The Theory Of Measurement In Economic Statistics

When I took a class in the theories of tests and measurements for my degrees in Psychology I still remember the two main premises for a measure.  Is the measure valid and is it reliable.  That is, does the test measure what it purports to measure and is the use of that measure consistent in the results of each measure.  If I want to measure the length of a piece of wood or steel, a linear measurement, then I could use a wooden yard stick that had been marked in feet, inches, and eights of an inch designations.  Unfortunately wood has a tendency to shrink and swell according to the amount of humidity in the air and so my measurement may be off by as much as an eight of an inch.  If I want exact measurement, indeed, if I have to have an exactness that is within the length of an atom, then wood is not the best material to use.  But a yardstick does measure a linear measure according to its reliability.  Or as we use to say, it’s good enough for government work.

So how does one measure an economy or any economic activity, for that part?  Kenyans came up with a new field of study in his examination of economics, the measurement of economies.  There have always been attempts to try and figure out the outputs of manufacturing and farming but most of that was far more haphazard in its collection of data.  When Hoover was Secretary of  Commerce he introduced regulations to collect more precise data on business activities and consumer spending.  Hoover was an engineer and demanded national standards.  Prior to his term in office there were no standard men, women, or children clothing sizes.  He was a standards maniac by most accounts.  A barrel was determined to be 55 gallons and its size included the air gap for expansion due to heat.  We have the Bureau of National Labor Statistics that reports on such metrics and unemployment and the various types of unemployment as well as the various types of employment.  An if you have ever received a business license (all it takes is paying the local city or county a fee for the privilege of conducting your own business, go figure) you are required to submit quarterly reports about your business even if you aren’t doing any business.  But where you might use standard accounting such as GAAP, economic accounting uses what is referred to a s social accounting, not quite so rigorous a standard.  These entities that make up national accounts are usually items that are grouped together in aggregate accounts.  And example is that the production of all automobiles, light duty trucks, heavy duty trucks, buses, semi-tractors and trailers, railroads cars, railroad locomotives, and all aircraft, could be lumped together in the category of transportation manufacture.  Some of these items within the aggregate category might have declined in output while a few others may have increased.  The error induced leads to wrong assumptions as to the health of a nation’s economy.

The U.S. Commerce Department’s Bureau of Economic Analysis is responsible for reporting GDP, that is, Gross Domestic Product, which differs from Gross National Product.  The GDP number includes the adjustments of exports minus imports data.  We could use the OECD Production Approach as shown below:

  1. Estimate the gross value of domestic output out of the many various economic activities;
  2. Determine the intermediate consumption, i.e., the cost of material, supplies and services used to produce final goods or services.
  3. Deduct intermediate consumption from gross value to obtain the gross value added.

Gross value added = gross value of output – value of intermediate consumption.

A second method is the Income Approach, a bit complicated to list all the steps here but here is one formula:

GDP = R + I + P + SA + W

where R : rents
I : interests
P : profits
SA : statistical adjustments (corporate income taxes, dividends, undistributed corporate profits)

Expenditure approach

The third way to estimate GDP is to calculate the sum of the final uses of goods and services (all uses except intermediate consumption) measured in purchasers’ prices.[2]

Components of GDP by expenditure

Components of U.S. GDP

GDP (Y) is the sum of consumption (C), investment (I), government spending (G) and net exports (X – M).

Y = C + I + G + (X − M)

This third approach is the one most commonly taught in beginning economic courses and would seem appropriate except for one item, that is government spending.  If we add in government spending to gross domestic product then we can see that excessive government spending inflates GDP, particularly if that spending is accomplished through deficit spending or government borrowing.  This ought to raise a red flag to anyone who considers Modern Monetary Theory valid.  If government spending through increase in government debt, ah, that’s right, under MMT the government can print more money, it doesn’t need to borrow from anyone, then business and consumer consumption will be constrained.  That is, there will be competition for resources.  Even if the government spending is aimed at giving those whose income is far below a level deemed to be necessary, that extra money being handed out will compete for the very goods the other consumers will need and or want.  This will produce inflation.  On the other hand, assuming MMT is wrong, then the government borrowing needed to achieve transfer payments to the poor will compete with business investment and still produce inflation for the consumer price index.

The question is whether when we include government spending are we truly measuring the domestic output and what affect does government spending have on that output?  Just as spending on military projects such as new warships, battle tanks, and aircraft has the benefit of employing more skill labor and management, it also increases the number of staff in the services to oversee these programs and increases the size of the  bureaucracy in the government.  The Department of Defense must increase but must the other government departments.  Then there are the increases in the size of the state and local governments as new plants are built, roads added and rail lines extended, power plants increased or new ones built.  The list goes on.  Yes, employment is provided by all, but at what cost?  It all must be paid for through tax money.  The local streets, roads, highways, transportation improvements such as rail overpasses and underpasses, and extensions of sewer lines, water lines, sewage treatment, and so forth.  We have not even gotten to the issue of schools and housing that must be added.  Everything comes at a cost and it is paid for through tax revenues and use permits and fees.  This is not a zero sum game, but the burden falls heavily on the tax or rate payer. So, when the President tells us that GDP has risen and all is well in America, the first question should be, “How much did government spending rise?”  The next question should be: “Just how much more did the government have to borrow to fund all this increase in spending?”

Next article we will take a look at unemployment statistics and the consumer price index.

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