Monday, September 19, 2011

Deficit Adjusted GDP - An improvement to measuring economic health.

This is essentially a basic-intermediate economics post that hopes to fix distorted public policy discussions.

Gross Domestic Product (GDP) is the sum of all income during a year/quarter in a nation.  It is used as an economic benchmark for the health of nations. So it becomes a politicized tool of economic policy management: Calling on government to create economic activity and jobs.

The single most important simple fix to economic distortion and mismanagement would be to use a new benchmark:  Deficit Adjusted GDP (DAGDP).  This benchmark simply substracts from GDP, social (governments for every level) annual growth in public debt.

The key reason for this benchmark is that any $10T(rillion) economy (as measured by GDP) can become an $11T economy by incurring a $1T deficit/public debt increase.  To remain at $11T, the economy must maintain that $1T deficit/public debt increase each year.

Gross Public Debt Fiscal Years 1996 to 2013
$ billion
Gross Public Debt -total -delta
$ billion
growth in public debt

a - actual reported
e - out-year estimate in US fy12 budget
g - 'guesstimated' projection by
b - budgeted estimate in US fy12 budget

Deficit increases can be effective (or inneffective)  in growing the economy by more than the deficit amount through what is known as the multiplier effect.  This is dependent on the kind of deficit, the tax rate, the proportion of deficit funding that is saved, and the proportion that remains within the society.  A $1T tax cut given to the wealthiest who will not spend any of it will not increase GDP at all.  A $1T spending increase that will be entirely spent within the society on taxable activity, whose recipients in turn spend it all on taxable activity within the society will not only increase GDP far more than $1T (through the respending), but will increase tax revenue by the full $1T (through infinite respending that creates more economic activity that is eventually taxed as someone's profits).

Comment on above US chart and table: From 2002, US debt increase has been above 500B/year, and grown dramatically to over 1T/year since 2008. DAGDP for 2009 (12,117B) was below DAGDP for 2006 (12,733B). This doesn't mean that 2008/09 stimulus programs were a poor reaction (or smart), but rather that there would have been substantial more economic collapse without them. The econometric labelling of a depression is a 10% reduction in GDP. That was practically achieved in 2008 in DAGDP terms. Political economics can avoid every depression or recession label by simply sufficient skyrocketing deficit increases. The practical future policy basis for DAGDP in dealing with current unsustainable budget deficits is to achieve stable to slight (0%-2%) GDP growth while targeting smart deficit reduction initiatives. DAGDP growth of 4%-6% can be targetted and achieved even while traditional economic measures show relative stagnation. Without DAGDP as a benchmark policy tool, it is too easy for politicians to keep increasing unsustainable deficits (or download to state governments) in order to keep apparent (GDP) economic measures, and short term electability prospects.

Another general argument against even broad tax reductions is that it tends to not affect the "beer money" component of average disposable income much.  Average citizen tax reductions mean that they can afford more for gas/food/rent/healthcare, and this causes price inflation in those sectors which capture most of the disposable income increase that is created by the tax reductions, and so very little true (job creating) economic activity is created by tax reductions.

A focus on disposable income, and especially the truly discretionary part of disposable income, is the key to sustainable economic growth.  Just as important is the reduction of the necessity of saving through lower healthcare costs (ideally socialized) and the existence of social safety nets.  A purely market approach to healthcare could allow individuals to think that they can buy infinite life, but they need to save millions to cling to that hope.  Socialized healthcare even if some end of life treatments are deemed socially unaffordable, are highly economically stimulative because they allow individuals to consume instead of saving throughout their life.  If you eliminate social safety nets such as healthcare and old age pensions, then you reduce disposable income more than through equivalent progressive taxes because every individual is forced to save/insure for future expenses, and  the flat/regressive nature of the forced savings significantly reduces the proportion of society able to afford homes, vehicles, and other consumer goods.

While natural governance focuses on the only truly fair entitlement of basic income (citizen dividend-as-equal-share of social tax income), there can be obvious other entitlements (healthcare) that are a net benefit to society's welfare and economic health/growth.  Even with our relatively corrupt current governance models, benchmarking economic performance through DAGDP instead of GDP would ensure that sensible policies are discussed, and underline the destructiveness of war spending, and crony giveaways to the wealthiest.  In the US specifically, the Congressional Budget Office (CBO - relatively independent analyst of policy proposals) should adopt DAGDP to score policy.

A More comprehensive alternative to using GDP as an economic benchmark was initially discussed.  That different approach focuses on aggregate social wealth.