GDP is Misleading

We economists have all been taught the Keynesian tautology that GDP = C + I + G + (X-M). I was thinking about this definition of the output of the economy wondering why we include G. After all, to have G is to have taken income from the private sector or to have borrowed in order to spend. At best, this G is another application of Bastiat’s broken window fallacy: G merely replaces what would have been done by the private sector. How can this increase output and standards of living? At worst, increased G reduces GDP relative to what would have occurred without it. The government multiplier effect has been estimated to be far below 1 so that each dollar taken from the private sector and spent by government does not provide a dollar of income but something much less than a dollar. In other words GDP is a misleading statistic. I have used it for 30 years as an indicator of standards of living, showing how rich the U.S. is relative to other nations, etc. I don’t know why it took until now for the lightbulb to come on.

Realizing that anything I discover or innovate is likely to have been discovered previously by someone else, I did a search on the internet and found some people calling for the use of a private sector GDP instead of GDP. This would be GDP less government expenditures. Another suggestion is to use something called a “structural” GDP. This would be GDP not financed by debt. So here is a comparison of these measures.








To provide an instructive illustration of the difference consider the period just after World War II when soldiers were coming home and the federal government was downsizing. In fact, the U.S. Government went from 43.6% of GDP to 11.6% in 1948. What happened? Measured by GDP, the nation had two short sharp recessions as the private sector figured out what to do with all the talent released from government employment, and real per capita GDP flat-lined. But, focusing on the private sector we get a totally different picture. From the peak of government expenditure in 1944 until 1952, the per capita real Structural GDP, the GDP that was not merely debt-financed consumption, soared by 87%; the Private Sector GDP, in per capita real terms, jumped by more than 90%.