipulating US inflation rates. The fed can only convince US citizens to buy more stuff (save less) that way. Every Chinese good bought reduces an American made good bought if Chinese citizens don't buy expensive American goods in return. Constant US inflation prevents US workers from making goods cheap enough to entice Chinese consumers to buy them, so the Chinese just save their earnings. Many US workers can't even produce goods cheap enough to entice US consumers to buy them, so they buy Chinese goods instead.

Constant inflation is basically the Fed skimming off all efficiency gains from tech improvements, trade, etc... The gov gains, along with a few workers whose wages rise faster than inflation, but the majority loses. In effect, the gov pockets most gains from increased efficiency. If the gov uses the pocketed trade gains to benefit the common welfare, citizens can still gain. If the gov uses the pocketed trade gains to benefit special interest groups, then the average citizen will lose all benefit from trade or improvements in the production process.

[reason]

OTB...
There are other differences between intra-country and inter-country trade with fixed exchange rates.
1. Different rates of inflation (happens internally too, but is offset more easily by trade)
2. Freedom on movement of resources (especially labour)
3. Federal Government intervention to support "disadvantaged" regions or industries (agricultural subsidies, pork).

Notice also I said "real" exchange rates.

[Outside the Box]

Yes, that's true, especially the relative inflation rates. Central banks can't manipulate internal inflation rates, and still expect the international market to function as if it were free. Gov intervention often does not promote maximum efficiency, especially when special interest groups write the legislation. My example was an over simplification.