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. ...