How serious is the influence of GDP information on the economy?

Faced with so many fundamental criticisms of GDP as a measure of social welfare, a recurrent response in debates with colleague economists has been not to worry too much about the shortcomings of GDP as the latter does not have much influence on the real economy. Such a response is of course entirely consistent with the lack of urgency shown in repairing, or in any other way overcoming, the shortcomings of the GDP. Many signs, however, indicate that GDP information has considerable influence on reality.

In the first place, one wonders why governments invest structurally in calculating and predicting GDP. This investment is shared by all countries, and since the GDP is standardized through the United Nations System of National Accounts, it allows for an international comparison of countries in GDP terms. All of this would represent a forthright waste of money if GDP information indeed had no impact on the economy at large.

A more obvious explanation is that many economic agents regard GDP information as an important input to their decision- making. This is certainly true for politicians and public servants – witness the common appearance of GDP information in governmental documents on performance and goals of the economy, or the broad concern arising when GDP growth figures turn out to be substandard. The importance of GDP information for firms, investors and citizens/consumers is illustrated by the media – television, radio, newspapers, financial and other magazines, and internet – informing us on a daily basis about the status of our national GDP, both over time and in comparison with other countries. To illustrate the widespread influence of GDP, note that a search on internet on July 7th 2008 for ‘‘GDP” delivered 44,700,000 hits (and ‘‘Gross domestic product” 4,970,000 more). This is, for example, more than five times the number of hits for ‘‘social welfare”, viz. 8,470,000.

One can identify more concrete indications of the influence of GDP information on economically-relevant decisions. Financial markets are sensitive to realizations and predictions of GDP growth, which if positive create optimism and if negative pessimism about the ‘‘economic climate”. Central banks generally formulate their interest policy on the basis of expectations about growth and inflation. Private companies regard GDP growth as an important element of the general investment climate. Even the confidence of consumers, which determines their purchasing behaviour, is influenced by expectations of GDP growth.

Politicians want to avoid low GDP growth rates because they fear negative voter responses. To some extent this is motivatedby the belief that insufficient growth will lead to economic instability characterized by much unemployment. If GDP does not grow according to hopes and expectations, politicians at both national and supranational levels become very nervous,

and will not relax until GDP retains its old growth pace. With the formation of the EU, GDP growth has become an even more explicit and important goal, witness the unconditional 3% growth objective of the Lisbon strategy. In addition, GDP growth allows for rising tax revenues, as a result of which public expenditures can increase – a nice prospect for politicians in power. All in all, there is no denying that public and private agents assign much importance to the national GDP indicator.

The influence of GDP information is easily underestimated, as it runs through multiple channels – government, politics, public officers, private businesses, financial markets, investors, consumers and international agencies such as the IMF and the OECD. Moreover, these channels reinforce each other. For example, when growth rates go down, the media and financial markets will focus all attention on it, and politicians will respond with appropriate measures, objectives and promises, which again will make headlines in the media, which in turn will influence expectations and therefore decisions on financial markets.

Over longer periods of time, the influence of GDP information is further established and reinforced as education at all levels, economic and financial research, and economic advisory councils of governments give much attention to GDP information.

The newspaper reader is influenced by the media, and the student of economics by her education, with the idea that GDP growth is relevant. The consequence is a large influence of GDP information on consumption, investment and policy decisions, with evident repercussions for economic structure and social conditions.

A recent indirect but important effect of GDP information relates to climate policy. Among the most influential climate policy studies are economic analyses in which the policy cost is expressed in terms of a reduced rate of GDP growth (an early study is Nordhaus, 1991; for an overview see Tol, 2008; and for a critical evaluation Söderholm, 2007). This type of research

has received much attention from policy makers, notably since it was widely diffused through reports of the IPCC (Intergov- ernmental Panel on Climate Change). In fact, in deciding to not ratify the Kyoto Protocol, the Bush administration referred to Nordhaus’ work as providing an important motivation.

Various other policy links can be observed. Especially in the United States, many commentators in public media and on the Internet try to justify tax cuts or a flat tax by arguing that these will boost GDP growth. Apart from the fact that this is not generally true (as it depends on many conditions), irony wants that GDP information is used to justify policies which will negatively affect income distribution, whose neglect (or implicit treatment) is an important reason for the GDP indicator being an invalid measure of well-being.

This is not the end of the story. Through pessimistic (optimistic) responses by individuals, firms, and governments to forecasts of a low (high) rate of GDP growth, GDP information creates a pro-cyclic effect. This resembles the way in which behaviour in financial markets is steered by perceptions, leading to herd behaviour which causes expectations to become true.

Likewise, a large number of individuals acting on the basis of publicly available GDP information can give rise to a considerable macroeconomic response. Beliefs and expectations become then reality, i.e. a ‘self-fulfilling prophecy’ is at stake. At best, the effect of GDP information may be reinforcing the cycle. The recent financial (credit) crisis clearly illustrates this.

Daily information in various news media about reduced GDP growth only serves to reinforce feelings of consumers, investors and others that things are going from bad to worse. The current financial crisis is illustrative of this phenomenon. We are overwhelmed by articles showing how little GDP growth the economy is expected to attain in the coming period. This creates a bleak atmosphere influencing expectations and through it behaviour of economic agents.

Unfortunately, rigorous empirical studies of the influence of GDP information on the economy are lacking. As economists study virtually everything, the reason must be that the topic does not seem to gather much interest. Anyway, readers who are not convinced by the arguments in this section and feel that GDP information does not have much impact on the economy at large should really be sympathetic to reducing the role played by GDP information in the public sphere, as it serves no purpose while its provision is costly.

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